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Curt Fowler: On Employee Retention Credit

Curt Fowler

Monday, July 12th, 2021

The Employee Retention Credit has been through a lot of changes since it was originally enacted in April 2020. In this article, I want to highlight what the ERC is today so you can decide if the ERC is something you should pursue with your tax advisor. 

The Laws

For 2020, employers whose operations were fully or partially suspended due to a COVID-19-related government order or whose gross receipts for any 2020 quarter were less than 50% of the gross receipts for the same quarter in 2019 were eligible for the credit for wages paid in 2020 Quarters 2, 3 or 4.

 

However, if the employer or any member of its controlled group received a Paycheck Protection Program loan, the entire controlled group was ineligible for the ERC.

The Consolidated Appropriations Act of 2021 (enacted Dec. 27, 2020) provided for retroactive applicability of the ERC for 2020 and extended the ERC to the first two quarters of 2021. It also liberalized the ERC requirements for 2021. One of the biggest changes was to allow employers or controlled groups who received a PPP loan to be eligible if they meet the other requirements.

On March 11, 2021, the American Rescue Plan Act was passed and made the ERC available for all four quarters of 2021.

The Act also extended the statute of limitations on the ERC from three years to five years. A lot of tax credit vendors are out selling the ERC right now. In many cases, they are suggesting employers qualify under the “partial shutdown” qualification. 

If you decide to pursue the ERC know the IRS has five years to review your case. You will have to pay back the credit with interest and possibly pay penalties if the IRS finds you did not qualify. Be careful.

Who is an Eligible Employer?

Key point: Employer includes all members of a controlled group as defined under IRC Sec. 52 and 414(m). To oversimplify, if a person controls over 50% of the entities you might have a controlled group.

Eligible Employer for 2020

Is an employer that:

1) Fully or partially suspended its operations due to a governmental order related to COVID-19 (employer can only claim the ERC for the suspension period), or

2) Had gross receipts for any 2020 quarter that were less than 50% of its gross receipts for the same quarter in 2019.

Eligible Employer for 2021

Is an employer that:

1) Fully or partially suspended its operations due to a governmental order related to COVID-19 (employer can only claim the ERC for the suspension period), or

2) Had gross receipts for any such quarter or for the immediately preceding quarter that are less than 80% of its gross receipts for the same quarter in 2019. (For example, to qualify for the first quarter of 2021, an employer may elect to use its gross receipts for the fourth quarter 2020 compared to those for the fourth quarter 2019.)

What Qualifies as a 'Partial' Shutdown?

This is a grey area. Many industries were affected “partially” by government orders designed to reduce the spread of COVID-19. Does the partial shutdown that you experienced qualify you for the ERC?

The IRS has tried to address this through questions and answers in Notice 2021-20.

The IRS response to Q17 states that businesses that are partially shutdown would qualify if the modifications required by the government have more than a “nominal” effect on the business based on facts and circumstances or if the operations that must be closed are more than a “nominal” portion of the business operations. 

The response goes on to list several examples of partial shutdowns and whether the changes required were nominal or not. I recommend you read these examples and see how your situation compares.

Q11 addresses whether the shuttered portion of your business is nominal or not. If the portion of the business shut down is 10% or greater of the gross receipts of the entire business or if the hours worked in that portion of the business are 10% are greater that portion of the business is not “nominal.” Q11 states these calculations should be based on data from the same calendar quarter in 2019.

Q18 addresses what “modifications” the IRS considers to have more than a “nominal” impact on business operations. The IRS response states that modifications that reduce an employer's ability to provide goods and services by 10% or greater will be considered more than nominal. This sounds like 10% is the “safe harbor”. If your business experienced less than a 10% impact, you will need to have a good case for why you qualify.

What if your operations were partially shut down and more than a nominal part of your business had to be closed, but your revenue and profits improved because of increased demand? I have not seen that situation addressed by the IRS, but it might be a tough position to defend if your ERC application is reviewed.

In tax law, Notices (like 2021-20) are intended to guide taxpayers until further guidance is drafted. Since this is all new, taxpayers will be deciding whether or not to apply for the ERC based on the guidance available.

Work with your tax advisors to fully understand the basis for your application and the ramifications of the IRS coming back later and saying you didn’t qualify.

How much is the Credit?

2020: For Q2, Q3, and/or Q4, the credit is 50% of the first $10,000 of qualified wages paid per employee for all qualifying quarters. To put this another way, the maximum ERC for all of 2020 is $5,000 per employee.

2021: An employer can receive 70% of the first $10,000 of qualified wages paid per employee in each qualifying quarter. This is a big change! Rather than a max of $5,000 for all of 2020, in 2021 the ERC can be up to $7,000 per employee per quarter.

What are Qualified Wages?

There is a big difference in what counts as qualified wages for “small” vs “large” employers. And the definition of large and small changes for 2020 vs 2021. Let me explain.

“Small” employers: All wages paid plus Qualified Health Plan Expenses paid for all employees for the applicable quarter.

“Large” employers: Only wages paid plus Qualified Health Plan Expenses paid for employees paid while not performing services. If you are a “large” employer, the only wages that qualify are wages you paid to employees while they were not providing services to you.

Note: Wages paid to relatives of more than 50% owners do not qualify but wages paid to the owner and spouse most likely do qualify under IRC Sec. 51(i)(1).

How are Small and Large Employers Defined?

Small Employer

For 2020: In 2019, averaged 100 or fewer full-time employees defined as an average of 30 hours per week or 130 hours per month.

For 2021: In 2019, averaged 500 or fewer full-time employees.

Large Employers are those employers that do not qualify as small.

Two Additional Opportunities for 2021 Q3 and Q4

“Recovery startup businesses” and “severely financially distressed employers” can now qualify for the ERC in Q3 and Q4 of 2021.

A recovery startup business is defined as an employer that began carrying on any trade or business after Feb. 15, 2020, and the employer's average annual gross receipts did not exceed $1 million.

A severely financially distressed employer is an employer that has gross receipts for a quarter that are less than 10% of its gross receipts for the same quarter in 2019.

No Double Dipping

Allowing employers who received PPP loans to be eligible for the ERC is a big deal, but there is a catch. Employers cannot “double-dip.”

Double dipping is using the same wages for PPP loan forgiveness and as ERC qualified wages. The IRS has stated that wages included as “payroll costs” in a PPP loan forgiveness application that were needed and used to obtain PPP loan forgiveness cannot be used as qualified wages for the ERC.

If you have not prepared your PPP loan forgiveness app and are considering applying for the ERC, use only the wages you must for PPP forgiveness. Use as many of the “other” qualifying expenses as possible so you can preserve wages for the ERC.

Also, I have seen other forms of stimulus (like those received in the health care industry) that also have double-dipping rules. You need to take a holistic approach to your stimulus strategy.

Timing

Employers have three years from the date the original 941 was filed or two years from the date the taxes were paid to file the 941-X for the ERC.

Disclaimer: I’ve done the best I could to condense this topic into something you can use to drive discussions with your tax advisors. Please do not take this as legal or tax advice!

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Curt Fowler is president of Fowler & Company and director at Fowler, Holley, Rambo & Stalvey.

Curt and the team at FHRS help leaders build great companies through Virtual CFO, strategy, tax and accounting services.

Curt is a syndicated business writer, keynote speaker and business advisor. He has an MBA in strategy and entrepreneurship from the Kellogg School, is a CPA and a pretty good guy as defined by his wife and five children. (Welcome Baby Owen – June 2021!)