The Employee Retention Credit (ERC) was first introduced by the Coronavirus Aid, Relief and Economic Security (CARES) Act enacted in March 2020 to encourage employers to keep their employees on payroll during the Covid-19 pandemic. The Consolidated Appropriations Act (CAA) of 2021 — passed on December 27, 2020, and the American Rescue Plan Act (ARPA) signed into law on March 11, 2021 — have expanded the provisions and extended the applicable period for ERC through December 31, 2021.

The following summarizes key information regarding the Employee Retention Credit, which reflects additional guidance provided by IRS Notice 2021-20 and Notice 2021-23.

Effective Date:

For payroll after March 12, 2020, and before January 1, 2022.

Credit

The ERC is a refundable credit described as follows:

March 13, 2020, through December 31, 2020

Equal to 50% of the qualified wages up to $10,000 per employee per year (Maximum $5,000 per employee)

January 1, 2021, through December 31, 2021

Equal to 70% of the qualified wages up to $10,000 per employee per quarter (Maximum $28,000 per employee)

*ARPA has added $50,000 per quarter cap on credit claimed by a Recovery Startup Business (RSB) for the wages paid between July 1, 2021, and December 31, 2021.

Who is Eligible:

Most private-sector employers and tax-exempt organizations who operated a trade or business during calendar year 2020 and 2021 and either:

  • Experienced a full or partial suspension of the operation of their trade or business by governmental order due to Covid-19; or
  • Experienced a significant drop in gross receipts.

Under the CARES Act, a company which received a Paycheck Protection Program (PPP) loan was not eligible to claim the ERC.  However, CAA has amended this provision and the businesses who took PPP loan are now also eligible and the eligibility is retroactive for wages paid between March 13, 2020, and December 31, 2020.

The ARPA expanded the eligibility for a Recovery Startup Business (RSB) to take the credit up to $50,000 per quarter during 3rd and 4th quarters in 2021.  The RSB is a business which: a) began business on or after Feb. 15, 2020; b) has no more than $1M in average annual gross receipts over the past 3 years; and c) is not otherwise eligible for the credit because business did not experience full or partial suspension by governmental order and did not experience a significant reduction in gross receipts.

Full or Partial Suspension of Business Operation by Governmental Order:

An employer may be treated as an eligible employer for purposes of the Employee Retention Credit if its operations are fully or partially suspended during a calendar quarter due to “orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes)” due to COVID-19.

The “orders from an appropriate governmental authority” includes orders, proclamations, or decrees from the Federal or any State or local government (of jurisdiction that your businesses operate) if they limit commerce, travel, or group meetings due to COVID-19 in a manner that affects an employer’s operation of its trade or business, including orders that limit hours of operation.

However, if an employer can continue operations comparable to its operations prior to the closure, the employer’s operations are not considered to have been fully or partially suspended due to a governmental order.  This includes evaluation of ability to work remotely and whether the business requires a special workplace such as laboratories or manufacturing involving special equipment or materials that cannot be accessed or operated remotely.

Significant Decline in Gross Receipts:

Gross receipts generally include total sales (net of returns and allowances), amounts received for services, interest, dividends, rents, royalties, annuities, gains from sales of assets.

March 13, 2020, through December 31, 2020

A business has experienced a significant decline in gross receipts for the period beginning on the first calendar quarter of 2020 in which its gross receipts are less than 50% of gross receipts for the same calendar quarter in 2019 and ends on the last day of the first calendar quarter in which gross receipts are more than 80 percent of gross receipts for the same calendar quarter in 2019.

  2019 GR 2020 GR %
           1st Qtr $210,000 $100,000 48%
           2nd Qtr $230,000 $190,000 83%
           3rd Qtr $250,000 $230,000 92%

Based on the example above, a business would be eligible for the credit for Q1 and Q2 of 2020 being there is a 50% decline in gross receipts in Q1 2020 and gross receipts increased to more than 80% in Q2 of 2020 when compared to the gross receipts for the same quarters in 2019.

January 1, 2021, through December 31, 2021

A business has experienced a significant decline in gross receipts when gross receipts are less than 80% of gross receipts for the same quarter in 2019.

  2019 GR 2021 GR %
           1st Qtr $210,000 $150,000 71%
           2nd Qtr $230,000 $200,000 87%

Based on the example above, a business would be eligible for a credit in Q1 2021, but not Q2.

*Note: There is an option to make an election of using the prior quarter’s gross receipts as the current quarter’s gross receipts.  As a result of the election, a business in this example would have 65% (less than 80%) in Q2 of gross receipts for the same quarter in 2019.  Therefore, the business could be qualified for the credit for Q1 and Q2 of 2021.

Small Eligible Employer Large Eligible Employer
2019 Average Full-time Employees of 100 or Fewer (500 or Fewer Effective January 1, 2021) 2019 Average Full-time Employees More Than 100 (or More than 500 Effective January 1, 2021)

Qualified wages are the wages and compensation (including qualified health plan expenses that are property allocable to the wages) paid to any employee, which includes seasonal employees, part-time employees and employees that did not exist in 2019 during eligible quarters.

 

Qualified wages include pre-existing vacation, sick and other personal leave policy.

Qualified wages are the wages and compensation (including qualified health plan expenses that are property allocable to the wages) paid to an employee for time that the employee is NOT PROVIDING SERVICES.

Qualified wages do not include amounts paid to employees for paid time off for vacations, holidays, sick days, and other days off. These wages are paid pursuant to existing leave policies that represent benefits accrued during a prior period in which the employees provided services and are not wages paid for time in which the employees are not providing services.

(Wage Limit in 2020)

Qualified wages may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.  This limit does not apply to wages paid in 2021.

(Expansion in Qualified Wages between July 1, 2021, and December 31, 2021)

The ARPA allows certain hardest hit business (gross receipts less than 10% of gross receipts in the same quarter in 2019) to claim the credit against all employee’s qualified wages instead of the wages for the time that employees are not providing services.

 

Exclusions – the following wages must be excluded from the calculation of qualified wages:

  • Wages for which the employer received a credit for qualified sick and/or family leave wages
  • Wages for which the employer received a credit for paid family medical leave under section 45S of the Code.
  • Wages included for purpose of the Work Opportunity Tax Credit under section 51 of the Code.
  • Wages for which the employer received a Paycheck Protection Plan Loan.
  • Wages paid to an employee who is exempt from Social Security and Medicare taxes.
  • Wages paid to former employees following termination of employment.
  • Wages paid to employees who are related individuals to more than 50% owner of business.

Claiming the Credit:

The credit is a payroll tax credit.  Generally, eligible employers will need to report their credit amount on their quarterly payroll tax returns, Form 941, which would decrease the required payroll deposit for the credit amount. To claim the credit retroactively for quarters in 2020, employers will need to file amended quarterly payroll tax returns, Form 941-X.  The credit is applicable to the employer’s share of Social Security tax with the excess being refundable under normal procedures. If a credit is claimed, an employer should retain a record of the employment taxes that would have therefore been deposited. This would include federal income tax withheld, the employees’ share of Social Security and Medicare taxes and the employer’s share of Social Security and Medicare taxes for all employees up to the amount of the credit without penalty.

Small eligible employers can request an advance payment of the credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, after first reducing their employment tax deposits. Advance payments are not available for large eligible employers in 2021.

Special Issues for Employers:

  • Income and Deduction – The ERC is not includible in gross income, but it is subject to expense disallowance rules. The amount of ERC reduces eligible employer’s deduction for qualified wages, including qualified health plan expenses.  Therefore, if an employer receives $100,000 ERC, the same amount of reduction in expense (hence income) will be subject to tax.
  • Timing of recognizing ERC related income – IRS does not address the timing issue in its Notice or FAQs regarding when to recognize expense disallowance when eligible employers claim 2020 ERC in 2021. However, for both cash and accrual taxpayers that claim the 2020 ERC in 2021, the expense disallowance most likely occurs in 2020 based on the all-events test and position by IRS for PPP expense disallowance explained in Rev. Rul. 2020-27.

Special Enforcement

The ARPA includes a special 5-year statute of limitation to allow the IRS to assess a deficiency against employers for improperly claiming the ERC.

Please contact us if you need our assistance on claiming the Employee Retention Credit.