The Consolidated Appropriations Act of 2021 (“CAA”) both enhanced and expanded the ability for taxpayers to receive the Employee Retention Credit (ERC) in 2021. As a result of the changes, we are providing this message to summarize what the credit is, whether you may be a qualified business for purposes of taking the credit, and to provide instructions for calculating and filing to claim the ERC during current year.
What is the Employee Retention Credit?
The CARES Act of 2020 created this fully refundable payroll tax credit to allow certain, eligible employers a credit equal to 50% of qualified wages (including allocable qualified health plan expenses) that are paid to their employees. Qualified employers are businesses and not for profit organizations that were either:
- At least partially shut down under government order, or
- Experienced a 50% drop in gross revenue in any quarter in 2020 relative to the same quarter in 2019.
- Note: the CAA has adjusted this drop in revenue to a 20% reduction for 2021.
- For 2021, a business may elect to use the quarter prior to its current quarter in calculation of the 80% of revenue as compared to the corresponding quarter in 2019. See example below.
In accordance with IRS FAQ #3, the operation of a trade or business is considered partially suspended for purposes of the ERC if an appropriate governmental authority imposes restrictions on the employer’s operations by limited commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 such that the employer can still continue some, but not all of its typical operations.
How is the Employee Retention Credit Determined?
If a business is considered a qualified employer under either of the above definitions, it will apply to qualifying wages paid to employees after March 12, 2020 through June 30, 2021. Thanks to the CAA, PPP loan borrowers are able to retroactively claim the ERC through December 31, 2020; and for the 2021 calculation, the credit received several computational adjustments. For purposes of qualifying for the ERC due of a drop in quarterly revenue, a business can elect to use the prior quarter and the corresponding 2019 quarter.
The calculation of the ERC is calculated under two methods of which the method to compute the credit is determined based on the number of full-time employees (FTEs) in 2019. For the 2020 ERC, employers with more then 100 FTEs (based on the shared responsibility provision in the Affordable Care Act) use a different qualified wage than such businesses with 100 or fewer FTEs. Note: Under the CAA, the FTE limit for determining which wages are applicable to the credit is increased to 500 for 2021 wages. Important: The FTE amount used to determine PPP loan forgiveness is not calculated in the same manner as the FTE for ERC purposes.
Method 1) Larger Employers with more than 100 FTE (500 FTE in 2021): Only wages paid to employees not providing services because of suspension or decline in business are qualified. Additionally, any wages paid for vacation, sick days, or other days off based on the employer’s current policy may not be included in the qualified wages for larger employers. In summary, employers can only use this credit on employees who are not working but are still being paid.
Method 2) Small Employers with 100 or fewer FTE (500 FTE for 2021): Such employers can consider all employee wages – employees working, not working, along with wages paid for time off, vacation, sick leave with the exception of any paid leave provided under the Families First Coronavirus Response Act. There are other guard rails to prevent double-dipping on payroll tax credits. As such, the same wages cannot be used if they are also the same qualified wages for paid family medical leave or Work Opportunity Tax Credits.
Once the qualified wages are determined the credit claimed is equal to 50% of the qualified wages paid, up to $10,000 per employee (in other words up to $5,000 per employee for the 2020 yearend) for wages paid between March 13 and December 31, 2020. Employers that qualify under the CAA expansion will allow them to claim 70% of the qualified wages paid. Additionally, the amount of wages paid per employee now qualifies per quarter (as such, an employer can claim $7,000 per employee per quarter or $14,000 of credit for 2021).
Summary of ERC Changes due to the CAA
The CAA introduced several changes to the Employee Retention Credit that greatly increased the usability and amount available for 2021. As previously discussed, a business is considered qualified if it experienced a 20% drop in gross revenue for 2021 as compared to the relative quarter in 2019. The CAA further expanded the usability of the ERC by allowing businesses that received PPP loans in 2020 or 2021 to also receive the ERC. Such borrowers had previously been precluded from taking the ERC. As a result, otherwise eligible employers are able to claim these credits retroactively by filing amended Form 941s to claim the ERC (using the 2020 rules for other qualification and calculation purposes). For the 2021 ERC, the CAA replaced using 50% of qualified wages per employee per year (through December 31, 2020) up to $10,000 per employee with 70% per employee, per quarter through June 30, 2021. Finally, the credit calculation for 2021 allows businesses with up to 500 or less FTEs to compute the credit under Method 2, as previously discussed.
Example: A business experiences a 20% decrease or greater in its fourth quarter revenue of 2020 as compared to its fourth quarter of 2019, but it did not for the first quarter of 2021 as compared to its first quarter of 2019. The business is able to elect to qualify for ERCs for the first quarter of 2021 by electing to use the quarter prior to the first quarter of 2021. Similarly, if the business experiences a 20% reduction or greater decrease in revenue for the first quarter of 2021 as compared to its first quarter in 2019, the business not only qualifies for the ERC in the first quarter of 2021, but it will be able to qualify for the second quarter of 2021 as well, regardless of the revenue the business receives during the second quarter.
Instructions for Employers: What is the process to claim the benefit?
Eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns, which will be Form 941 for most employers, beginning with the second quarter of 2020. The credit is taken against the employer’s share of social security tax, but the excess is refundable under normal procedures. We recommend that any eligible employers that use a third-party payroll service contact their administrator to determine the proper process for claiming ERCs on their quarterly payroll tax filings.
In anticipation of claiming the credit, employers can retain a corresponding amount of the employment taxes that otherwise would have been deposited, including federal income tax withholding, the employees’ share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes for all employees, up to the amount of the credit, without penalty, taking into account any reduction for deposits in anticipation of the paid sick and family leave credit provided in the Families First Coronavirus Response Act.
Eligible employers can also request an advance of the Employee Retention Credit by submitting Form 7200.
Finally, if you later determine that you qualify for the ERC, an employer can amend its Form 941s for prior quarters to claim the credit and receive a refund for the overpayment.
If you have any questions or if you would like our assistance in calculating and claiming the ERC, please let us know. We’re happy to help!