Employee Retention Credit: Answers to Frequently Asked Questions
Eligibility, Paycheck Protection Program effects and more
The Employee Retention Credit offers substantial liquidity potential for many businesses, a crucial boon, perhaps, to those pushing through difficulties caused by the pandemic. Better yet, the Employee Retention Credit was expanded by relief legislation in December 2020 and again in March 2021. Those changes could result in payroll tax refund opportunities and prospective savings, including for companies previously ineligible for the retention credit because they obtained Payroll Protection Program (PPP) loans.
Here are answers to some frequently asked questions about the employee retention tax credit (ERTC) and how it may apply to you:
Q. What exactly is the retention credit?
A. The ERTC is a refundable payroll tax credit that was enacted as part of the CARES Act in March 2020. The credit from the CARES Act is equal to 50% of payroll-related costs over the eligible period up to a maximum credit of $5,000 per employee for 2020. Prior to enactment of the Consolidated Appropriations Act of 2021 (CAA) on Dec. 27, 2020, an employer was not eligible for the ERTC if it obtained a PPP loan.
The CAA expanded the ERTC for six months into 2021 with several changes, including allowing companies that obtained PPP loans to benefit from the ERTC—even retroactively to 2020. Later, the American Rescue Plan Act extended the ERTC for the remaining six months of 2021 so it is now available for the full calendar year.
For 2021, the definition of a small employer is expanded from 100 or fewer employees to 500 or fewer employees; the credit as a percentage of qualified wages increased from 50% to 70%, resulting in a credit up to a maximum of $7,000 per employee for each of the four quarters in 2021 (or $28,000 total per employee). Also, the definition of a significant revenue decline is less than 80% of gross receipts for the same quarter in 2019, and you may elect to calculate that based on the immediately preceding quarter.
Q. Who is eligible for the retention credit?
A. To qualify for the ERTC, a company must meet either of the following tests, but not both;
1. the company must have been fully or partially impacted by government orders implemented to mitigate the spread of COVID-19, or
2. the company experienced a significant decline in gross receipts for a quarter. (For 2020, this begins in the quarter with a 50% decline in gross receipts as compared to the same quarter in 2019 and ends with the first quarter following the quarter in which they are greater than 80% of gross receipts as compared to the same quarter in 2019; for 2021, instead of a 50% decline, only a 20% decline in gross receipts as compared to the same quarter in 2019 is necessary, and there is an election to use the immediately-preceding quarter instead of the current quarter).
Q. Do I have to physically shut down locations to be considered impacted by government orders?
A. It’s a common misconception that a company must be fully shut down to be considered impacted by government orders. To determine if a company is eligible for the ERTC, we would consider a partial or full impact due to a governmental order. This may be straightforward for a business that was not allowed to be open for a period of time under a state or local order. In many instances, however, you should consider if operational hours were limited due to a government order; or if your business was impacted by your suppliers suspending business partially or fully due to a governmental order, resulting in supply chain disruptions for your business; or if certain aspects of your business could not be carried out due to orders limiting certain activities while other activities continued.
To qualify, the impact on your business of such government orders must be more than nominal—but this is based on facts and circumstances, as it is not defined. It’s important to note that these considerations apply to essential businesses, too, so don’t assume your business fails to qualify solely because it is deemed essential. Companies can generally think of the impact on their business during 2020 and then work backwards toward finding the cause of that impact and whether it was related to a government order.
Q. How do I use both the PPP and ERTC?
A. While you can’t use the same wages for both the PPP loan forgiveness and the ERTC, you should consider if the company has sufficient payroll for both. In this case, it is pertinent to document that the wages used for PPP forgiveness and the ERTC are not the same wages. When a company does not have sufficient payroll for both, getting full-dollar PPP loan forgiveness is better than a partial-dollar credit, so some analysis and calculations will be helpful when deciding what combination of the two makes the most sense. For instance, if the company has flexibility in the PPP forgiveness period, determining the quarters in which it may have qualified for the payroll credit first may be helpful in getting the most benefit from both the ERTC and PPP forgiveness.
Q. Is it worth doing the analysis if I have losses or low payroll taxes?
A. Yes, the ERTC is a refundable credit, so even companies with losses or small amounts of payroll tax can still get some cash flow from the credit. Plus, as a payroll tax credit, it’s a so-called “above the line” or EBITDA savings, which is an added benefit to many companies as well.
The maximum credit per employee for 2020 was $5,000, and that increased to $28,000 for 2021, so companies are looking at up to $33,000 per employee, which can be substantial.
Q. If I’m a large employer (more than 100 employees for 2020 or more than 500 employees for 2021) is it still worth doing an analysis?
A. Yes. While the definition of qualified wages is more limited for large employers, the company can still take advantage of the ERTC if it has employees that are being paid but are either not yet working or are working reduced hours. Depending on the size of the company and amount of qualified wages paid during the quarter, the ERTC claimed can still be substantial.
To determine if your company is considered a large employer, we would look at the average number of full-time employees (on an aggregated basis) in 2019. If the average number of full-time employees is 100 or fewer or 500 or fewer for the respective 2020 and 2021 calculations, the employer would be considered a small employer.
If the company is determined to be a large employer, the wages eligible for the credit are reduced, but the company still calculates the credit using all qualified wages, including qualified wages for part-time employees. For example, if you have 500 employees working only 80% of the time but still being paid 100% of their pay, it may be possible to still find $10,000 of qualified wages per employee allocable to their percentage of time not working (20% in this example) and still receive a credit of $2,500,000 (500 employees multiplied by $10,000 wages-per-employee multiplied by 50% credit in 2020).
Q. How do the aggregation rules apply?
A. The ERTC uses the aggregated group to determine eligibility (impacts of orders and gross receipts tests) and the number of full-time employees, which affects the determination of qualified wages. Entities under common control or management will need to evaluate whether they will be treated as a single employer for purposes of the ERTC. Generally, taxpayers may be required to aggregate when there is a parent-subsidiary controlled group, a brother-sister controlled group, a combined group of corporations, or an affiliated service group. The aggregation rules can be complex, but they do not by themselves preclude eligibility; they determine what entities must be combined and treated as a single employer.
Q. What is the process of claiming the ERTC?
A. A company should work with qualified advisors to document the requirements of qualifying as an eligible employer, quantify qualified wages and calculate the ERTC. Then, file the Form 941 Employer’s Quarterly Federal Tax Return or Form 7200 Advance Payment of Employer Credits due to COVID-19 for 2021 quarters that are filed timely and Form 941-X Adjusted Employer’s Quarterly Federal Tax Return for 2020 or 2021 quarters that have already had the Form 941 filed timely. For companies that use a third-party payroll provider, some coordination with the payroll provider will be necessary, but the company needs to be active in the process.
While this article covers some FAQs related to the Employee Retention Credit, it is certainly not all inclusive of the retention credit rules. With limited guidance available, each aspect of the ERTC can require analysis. If you have not examined your eligibility for the credit, please reach out to your tax advisor or specialist to discuss. The ERTC can provide significant liquidity, so don’t leave dollars on the table!
Anne Bushman is a partner at RSM US LLP.
Nicole Kelley is a manager at RSM US LLP.