Expanded Employee Retention Tax Credit Opportunities

Thoughtware Alert Published: Jan 08, 2021
Tax planning and consulting services

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Act) was signed into law on December 27, 2020. The bipartisan legislation includes another round of COVID-19 stimulus funding and further relief for taxpayers affected by the COVID-19 pandemic (read our summary of the Act here). This article will focus specifically on the Employee Retention Credit (ERC) and the significant changes that were made to the credit that extend the credit period, increase the credit amount in 2021, and expand the ability for organizations to qualify. These changes may allow some organizations that previously weren’t eligible to claim the credit in 2020 to now qualify and retroactively apply for refunds.

Background

The ERC, a refundable tax credit against certain employment taxes, was established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Here are several significant changes made to the ERC in the Act:

  • Paycheck Protection Program (PPP) loan recipients are now eligible to claim the credit in 2020 and 2021 to the extent those organizations meet ERC qualifications. The credit is only eligible for wages not included in the PPP loan forgiveness calculation. Under prior law, PPP loan recipients weren’t eligible to claim the credit.
  • The credit period was extended to wages paid before July 1, 2021.
  • The maximum refundable credit amount for 2021 increased from 50 percent to 70 percent of qualifying wages for each employee. In addition, the maximum qualifying wage in 2021 for each employee increased from $10,000 per year to $10,000 per quarter.
  • For 2021 credits, the required decline in gross receipts was reduced from at least 50 percent to at least 20 percent.
  • For 2021, the 100-employee threshold is increased to 500 employees.
  • Under the CARES Act, federal, state, and local governmental employers or agencies and instrumentalities thereof weren’t eligible for the credit. For credits in 2021, the Act expands the eligibility to include public colleges or universities, organizations whose principal purpose or function is providing medical or hospital care, and organizations described in Internal Revenue Code (IRC) Section 501(c)(1) and exempt from tax under IRC §501(a).

As the credit calculation and organizations’ eligibility are different for credits claimed for 2020 and 2021, we have included an overview of the rules for each year below.

Overview of Credit Calculation

Credit Calculation for 2020 Credits

  • 50 percent of an employee’s qualified wages during the period of March 12, 2020, to December 31, 2020
  • Qualified wages limited to $10,000 per employee for 2020, i.e., maximum credit per employee is $5,000 per year:
    • Qualified health plan expenses allocable to an employee also are deemed qualified wages

Credit Calculation for 2021 Credits

  • 70 percent of an employee’s qualified wages during the period of January 1, 2021, to July 1, 2021
  • Qualified wages increased to $10,000 per quarter, i.e., maximum credit per employee is $7,000 per quarter:
    • The disallowance of pay rate increases qualifying as creditable wages is repealed
    • Hazard pay increases and qualified health plan expenses are included in qualified wages

Overview of Employer Eligibility

Eligible Employer for 2020 Credits

  • Has a trade or business in 2020 and, with respect to any calendar quarter, the employer experienced one of the following:
    • Operations are fully or partially suspended during the quarter due to orders from governmental authority limiting commerce, travel, or group meetings due to COVID-19
    • Such quarter is within the period of a “significant decline in gross receipts”:
      • This period begins in the first post-December 31, 2019, quarter where gross receipts are less than 50 percent of the gross receipts for the same quarter of 2019 and ending with the calendar quarter following the beginning quarter for which gross receipts are greater than 80 percent of the gross receipts for the same quarter in 2019
  • Employees’ qualified wages eligible for credit:
    • If the average number of full-time employees for 2019 was greater than 100, only qualified wages paid to employees not performing services during the periods described earlier are eligible for the credit
    • If the average number of full-time employees for 2019 was fewer than or equal to 100, wages paid to all employees (other than owners) during the periods described earlier are eligible for the credit

Eligible Employer for 2021 Credits

  • Ultimately, the Act retains the same qualifications as the 2020 credit with the following significant changes:
    • The required decline in gross receipts is reduced from a greater than 50 percent decline to a greater than 20 percent decline compared to the corresponding 2019 quarter:
      • An election is available to use the immediately preceding calendar quarter
    • The 100 full-time employee threshold to use all employees’ wages regardless of whether the employee is actually providing services is increased to 500 employees. As such:
      • If the average number of full-time employees for 2019 was greater than 500, only qualified wages paid to employees not performing services during the periods described earlier are eligible for the credit
      • If the average number of full-time employees for 2019 was fewer than or equal to 500, wages paid to all employees (other than owners) during the periods described earlier are eligible for the credit

Other Key Considerations

  • The Act clarifies the definition of gross receipts for tax-exempt entities is within the meaning of IRC §6033. For employers other than tax-exempt organizations, “gross receipts” has the same meaning as when used under IRC §448(c).
  • For purposes of the 100- or 500-employee threshold, the term “full-time employee” only includes employees who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month. This is an important distinction for employers who are near the applicable threshold and have several part-time employees.
  • Employers with 500 or fewer full-time employees may be eligible to receive an advance payment of the credit (limited to 70 percent of the average quarterly wages paid by the employer in calendar-year 2019).
  • The determination of whether an employer’s operations have been fully or partially suspended during a quarter due to orders from governmental authority limiting commerce, travel, or group meetings will be based on each employer’s facts and circumstances. The IRS has provided many helpful examples on its ERC frequently asked questions page.
  • Certain related employers are required to be aggregated and treated as a single employer for purposes of the following ERC rules. The aggregation rules are complex and can have a significant effect on an organization qualifying for the credit:
    • Determination if employer had a trade or business that was fully or partially suspended
    • Determination if the employer had a “significant decline in gross receipts”
    • Determination of whether the employer exceeds the 100- or 500-employee threshold
  • An employer receiving an ERC for qualified wages, including allocable qualified health plan expenses, doesn’t need to include the credit in gross income for federal income tax purposes. However, an employer’s wage deduction should be reduced by the amount of the credit as a result of the disallowance rule under IRC §280C(a).
  • Now that PPP loan recipients may qualify for the ERC on qualified wages not used for loan forgiveness, it’s important to evaluate the potential ERC benefit compared to a PPP 2 Loan and to take advantage of the ability to use up to 40 percent of qualifying nonpayroll costs for purposes of the PPP loan forgiveness calculation.

Click here for an overview of what organizations should know about the Employee Retention Credit for 2020 and 2021.

Conclusion

The changes to the ERC in the Taxpayer Certainty and Disaster Tax Relief Act of 2020 provide an opportunity for additional organizations to qualify for the credit. Organizations that previously didn’t qualify because they received PPP loans or weren’t eligible because of the percentage decline in gross receipts or number of employees should review these rules to determine if they’re now eligible.

BKD will continue to follow this developing situation. As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication. Visit BKD’s COVID-19 Resource Center to learn more. If you have questions about these changes, contact your BKD Trusted Advisor™ or submit the Contact Us form below.

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