By Raffi Yousefian | Published 03/09/2021; Updated 04/07/2021 12:00:48 PM

The Employee Retention Credit (ERC), which was originally included in the CARES act has come a long way. We have followed it through good, bad, and the ugly until we decided it’s about time, this baby deserves a post of its own. Before Stimulus 4.0 passed in December 2020, the ERC wasn’t allowed for PPP recipients. That piece of legislation changed everything. It opened up the ERC to PPP borrowers and it drastically changed the calculation for the ERC beginning in January 2021. Therefore, we will refer to 2020 ERC and 2021 ERC as ERC 1 and ERC 2 respectively. Let’s take a look at each. 

ERC 1

Who is eligible? 

If a business (or nonprofit organization described under 501(c) of IRC and exempt from tax under 501(A)) is:

  • fully or partially suspended by government order due to COVID-19 during the calendar quarter; or
  • the employer’s gross receipts are below 50% of the comparable quarter in 2019 (once the employer’s gross receipts go above 80% of a comparable quarter in 2019, they no longer qualify after the end of that quarter);

and continues to pay its workers, then the business can receive a credit against the payroll taxes it pays on wages equal to 50% of qualified wages paid to each employee for that quarter. The amount of qualified wages for each employee across all quarters cannot exceed $10k. So basically, you can receive up to $5k back from the Federal government for each employee during each of the qualified quarters mentioned above.  

Employers can immediately see the benefit of this by reducing their required payroll tax deposits that have been withheld from employees wages. The employer will report their total qualified wages and the related health insurance costs for each quarter on their quarterly Form 941 beginning with Q2 2020 through Q4 2020. If the employer’s employment tax deposits are not sufficient to cover the credit, the employer may receive a refund from the IRS by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19. Employers will need to ask their payroll processor how they’re going to administer this process. Alternatively, an employer can submit amended quarterly 941x forms to claim a refund after the fact. 

What are qualified wages?

The business’s qualified wages depend on whether it has less than or more than 100 employees.

  • If < 100 employees, then the the credit is based on wages paid to all employees, regardless if they worked or not. If the employees worked full time and were paid for full time work, the employer still receives the credit. 
  • If > 100 employees, then the credit is allowed only for wages paid to employees who did not work during the calendar quarter.

Limitation

Finally, no double-dipping is allowed. If you take advantage of this credit, then you can’t use those wages to claim the sick and paid leave credit under the Families First Coronavirus Response Act, and vice versa. 

ERC 2

For 2021, the ERC has been extended through July 1, 2021, benefits have been expanded, and there are new requirements. 

Who is eligible? 

If a business (or nonprofit organization described under 501(c) of IRC and exempt from tax under 501(A)) is:

  • fully or partially suspended by government order due to COVID-19 during the calendar quarter; or
  • the employer’s gross receipts are below 80% (20% decline in sales) of the comparable quarter* in 2019 (once the employer’s gross receipts go above 80% of a comparable quarter in 2019, they no longer qualify after the end of that quarter);

*There’s a safe harbor that allows employers to use prior quarter gross receipts to determine eligibility. For example, if in Q1 2021 you don’t qualify, you can elect to compare Q4 2020 sales to Q4 2019 sales. Once you use this method, you’re not locked in, you can choose to use the “2019 vs 2021” method for the next quarter. 

*If a business did not exist at the beginning of the same quarter of 2019, the same quarter in 2020 is substituted.

and continues to pay its workers, then the business can receive a credit against the payroll taxes it pays on wages equal to 70% of qualified wages paid to each employee for that quarter. The amount of qualified wages for each employee across per quarter cannot exceed $10k. So basically, you can receive up to $7k back from the Federal government for each employee during each quarter mentioned above.  The maximum credit allowed per employee in 2021 is $14,000.

Employers can immediately see the benefit of this by receiving an advance of the credit. You heard that right. In the 2020 version of the ERC, employers saw the benefit of the credit by reducing their required payroll tax deposits that were withheld from employees’ wages and receiving a refund for the excess of the credit over payroll tax withholdings. Now, the employer will receive an advance of the credit then make up any difference when filing their quarterly payroll tax returns. Employers will need to ask their payroll processor how they’re going to administer this process. 

What are qualified wages?

The business’s qualified wages depend on whether it has less than or more than 100 employees.

  • If < 500 employees, then the credit is based on wages paid to all employees, regardless if they worked or not. If the employees worked full time and were paid for full-time work, the employer still receives the credit. 
  • If > 500 employees, then the credit is allowed only for wages paid to employees who did not work during the calendar quarter.

*health care costs are included in wages even if no wages are paid to the employee

Limitation

Finally, no double-dipping is allowed. If you take advantage of this credit, then you can’t use those wages to claim the sick and paid leave credit under the Families First Coronavirus Response Act, and vice versa. Payroll costs (as defined for PPP purposes) which include wages used to claim an ERC are NOT eligible to be forgiven as part of the PPP process. Therefore, a taxpayer may claim both the ERC and borrow a PPP loan, but they cannot do it on the SAME wages or health care costs. 

If a PPP loan borrower includes wages for PPP forgiveness rather than the ERC credit, and the PPP payroll costs are not forgiven, then these wages can be claimed for the ERC. 

The issue here is that by default wages are considered qualified for ERC, therefore a taxpayer has to elect out of counting these wages towards the ERC and choose to use them for PPP loan forgiveness instead. The election is done by simply not claiming the wages on the payroll tax return for the ERC. 

Application

In order to claim the employee retention tax credit, eligible employers report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns, Form 941, Employer’s Quarterly Federal Tax Return, beginning with the second quarter. The credit is taken against the employer’s share of social security tax but the excess is refundable under normal procedures. Eligible employers can also request an advance of the employee retention credit by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19 for an advance credit.

Strategy

PPP borrowers should determine whether they had any qualified wages for purposes of the ERC so they can determine whether those wages are better utilized as part of claiming an ERC or forgiven as part of the PPP. On the other hand, if payroll costs exceeded their PPP loan amounts, then this excess could be used towards claiming the ERC retroactively. 

We LOVE this article from Tony Nitti that demonstrates how the calculation for the 2021 ERC would work compared to the 2020 ERC.