The Employee Retention Credit: The Refundable Payroll Tax Credit Explained

January 22, 2021 The Doty Group

Katy Bardizian, CPA
Director of Accounting Services

New legislation from the Consolidated Appropriations Act, 2021 creates an opportunity for many businesses to take advantage of both Paycheck Protection Program (PPP) loans and the Employee Retention Credit (ERC).

Several changes specific to the ERC can provide an opportunity for additional relief for many businesses. The majority of the changes are effective January 1, 2021 and impact the first two quarters of the year.

The significant changes that affect small businesses include:

Extension of the ERC through June 30, 2021
Increased credit rate from 50% to 70% of qualified wages
Increased the limit on per-employee qualified wages from $10,000 for the year to $10,000 for each quarter
Reduced year-over-year gross receipts decline from 50% to 20% and
Created a safe harbor to allow employers to use prior-quarter gross receipts to determine eligibility

In addition, the legislation had a key retroactive change that employers who receive PPP loans may still qualify for the ERC retroactive to March 13, 2020.

Previously, businesses receiving a PPP loan during the first round of relief couldn’t take advantage of the ERC. However, with the new legislation, a business can take the ERC even if they received PPP funding and loan forgiveness as long as the payroll identified for the ERC was not paid out of PPP funds. As noted above, this change is retroactive to March 13, 2020.

Specifically, the bill allows eligible entities to claim the prior quarter’s credits from 2020 in the quarter in which the bill was signed: the fourth quarter of 2020.

The ERC is a fully refundable payroll tax credit for employers that, for 2020, is equal to 50% of qualified wages employers paid beginning March 13, 2020. Businesses are eligible if:

They were fully or partially suspended due to an order from a governmental authority limiting travel, business, and meetings during the quarter of payroll not paid out of PPP funds, or:
The business had a reduction in gross receipts of 50% or more during a calendar quarter compared to the same calendar quarter in 2019.

When the covered period for PPP loans was extended to 24 weeks, many business’ applications for debt forgiveness qualified for 100% forgiveness on payroll alone without considering the other eligible nonpayroll costs. However, those other costs now may play a significant role in receiving the ERC benefit. Analyzing the ratio of payroll and nonpayroll costs is a critical step. If sufficient nonpayroll costs are available, limiting payroll costs to the 60% threshold required for full forgiveness may allow the remaining payroll to be eligible for the ERC-provided relief.

The IRS is expected to release guidance on how to implement these provisions, however, this is still a planning opportunity to be discussed with your advisors while the fourth quarter of 2020 is being finalized.

Below is a summary of key provisions of the credit, comparing the original and new law.

CARES Act

Consolidated Appropriations Act, 2021

Time Period Credit is Available

Qualified wages paid after March 12, 2020, and before January 1, 2021.

Qualified wages paid after March 12, 2020, and before July 1, 2021 (now available in the first two quarters of 2021).

Eligibility Requirements

Businesses with operations that were either fully or partially suspended by a COVID-19 governmental order and only during the period the order is in force; or

Gross receipts were less than 50% of gross receipts for the same quarter in 2019 until such quarter as gross receipts are 80% of same quarter in 2019.

Businesses that were not in existence in 2019 could use a comparison to 2020 for purposes of the credit.

Beginning January 1, 2021, the credit will be available to businesses with operations that are either fully or partially suspended by a COVID-19 governmental order and only during the period the order is in force; or

Gross receipts are less than 80% of gross receipts for the same quarter in 2019.

Businesses that were not in existence in 2019 may use a comparison to 2020 for purposes of the credit.

Percentage of Wages

The credit was 50% of the qualified wages paid to an employee, plus the cost to continue providing health benefits to the employee.

Beginning January 1, 2021, the credit is 70% of qualified wages, plus the cost to continue providing health benefits to the employee.

Maximum Credit Amount

Annual cap of $5,000 per employee ($10,000 in qualified wages x 50%).

Beginning January 1, 2021, the cap is increased to $7,000 per employee for each of the first two quarters of 2021 ($10,000 in qualified wages x 70%) for a possible $14,000 credit per employee.

The 2021 credit is available even if the employer received the $5,000 maximum credit for wages paid to such employee in 2020.

Employer Size for Whether an Employee is Working or Not:

A company with more than 100 employees could not take the credit for wages paid to an employee performing services for the employer (either teleworking, or working at the workplace, even though at reduced capacity due to reduction in business).

A company with 100 or fewer employees was eligible for the credit, even if the employee was working.

Beginning January 1, 2021, the threshold increases to 500.

An employer with 500 or fewer employees will be eligible for the credit, even if employees are working.

When calculating the 500-employee threshold, the employees of all affiliated companies sharing more the 50% common ownership are aggregated.

PPP Loan Interplay

REPEALED – A company that received a Paycheck Protection Program (PPP) loan was ineligible to claim the employee retention credit.

This disallowance rule extended to all affiliated companies that shared common ownership, so that if one company received a PPP loan, any other company with more than 50% common ownership was ineligible to claim the credit.

This change is retroactive to the effective date under the original law for wages paid after March 12, 2020.

A company that received or receives a PPP loan is no longer prohibited from claiming the employee retention tax credit.

The credit, however, may not be claimed for wages paid with the proceeds of a PPP loan that have been forgiven.

A company that received a PPP loan in 2020 and paid qualified wages in excess of the amount of the forgiven PPP loan used to pay wages, and is otherwise eligible to claim the credit, can claim the credit retroactively. The IRS is expected to issue guidance on how to claim the credit retroactively.

Companies related to a PPP borrower that did not claim the credit because of the affiliation rules should be able to claim the credit retroactively, if they are otherwise eligible for the credit.

Advance Payments

In 2020, there was no provision to receive the credit before qualified wages were paid.

The IRS is expected to draft guidance to allow an advance payment of the credit for companies with 500 or fewer employees, based on 70% of average quarterly payroll for the same quarter in 2019.

If the amount of the actual credit determined at the end of the quarter is less than the amount of the advance payment, the company will need to repay the excess.

Limitation on Hazard Pay

No credit for pay rate increases.

Under the new law, the credit is allowed for hazardous duty pay increases.

Disallowance of Credit for Governmental Entities

The employee retention credit was not available to any federal, state, or local governments, or any agency or instrumentality thereof.

Effective January 1, 2021, the following entities are eligible for the credit:

-Public colleges or universities
-Organizations whose principal purpose is providing medical or hospital care
-Certain Federal instrumentalities, such as federal credit unions

Definition of Gross Receipts for Tax Exempt Entities

No definition of gross receipts as applicable to tax exempt entities was included.

The new law defines gross receipts for tax exempt entities by reference to Section 6033 of the Internal Revenue Code.

Gross receipts include the following: contributions, gifts, grants, dues or assessments, sales or receipts from unrelated business activities, sale of assets, and investment income (e.g., interest, dividends, rents, and royalties).

Gross receipts are not reduced for any associated costs or expenses.