After the passage of the CARES Act last year, the clear focus of small businesses was on the Paycheck Protection Program (the “PPP”). A slightly less reported feature was the tax credit available for the retention of employees (the “ERC”), largely resulting from the prohibition on utilizing both the PPP and the ERC. When the Coronavirus Response and Relief Supplemental Appropriations Act (“Relief Act”) was passed in December 2020, the ERC was extended and expanded and the limitations surrounding the use of the ERC by PPP borrowers were effectively eliminated. The ERC is designed to aid employers that experienced a significant decline in revenues or were otherwise forced to shut down during the COVID-19 pandemic, but nonetheless retained their employees during that time. Eligible employers that pay qualified wages to some or all employees may use the ERC against applicable employment taxes. In this advisory, we outline considerations when applying the ERC.
1. For what period is the ERC applicable?
The amount and applicability of the ERC a business may be entitled to depends on what tax year the employer was eligible to claim that credit and which act covered that period of time. The CARES Act covers qualified wage payments made by employers from March 12, 2020 and before January 1, 2021. A company may amend their 2020 tax filings to retroactively claim an ERC if it would have qualified but did not apply because the company was participating in the PPP. The Relief Act applies to payments made after December 31, 2020 and before July 1, 2021 (currently available for only the first two quarters of 2021).
2. How do I qualify for the ERC?
For wages paid between March 12, 2020 and December 31, 2020, the CARES Act governs the treatment of eligibility for the ERC. Any private-sector business or tax-exempt organization employer that carried on a business during the calendar year 2020 is eligible to claim the credit if it either: (1) had operations fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19; or (2) experienced a significant decline (defined as greater than 50%) in gross receipts during the calendar quarter compared to the corresponding calendar quarter in 2019.
For wages paid between January 1, 2021 and June 30, 2021, the Relief Act governs the treatment of eligibility for the ERC. The main change with the Relief Act’s test relates to the definition of “significant decline” in gross receipts. Employers qualify under the second prong of the CARES Act test if its gross receipts in a calendar quarter are less than 80% of its gross receipts for the corresponding calendar quarter in 2019. Employers that did not exist in 2019 may use the corresponding quarter in 2020 to measure the decline in their gross receipts.
3. What effect does the size of my business have on the ERC?
While the number of employees an employer has does not affect its eligibility, it does determine what wages will qualify for the exemption. For an ERC with respect to 2020 wages, any employer which averaged more than 100 full-time employees during 2019 is considered “large” and may only claim a credit for those wages paid to employees who are not providing services due to the slowdown of business. For example, if an employer was closed due to COVID-related safety restrictions but nonetheless kept employees on the payroll, those wages qualify for the ERC. Simply paying wages to employees for their services rendered do not count for ERC treatment for “large” employers. On the other hand, “small” employers with 100 or fewer employees may claim a credit for all wages paid to employees during the quarter in which they qualify and are not limited to wages paid to employees who are not performing services.
With the passage of the Relief Act, for 2021 the decisive number of employees for determining whether you qualify as a “small” or “large” business was increased to 500 full-time employees during 2019.
4. How much is the ERC worth?
For 2020, the credit is worth 50% of qualified wages paid per employee, capped at $5,000 per year. For example, an employer would be awarded a $5,000 tax credit for paying its employee $10,000; a $3,000 tax credit for paying its employee $6,000; and a $5,000 credit for paying its employee $20,000 (due to the cap). Qualified wages are capped at the amount the employee would have received for working an equivalent duration during the 30 days preceding the shutdown or the significant decline in gross receipts.
Under the Relief Act and for the first two quarters of 2021, the maximum ERC has been increased to 70% of up to $10,000 in qualified wages that an eligible employer pays per calendar quarter, with a maximum credit of $7,000 per employee, per quarter. This means that the maximum credit for the first two quarters of 2021 is $14,000 per employee. The credit is available even if an employer received the $5,000 maximum credit in 2020. Unlike in 2020, there is no cap on wages, which allows the credit to be claimed on pay increases and bonuses paid in excess of what the employee earned prior to the shutdown or significant declined in gross receipts.
5. Are there any limitation on the credit?
Several limitations within the Original CARES Act have been lessened or removed. For example, while the original CARES Act prohibited an employer that received a PPP loan from claiming an employee retention tax credit, the Relief Act now allows employer recipients of PPP loans to claim the credit—including retroactively for periods beginning as early as March 13, 2020. That said, an employer may not double benefit from the PPP and the ERC. An employer may claim credit for wages that were paid with a PPP loan that was not forgiven but may not claim credit with respect to wages paid with the proceeds of a PPP loan that was forgiven. Employers may also claim a credit for wages that were not paid to employees by the forgiven PPP loan.
In addition, unlike under the CARES Act, certain public entities may now qualify for the credit. This includes colleges and universities, entities with the principal purpose or function of providing medical or hospital care, and certain tax-exempt corporations organized as an instrumentality of the United States.
The ERC may be a potentially significant benefit to employers, particularly for the first two quarters of 2021 as a result of the expanded benefits pursuant to the Relief Act. Your ability to qualify and the restrictions that may be applicable to your situation could, however, be complicated. Please do not hesitate to contact Shannon Zollo, Josh French, or your Nutter attorney with any questions you may have on your ability to take advantage of the ERC.