IRS Releases New Guidance on the Employee Retention Credit
The employee retention credit (ERC) is a powerful tax incentive available to eligible employers that maintain payroll during certain eligible periods. The ERC was initially created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law March 27, 2020. The ERC was then expanded and extended on Dec. 27, 2020, by the Consolidated Appropriations Act, 2021 (CAA). (Details regarding eligibility and basic credit mechanics can be found here.)
While the ERC seems straightforward on the surface, there are hidden complexities and layers of nuance applicable to each situation that raise many questions. Guidance from the Internal Revenue Service (IRS) on these important unanswered questions is needed to fully implement the ERC program.
On Monday, March 1, the IRS issued Notice 2021-20, providing guidance regarding various aspects of claiming a retroactive ERC for 2020. However, the notice does not answer every question relative to the 2020 ERC nor does it provide guidance with respect to the ERC for 2021. The IRS stated that additional guidance will be released soon. The following are key aspects the notice does address.
Interaction With Paycheck Protection Program (PPP) Loans
PPP borrowers were previously prohibited from claiming ERC benefits for 2020. This limitation was retroactively repealed by the CAA. However, the same wages cannot be used for both ERC benefits and PPP loan forgiveness. There was significant uncertainty regarding how a PPP borrower calculates their ERC benefits in coordination with their PPP loan forgiveness application. Notice 2021-20 provides the first bit of guidance regarding the IRS’s positions on allocating wages between ERC and PPP loan forgiveness.
Notice 2021-20 states that wages reported on an eligible employer’s PPP loan forgiveness application up to (but not exceeding) the minimum amount of wages needed to support the amount of PPP loan forgiven cannot be used to claim ERC benefits. The notice further provides that other eligible expenses reported on the PPP loan forgiveness application can be considered in determining the minimum amount of wages needed to support the PPP loan forgiveness amount. This standard leads to the following considerations:
- Excess wages reported on the PPP loan forgiveness application can be used to claim ERC benefits despite such wages being reported on the application.
- Eligible expenses other than wages cannot be considered unless such expenses were reported on the PPP loan forgiveness application.
Despite the guidance provided by Notice 2021-20, employers must continue to carefully consider the interaction of ERC and PPP in order to maximize their overall benefit from the two programs. KSM will continue to monitor the possibility of amending PPP loan forgiveness applications to add eligible expenses that were omitted from the original application. However, there is no indication at this time that such amended applications will be permitted.
The “More Than Nominal” Standard
Employers that do not have a significant decline in gross receipts can qualify for the ERC if they have a full or partial suspension of operations due to a government order – but only if such full or partial suspension is more than a nominal portion of their business operations. Notice 2021-20 provides that a portion of an employer’s business operations will be deemed to constitute more than a nominal portion of its business operations if such portion is 10% or more of the business operations. The 10% threshold is measured by gross receipts or hours of service in the same calendar quarter in 2019.
Partial Suspension of Business Operations
Determining eligibility via a partial suspension of business operations due to a government order is one of the most uncertain aspects of the ERC. There are many fact patterns that will lead to uncertain conclusions, and careful analysis is needed. Notice 2021-20 provides guidelines and concepts to consider with respect to a partial suspension.
Employers may experience a partial suspension in the following circumstances:¹
- Critical suppliers are forced to suspend their operations due to government orders.
- Operating hours must be reduced due to government orders.
- Operations are subject to modifications due to a governmental order.²
- There are government orders requiring a partial suspension in at least one jurisdiction within which the business operates.
Employers may not experience a partial suspension in the following circumstances:
- Government orders require their customers to stay home or otherwise cause a reduction in demand for their products or services.
- There is a voluntary suspension of operations due to COVID-19.
- Business operations can continue remotely in a comparable manner.³
It is important to note that these are general guidelines provided by the notice. The facts and circumstance of each particular situation must be carefully considered in determining whether or not an employer has experienced a partial suspension for purposes of claiming ERC benefits. In this notice, the IRS simply provides a list of potential scenarios.
- Does not indicate that an equivalent component based on part-time employees needs to be included in the calculation of average 2019 full-time employees4
- Provides many important clarifications regarding the allocation of qualified health plan expenses when calculating total wages paid
- Confirms that tax-exempt organizations cannot reduce gross receipts from the sale of assets by any expenses of sale or cost basis in determining eligibility via a significant decline in gross receipts
- Introduces new substantiation requirements to maintain in order to substantiate ERC eligibility
- Reinforces the importance of considering aggregation rules in determining if multiple entities are to be treated as a single employer
We’re Here To Help
We will continue to monitor the evolution of the ERC program and keep you apprised of changes and updates to this and other COVID-19-related legislation. In the meantime, please reach out to your KSM advisor for help determining ERC eligibility, or complete this form.
¹ In all instances, the partial suspension must be due to a government order, and it must have a more than nominal impact on business operations.
² Notice 2021-20 provides factors that should be considered in determining if a modification has a more-than-nominal effect.
³ Notice 2021-20 provides factors that should be considered in determining if an employer is able to continue comparable operations with a remote workforce.
4 The Joint Committee on Taxation’s description of the CARES Act indicates that an equivalent component must be factored in to this calculation.
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