Revisiting the benefits of the Employee Retention Credit

The Employee Retention Credit (ERC) was enacted by the CARES Act in March 2020 as an incentive to employers to keep their labor force intact during the COVID-19 pandemic. However, the new American Rescue Plan Act (ARPA) expanded eligibility and extended the credit, now worth as much as $28,000 per employee for 2021. Therefore, what was previously an attractive incentive has become a “can’t miss” opportunity for additional cash flow to eligible businesses. However, many questions about the program remain for many employers, so it is worth revisiting the details.

Credit history

The CARES Act generally made the ERC available to employers whose:

      • Operations were fully or partially suspended due to a COVID-19-related government shutdown order, or
      • Gross receipts in a calendar quarter of 2020 dropped more than 50% compared to the same quarter in 2019 (qualification does not cease until the quarter following the quarter in which gross receipts exceed 80% of gross receipts for the same calendar quarter in 2019).

For 2020, the credit equals 50% of “qualified wages” — including health care benefits. Qualified wages are limited to a maximum of $10,000 per eligible employee from March 13, 2020 through December 31, 2020. As a result, the maximum benefit for 2020 is $5,000 in fully refundable credits per employee. The ERC is a credit against payroll tax deposits and its classification as a refundable credit means that any amount of qualifying credits in excess of payroll deposits will be issued as a refund from the IRS to the employer.

The Consolidated Appropriations Act (CAA), enacted in December of 2020, extended the credit for eligible employers that continue to pay wages during COVID-19 closures or record reduced revenue through June 30, 2021. That was not the only change the law made to the ERC.

The CAA increased the amount of the credit to 70% of qualified wages, beginning January 1, 2021, and raised the limit on per-employee qualified wages from $10,000 per year  to $10,000 per quarter. In other words, you can obtain a credit as high as $7,000 per quarter per employee. The CAA also expanded eligibility by reducing the requisite gross receipt decline from more than 50% to only more than 20%. Additionally, it raised the threshold for determining whether a business is a “large employer” — and, therefore, subject to a stricter standard when computing the qualified wage base — from 100 to 500 full-time employees.

Under the CARES Act, Paycheck Protection Program (PPP) loan borrowers were not allowed to claim ERCs. The CAA changed that. Employers became eligible to receive PPP loans and still qualify for ERCs on qualified wages not paid with forgiven PPP funds. This provides an incentive for PPP borrowers to maximize and claim eligible non-payroll costs on their PPP loan forgiveness applications.

ARPA changes

The ARPA extends the ERC through the end of 2021. It also makes some changes that apply solely to the third and fourth quarters of the year. For example, the credit will be applied against an employer’s share of Medicare taxes rather than Social Security taxes. Excess credits continue to be refundable.

The new law expands the pool of employers who can take advantage of the credit by establishing a third path to eligibility beyond the suspension of operations or decline in gross receipts. Now, so-called “recovery startup businesses” may also qualify for the ERC.

A recovery startup business generally is an employer that:

    • Began operating after February 15, 2020, and
    • Has average annual gross receipts of less than or equal to $1 million.

While these employers can claim the credit without suspended operations or reduced receipts, they are limited to $50,000 in credits per quarter.

The ARPA also targets extra relief at “severely financially distressed employers,” meaning those with less than 10% of gross receipts for 2021 when compared to the same period in 2019. Such employers can count any wages paid to an employee during any calendar quarter as qualified wages — regardless of employer size. Otherwise, the ARPA continues to distinguish between large employers and small employers for purposes of determining qualified wages.

For large employers that averaged more than 500 full-time employees during 2019 (or 2020 if the employer did not exist in 2019), qualified wages are those paid to an employee who is not providing services because of the circumstances that made the employer eligible for the ERC. For smaller employers, qualified wages include wages paid — regardless of whether the employee was working — during the period of suspended operations or the calendar quarter in which the gross receipts test was satisfied.

Qualified wages cannot include wages used to compute other credits, loan forgiveness, or certain grants received from the Small Business Administration. This applies to all eligible employers.

Note that the ARPA extends the statute of limitations for the IRS to evaluate ERC claims. The IRS will have five years, as opposed to the typical three years, from the date the original return for the calendar quarter for which the credit is computed is deemed filed.

IRS guidance on “partial suspension of operations”

In early March 2021, prior to passage of the ARPA, the IRS issued additional guidance on the ERC. Among other things, it provided some help for determining whether operations were partially suspended because of a COVID-19-related government order.

The IRS has previously stated that “more than a nominal portion” of operations had to be suspended. In Notice 2021-20, it explains that this criterion is met when:

    • Gross receipts from the suspended operations measure 10% or more of total gross receipts during the same period in 2019,
    • Hours of service performed by employees in the suspended operations measure 10% or more of total hours of service performed during the same period in 2019, or
    • Modifications to operations result in a reduction of 10% or more of the employer’s ability to provide goods or services.

The notice provides additional guidance, but it is applicable only for the ERC in 2020. The IRS followed up with supplementary guidance in Notice 2021-23 that addressed certain unresolved questions, including ERC topics particular to 2021.

A complicated calculation

The precise amount of your ERC will vary depending on the period, your number of employees, and other factors. We can help ensure that you properly calculate your credit and don’t leave money on the table with a complimentary Discovery Phase consultation. Simply complete a short survey and we will reach out to discuss your options around the credit.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.