COVID-19 Relief Legislation Expands Employee Retention Credit
Update: This article has been updated with the latest guidance as of April 13.
The Consolidated Appropriations Act, 2021, signed into law Dec. 27, 2020, is an omnibus bill that includes an array of changes and updates to the prior COVID-19 relief legislation. One such update includes the expansion of the payroll tax credit known as the Employee Retention Credit (ERC).
Not only does the new legislation expand the number of employers eligible to claim ERC benefits, it also extends the credit to include the first two quarters of 2021 and, in some instances, increases the credit’s value for 2021.1
Coordination With Paycheck Protection Program
The ERC was initially created when the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law March 27, 2020. However, pursuant to the original CARES Act legislation, employers that received Paycheck Protection Program (PPP) loans were not eligible to claim ERC benefits. Thus, many employers that received PPP loans largely ignored eligibility requirements for the ERC.
The Consolidated Appropriations Act, 2021, retroactively repealed the restriction that prevented PPP borrowers from claiming ERC benefits. Thus, PPP borrowers that are otherwise eligible to claim ERC credits can retroactively claim these credits on qualified wages paid after March 12, 2020, by filing Form 941-X to amend the originally filed Form 941 for the appropriate quarter.
The legislation also prevents employers from using the same wages to calculate ERC credits and count towards PPP loan forgiveness. A careful analysis will be required to maximize ERC credits and achieve full PPP loan forgiveness. Payroll costs are often the easiest costs to identify when preparing and submitting PPP loan forgiveness applications. PPP borrowers that are also eligible for ERC credits may need to spend time identifying non-payroll costs to apply to PPP loan forgiveness in an effort reduce the amount of payroll costs needed for full forgiveness.
ERC: 2020 v. 2021
It is important to distinguish between the two different ERC time periods established by the Consolidated Appropriations Act, 2021. (We will refer to credits claimed from March 12, 2020, through Dec. 31, 2020, as 2020 ERC credits, and credits claimed from Jan. 1, 2021, through June 30, 2021, as 2021 ERC credits.) The new legislation retroactively allows PPP borrowers to claim ERC credits back to March 12, 2020, but it does not change the computational rules applicable to the 2020 ERC. The new legislation also allows PPP borrowers to claim the 2021 ERC, but it also makes significant changes to the computational rules applicable to the eligibility and calculation of 2021 ERC credits.
An in-depth look at the differences between 2020 ERC rules and 2021 ERC rules will follow, but for quick reference we have provided a chart to further illustrate the similarities and differences between the two time periods.
Eligibility for ERC credits is determined on a quarter-by-quarter basis. The quarter becomes an eligible quarter for employers that pass either the business suspension condition or the gross receipts condition.
Business Suspension Condition
An employer satisfies the business suspension condition for any period during which business operations were fully or partially suspended due to orders from an appropriate governmental authority relating to COVID-19. It is generally clear when business operations have been fully or partially suspended due to a government order. However, there can be uncertainty in determining instances where a partial suspension may qualify.
The IRS has provided guidance on their website via 94 FAQs. While the FAQs do not yet take into account the new legislation, many of the basic principles, including the business suspension condition, were not changed by the new legislation. Furthermore, the FAQs may not be relied upon as legal authority. Nonetheless, the FAQs contains 10 questions and answers that provide insight into the IRS’s current view of many key issues. For example, the FAQs provide the following basic principles with respect to the business suspension condition:
- A partial suspension of business operations might include a restaurant that is required to close in-door dining services or a health care provider that is required to suspend certain elective procedures even though other aspects of their business operations continued such as carry-out service or emergency procedures.
- An essential business that is allowed to remain open must have a “more than nominal portion” of its overall business operations impacted by a government order in order to constitute a partial suspension of business operations.
- An essential business may have a partial suspension if their business operations are impacted by suppliers that are impacted by a government order.
- A government order requiring businesses to reduce their normal operating hours can constitute a partial suspension of business operations.
- Businesses generally will not qualify due solely to a loss of customers.
- Businesses generally will not qualify if they are able to continue comparable operations by requiring their employees to telework.
It is important for businesses to examine any potential disruption in their business operations to determine if such disruption has a “more than nominal” impact and whether such disruption can be tied back to mandatory obligations imposed by a government order.
Gross Receipts Condition
The other eligibility condition is the gross receipts condition. This is a mechanical test that compares the current quarter’s gross receipts with the gross receipts from the same quarter in 2019. The gross receipts condition was also changed by the new legislation, for 2021 only, to allow for more employers to be eligible. Thus, the gross receipts test is different based on whether the quarter being tested is a quarter in 2020 versus a quarter in 2021. The gross receipts condition is satisfied as follows:
- 2020 ERC:
- Gross receipts for a quarter declined by more than 50% as compared to gross receipts during the same quarter in 2019.
- Employers remain eligible until the end of a quarter whereby gross receipts exceed 80% of gross receipts during the same quarter in 2019.
- 2021 ERC:
- Gross receipts for a quarter declined by more than 20% as compared to gross receipts during the same quarter in 2019.
- Employers can elect to use the prior quarter in order to qualify the quarter of 2021 being tested. For example, for Q1 2021 an employer can either test Q4 2020 against Q4 2019 or Q1 2021 against Q1 2019.
If an employer is an eligible employer because they have an eligible quarter, then the credit amount will be determined based on the amount of qualified wages paid during the eligible period. The eligible period is different based on which eligibility condition was satisfied. Qualified wages are limited to wages paid during the period business operations are fully or partially suspended if the business suspension condition is the basis for qualification. However, qualified wages can include wages paid during the entire quarter if the gross receipts condition is the basis for qualification. Thus, it is generally more beneficial to qualify pursuant to the gross receipts condition whenever possible unless business operations were fully or partially suspended during the entire quarter as well.
There is a significant limitation on what constitutes qualified wages based on an employer’s average number of full-time employees (FTE) during 2019. If an employer is at or under the FTE threshold, then all wages paid during the eligible period can constitute qualified wages. However, if an employer is over the FTE threshold, then only wages paid to employees for time they were not providing services during the eligible period can constitute qualified wages.
The FTE threshold is another area where the new legislation has expanded the usefulness and potential value of the ERC for 2021. The new legislation increases the FTE threshold from a 100-FTE threshold for the 2020 ERC to a 500-FTE threshold for the 2021 ERC. This can significantly expand the value of ERC credits for employers in the 101 to 500 range. Remember, the 500-FTE threshold applies to 2021 only, and it is based on the average number of full-time employees from 2019.
An employer that can establish an eligible quarter and determine the amount of qualified wages will be entitled to a credit equal to a percentage of such qualified wages. The new legislation has increased this percentage and expanded the definition of qualified wages for 2021. The credit amount for the two time periods is:
- 2020 ERC:
- 50% of qualified wages
- Qualified wages are limited to $10,000 per employee per year
- Maximum credit amount is $5,000 per employee for 2020
- 2021 ERC:
- 70% of qualified wages
- Qualified wages are limited to $10,000 per employee per quarter
- Maximum credit amount is $7,000 per employee per quarter of 2021
The additional value of the expanded credit amount for 2021 can be significant.
Employer A is an eligible employer for the five quarters that include the second, third, and fourth quarter of 2020 and the first and second quarters of 2021. Employer A pays Employee B $10,000 per quarter in wages that are otherwise qualified wages for each of the five eligible quarters. The credit allowed for 2020 is $5,000 on the $30,000 of wages paid to Employee B during the three eligible quarters in 2020 (i.e., 50% of $10,000 per employee per year). The credit allowed for 2021 is $14,000 on the $20,000 of wages paid to Employee B during the two eligible quarters in 2021 (i.e., 70% of $10,000 per employee per quarter). Thus, the 2021 credit amount is nearly three times more than the 2020 credit amount despite fewer eligible quarters in 2021 and fewer qualified wages paid in 2021.
- No Double Dipping – 2020 ERC: As discussed above, wages used to claim an ERC credit cannot count towards PPP loan forgiveness. Similarly, wages used to claim paid leave credits pursuant to the Families First Coronavirus Response Act or Section 45S Family and Medical Leave Act (FMLA) credits are excluded from the ERC calculation. Furthermore, no wages paid to an employee for which a work opportunity credit is allowed can count towards the ERC credit.
- No Double Dipping – 2021 ERC: The limitations related to PPP coordination, paid leave credits, and FMLA credits are the same, but for 2021, only the wages taken into account in determining the work opportunity credit are excluded from the ERC. Furthermore, wages taken into account in determining research credits are excluded from the ERC.
- Aggregation Rules: The applicable aggregation rules must be considered whenever there are businesses with common ownership. The aggregation rules can apply to parent-subsidiary relationships, brother-sister relationships, and affiliate service groups. Aggregating businesses together will impact determination of the business suspension condition, calculation of the gross receipts condition, and full-time employee counts.
- Advanced Claim of 2021 ERC: Employers with fewer than 500 FTEs can request advanced refunds of 2021 ERC credits based on 70% of the average quarterly wages paid in 2019. Employers will need to work closely with their payroll providers or internal payroll professionals regarding procedures for timely claiming ERC credits.
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1 The American Rescue Plan Act of 2021 (ARPA), signed into law on March 11, 2021, has extended the ERC to also include the third and fourth quarters of 2021.
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