In March 2020, when the CARES Act was signed into law, all of the rage for small business owners was the Payroll Protection Plan (PPP). Also part of that act was the Employee Retention Credit (ERC). The ERC was the little talked about cousin for PPP.
The ERC is a refundable payroll tax credit for “qualified wages” paid to retained employees between March 13 and December 31, 2020. The purpose of this provision is to encourage employers to keep employees on the payroll. If a business was shuttered or adversely affected by COVID, the ERC would provide an avenue to keep up payroll.
There was a good reason that many small business owners ignored ERC. The CARES Act didn’t allow business owners who took advantage of PPP to be eligible for ERC. Business owners took advantage of the PPP because the potential funds were much larger, and the program was more straightforward (if you can believe it!).
Skip ahead to the latest stimulus package passed by Congress and signed into law on December 28, 2020, and the rules changed. Gone was the stipulation that if a business participated in the PPP, they could not take advantage of the ERC. The new rules only said that payroll expense used for PPP forgiveness could not be used for the ERC. Essentially, a business couldn’t double-dip.
Again, however, because of the PPP, the ERC was largely ignored. Go ahead and ask your accountant about it….most have never heard of it. There is very little press around the ERC. Further, the guidance released by the government leaves a lot to be desired. A business owner who wishes to take advantage of the program must know where to dig to find the information.
The purpose of this article is to explain what the ERC is, what businesses are eligible, how to compute the potential credit, and what tangible steps an owner should take. The guidance from the Internal Revenue Service lacks the last item; tangible steps businesses should take. After reading this article, you’ll have a better idea of whether this potentially lucrative credit applies to your business or those other businesses you consult with (i.e. franchisees).
ERC Eligibility
The eligibility for the ERC is more strict than PPP. To qualify to receive this credit, a business must have conducted business in 2020 and either has had to:
- Fully or partially suspend business operations during any calendar quarter in 2020 due to orders from a government authority; or
- Experienced a “significant decline in gross receipts” during a calendar quarter equal to less than 50% of gross receipts in the same quarter in 2019
For example, a restaurant is ordered closed to sit-down customers but allowed to continue carryout, drive-thru, or delivery operations. This business would qualify for the credit based on a coronavirus-related partial shutdown. They could also qualify any quarter during which the government order applied—up to four quarters in 2020.
To meet the revenue test, for any quarter in 2020 a business’s gross receipts must be less than 50% of what they were for the same quarter in 2019. Once eligble, every quarter is an “eligible quarter” until the end of the quarter in which the business’s receipts have returned to at least 80% of what they were for the same quarter in 2019.
A recent Forbes article gives this example: “if receipts in Q1, Q2, Q3 and Q4 of 2019 were $100,000, $120,000, $100,000 and $150,000, and for the same quarters in 2020 receipts were $40,000, $70,000, $85,000 and $125,000, the “eligible quarters” for 2020 are Q1 (the first quarter in which receipts are less than 50% of 2019), Q2 (still less than 80% of 2019) and Q3 (the end of the first quarter in which receipts have returned to at least 80% of the same quarter of 2019).”
The ERC is not available to government agencies or self-employed. There are a few other restricted businesses as well. The IRS has put out a FAQ guide, which is somewhat helpful in determining eligibility. It can be accessed here.
How Much is the Potential Credit Worth?
The ERC is equal to 50% of qualified wages (including qualified health plan expenses) that eligible employers pay their employees. This ERC applies to qualified wages paid after March 12, 2020, and before July 2, 2021.
There is a lot to unpack in that statement. Let’s start with what are qualified wages?
Qualified wages are wages and compensation paid by a business to some or all employees after March 12, 2020, and before July 1, 2021. Qualified wages include the qualified health plan expenses that are allocable to the wages. Essentially this includes base pay, overtime, commissions, and most other wage types.
The definition of qualified wages depends on the average number of full-time employees employed by the Company during 2019.
Suppose the Company averaged more than 100 full-time employees in 2019. In that case, qualified wages are the wages paid to an employee when the employee is not providing services due to economic hardship. Specifically, either a full or partial suspension of operations by order of a governmental authority due to COVID-19 or period of significant decline in gross receipts. For these employers, qualified wages for an employee 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 described above.
If a company has more than 100 average monthly FTEs for 2019, only wages paid to an employee during an eligible quarter to not provide services are eligible for the credit. A business must be paying an employee not to work.
If a company has less than or equal to 100 average monthly FTEs for 2019, then all wages paid to an employee during an eligible quarter are eligible, even if the employee is currently at work.
To calculated FTEs, the IRS has provided guidance on their site.
Next, the time period is essential. Many resources, including the IRS website, have not been updated for the Consolidation Appropriations Act passed in December. This act, among other things, extended the period of wages allowed under the ERC to July 1, 2021. Further, the act allows businesses to retroactively both borrow a PPP loan and alternative claim an Employee Retention Credit for 2020. This is important to remember (we’ll get to this more later).
Lastly, the ERC equals 50% of the qualified wages (including qualified health plan expenses) that a company pays in a calendar quarter. The maximum amount of qualified wages for each employee for all calendar quarters is $10,000, so that the maximum credit for qualified wages paid to any employee is $5,000.
Wages cannot be double-counted with PPP wages. In other words, if a company used some of their wages towards PPP forgiveness, those specific wages cannot count towards the ERC.
A Real-Life Example
MB is an indoor play park with less than 100 average monthly FTEs in 2019. Starting in Q2, quarterly sales in 2020 were $40,000 compared to $100,000 the prior year. The business has now met the criteria of a 50% decline in revenue.
However, at the beginning of May, the Company also took advantage of a PPP loan. They used an 8-week covered period, meaning the payroll that was paid through the end of June.
MB would not be able to take advantage of the ERC until July.
All wages paid during Q3 and Q4 to employees would be eligible for the credit. The business would be able to take the credit even if employees continued to be paid during this period.
Wages could continue to be qualified wages until MB has a quarter in which revenue is at least 80% of the previous year’s quarter.
Maximum Allowed Credit
The maximum amount of wages you can consider for any one employee for the entire year is $10,000. It is important to note that 2020 and 2021 are different years. In other words, we are not talking about a 12 month period, rather we are talking about calendar years. So once a business has paid an employee $10,000, they can not consider their wages anymore for the credit.
The credit per employee is limited to 50% of their qualified wages. This means that if a business pays an employee $10,000, the amount of credit they are entitled to is $5,000.
A Real-Life Example
MB has an employee, Kate, who was paid $7000 in Q3 and $8000 in Q4.
In Q3, MB can claim a credit related to Kate for $3500 ($7000 x 50%). In Q4. MB can claim a credit of $1500 (maximum wages of $10,000 less $7000 taken in Q3, multiplied by 50%).
So What does this Credit Mean? What Should a Bussiness do?
That is an excellent question. To recap, so far, we have talked about how to determine if a business is eligible for the credit. Once a business determines that, we have discussed calculating the allowed wages and how to calculate the credit available.
The ERC is a credit against the employer portion of federal social security taxes. Any amount not used in a calendar year will be reimbursed back to the business.
Just those two sentences say a lot. As I write this in January 2021, there is both a backward and forward strategy that a business must take.
First, let me assure business owners that most payroll companies are set up to deal with the ERC. I have first-hand experience with Gusto, ADP, Paychex, and Intuit and seamlessly handle the credit (assuming a business owner knows to ask for it).
The Backward View
For a business to retroactively claim this credit, they will need to refile their 941 quarterly tax filings for the applicable quarters for 2020. If they determine that based on the criteria outlined in this article, they are eligible, then they should contact their payroll provider. A business should ask their provider what steps to take in refiling their 941 reports.
I did this with Intuit last week, and the overall experience was painless. They asked me to pull together some information, and within 30 minutes, I was on the road to refiling Q3 and Q4 returns.
The cost to have your provider refile your returns should be around $300. However, the credit that you receive should be far more than this amount.
One question that remains unanswered is what happens next. Any credit not used during the calendar year is required by law to be refunded to the business. We are still awaiting guidance on what this means for businesses retroactively applying for the credit. In the best case, it means that businesses will get an immediate refund. In the worst case, it means they will have a considerable credit against any payroll taxes to be paid in 2021.
The Forward View
As businesses look to utilize the ERC for 2021, there is some planning. First, most businesses that qualify for the ERC in 2021 will qualify for a PPP Round 2 loan. Businesses must remember they can mix ERC qualified wages with PPP wages that they will use for forgiveness. As a result, planning must be done to ensure a business can benefit the most from combining the two programs.
Businesses can easily set up the ERC by talking with their payroll providers. Some providers, such as Intuit and Gusto can be set up in a matter of minutes without talking with anyone.
A Must Read Conclusion
The ERC is a little bit of a black hole at the moment. Unlike the PPP which has a lot of documentation and guidance at this point, the ERC still has a lot of questions.
Undoubtedly, businesses may have specific situations that apply to them. The point of this article was to establish a baseline of the ERC. A business that believes they can take advantage of the program should read the IRS FAQ guide for more details.
Lastly, if you are a business owner that thinks you can take advantage of this program, your head is most likely spinning a little bit. That is OK – none of this is easy stuff. Talk with your accountant, payroll company, financial advisor, or me. There are people that have a solid understanding of the program that can provide you more guidance.
About Krieger Analytics
My name is Matt Krieger, and I am the founder of Krieger Analytics. We are a virtual CFO and bookkeeping services partner for small businesses and franchisors. Our goal is to completely outsource your accounting department from bookkeeping to virtual CFO services. I am also the owner and franchisor of a concept called Monkey Bizness, in Denver, Colorado. I know what running a business entails.
As a small business owner with a finance and strategy background, I realized the benefits that a virtual CFO could bring to smaller organizations. Most franchisors and small business owners don’t have a need (or budget) for a full-time CFO or bookkeeper. To better fit my clients, Krieger Analytics is a part-time resource. While most think of CFO’s being involved in finance and accounting (we are), we are also involved in much more. We partner with clients by coaching, giving them clarity into their business, and creating growth strategies. Conversations are free, so don’t hesitate to reach out to me at [email protected].