ERC for Manufacturers: Dispelling the Myths
The Employee Retention Credit (ERC) is a refundable payroll tax credit that was enacted to assist businesses impacted by the COVID-19 pandemic. The ERC can provide significant refund opportunities to eligible employers. (Click here for an in-depth history of the ERC program.)
Unfortunately, several misconceptions have caused tax professionals and businesses alike to overlook the potential benefits for the manufacturing industry. Common myths include, “I still had a good year, so I don’t qualify for the ERC.” Or, “I have a PPP loan, so I’m ineligible for the ERC.” These myths can and should be dispelled as the ERC can significantly benefit manufacturers under the right circumstances.
What Is the ERC?
In short, the refundable credit amount is based on qualified wages paid to employees by eligible employers. For 2020, the credit amount is 50% of qualified wages and healthcare costs up to $10,000 per employee for the year. The credit amount was increased for 2021 to 70% of qualified wages and the $10,000 per employee wage limit applies per quarter rather than on a per year basis.
To demonstrate the potential benefit, let’s consider a small manufacturer with 20 employees that is eligible beginning in Q2 2020 and continues to qualify through Q2 2021. Each employee is paid $10,000 per quarter.
How Manufacturers Can Qualify for the ERC
There are two ways for manufacturers to qualify for ERC benefits for 2020 and 2021*:
- Significant decline in gross receipts: Manufacturing employers that suffer a significant decline in gross receipts are eligible for the entire quarter that qualifies. In 2020, a taxpayer is eligible for a quarter where its gross receipts are less than 50% of the same calendar quarter in 2019. In other words, the gross receipts dropped by more than 50%. The taxpayer continues to qualify in 2020 until the calendar quarter after its gross receipts exceed 80%.
In the below example, the taxpayer would qualify for Q2 and Q3 of 2020.
In 2021, the rules were modified so an employer only needs a 20% decline in gross receipts for a quarter in 2021 as compared to the same calendar quarter in 2019. The modified rules also include an election that allows an employer to qualify for a quarter in 2021 based on the prior quarter. This allows employers that have a 20% decline for one quarter in 2021 to automatically qualify for two quarters.
- Full or partial suspension of trade or business operations: Manufacturing employers whose business operations are either fully or partially suspended due to a governmental order qualify during the period in which business operations are restricted due to such government order. It is important to note that this is much broader than being “fully shutdown.” Examples include:
- The inability to produce goods or provide services due to supplier shutdowns. COVID-19 caused global supply chains with effects rippling throughout the United States and the rest of the world. If you were unable to operate a portion of your business due to supplier shutdown, you might be eligible.
- Mandatory cleaning that reduces the amount of operating time. You may qualify if you have historically run 24 hours a day, but due to governmental orders you had to go to two shifts or reduce shift lengths in order to implement cleaning procedures.
- There were limitations on employee capacity or social distancing that require unfavorable modifications to the operations.
Expenses That Qualify for ERC
Eligible expenses hinge on whether a manufacturer is a small or large employer. Small employers can include all eligible wages and health care costs paid during the eligible timeframe. Large employers, however, can only include amounts associated with time spent not working. The large employer threshold is 100 for 2020 and 500 for 2021. This headcount is based only on full-time employees and does not include equivalents.
Dispelling the Myths
Myth #1: I had a normal or even a good year in 2020 and 2021. How can I qualify?
- Actual operating results for the period do not factor into ERC eligibility. Many businesses found new ways to generate revenue even though a portion of their business was restricted or impacted. This does not disqualify you from the credit. The focus is on the portion of your business operations that were restricted and whether that was a significant portion of your business based on operations during 2019.
- In 2021, only a 20% decline in gross receipts is required. We have seen many clients with an otherwise “okay” year hit the 20% mark due to a one-time event in 2019 or other financial blip. Further, this test is based on your tax accounting method. For example, the timing of cash receipts can produce unexpected results for employers using the cash method of accounting.
Myth #2: I had a PPP loan. I am not eligible for the credit.
- When the credit was enacted, employers that received a PPP loan could not claim ERC benefits. However, this limitation was retroactively repealed. Now, employers can receive a PPP loan and claim ERC benefits, but they cannot count the same wages towards both PPP loan forgiveness and ERC credit calculations.
Myth #3: I had more than 100 employees (or more than 500 employees) and I didn’t pay anyone for not working.
- It is important to ensure that you have an accurate headcount. For ERC purposes, only employees who average more than 30 hours/week are counted. Excluding part time employees can make a very significant difference.
Myth #4: I analyzed my employee count, and I am confident I’m a large employer. I didn’t pay anyone for not working.
- If you continued to pay the employer portion of your furloughed employees’ benefits this could qualify. Also, if you had historically been paying someone to work 40 hours a week, but now they only work 20 hours, there may be an opportunity to treat a portion of their benefit costs as payment for not working.
Manufacturers should do the following to maximize their ERC potential.
- Consider whether you may qualify for the ERC before submitting your PPP forgiveness application. As noted above, you cannot use the same costs towards both ERC and PPP. While receiving a PPP loan does not disqualify you, how you complete your application could potentially limit the amount of ERC you can claim.
- Perform the gross receipts test for every calendar quarter in 2020 and 2021. This must be done using your tax accounting method and all members under common control must be aggregated.
- If you fail the gross receipts test, consider whether you may be fully or partially suspended. It is important to think about this broadly. Rather than think about whether you were “shutdown,” consider whether government restrictions impacted your business and what effects those restrictions had.
- Consider aggregation rules to determine if multiple entities must be considered when determining eligibility, full-time employees, qualified wages, and other ERC calculations.
We’re Here To Help
We will continue to monitor the evolution of the ERC program and will keep you apprised of changes and updates to this and other COVID-19-related legislation. Please reach out to your KSM advisor with questions, or complete this form.
*For employers that qualify as a Recovery Startup Business, there is a third route to qualifying for ERC benefits for Q3 and Q4 of 2021. Click here for more information.
The results are in from the 2020 Indiana Manufacturing Survey: COVID-19 Special Edition. Learn how Hoosier manufacturers are weathering the pandemic.