What is the Employee Retention Credit?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act developed the Employee Retention Credit. Becoming law in March 2020, the CARES Act helps businesses keep employees on the payroll.
Other laws impacting the act include the Consolidated Appropriations Act 2021 (CAA) and the American Rescue Plan Act (ARPA). Both acts amend and extend credits and advance payments through 2021.
Under the ERTC, small to mid-size businesses are eligible to receive up to 50% of qualifying wages paid from March 13th to December 31, 2020. This includes employers receiving a loan under the Paycheck Protection Program (PPP). The maximum is $10,000 in wages per employee.
The CAA increases the tax credit to 70% for employee wages paid through the end of 2021, including some health insurance costs. This credit is for a maximum of $10,000 in wages per employee per quarter during the first two quarters of 2021.
Employee Retention Tax Credit of 2020
The Employee Retention Credit is a refundable tax credit against certain employment taxes. Employer can claimed the Employee Retention Credit equal to 50% of the qualified wages paid to employees after March 12, 2020, and before January 1, 2021. For each employee, wages up to $10,000 can be counted to determine the amount of the 50% credit. The maximum credit the employer can claim is $5,000 per employee in 2020.
For each employee, wages (including certain health plan costs) up to $10,000 (for the year) can be counted to determine the amount of the 50% credit. Employers, including tax-exempt organizations, are eligible for the credit if they operate a trade or business during calendar year 2020 and experience either:
the full or partial suspension of the operation of their trade or business during any calendar quarter because of governmental orders limiting commerce, travel or group meetings due to COVID-19, or
a significant decline in gross receipts.
A significant decline in gross receipts begins:
on the first day of the first calendar quarter of 2020
for which an employer’s gross receipts are less than 50% of its gross receipts
for the same calendar quarter in 2019.
The significant decline in gross receipts ends:
on the first day of the first calendar quarter following the calendar quarter
in which gross receipts are more than of 80% of its gross receipts
for the same calendar quarter in 2019.
If an employer averaged more than 100 full-time employees during 2019, qualified wages are generally those wages, including certain health care costs, (up to $10,000 per employee) paid to employees that are not providing services because operations were suspended or due to the decline in gross receipts. These employers can only count wages up to the amount that the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
If an employer averaged 100 or fewer full-time employees during 2019, qualified wages are those wages, including health care costs, (up to $10,000 per employee) paid to any employee during the period operations were suspended or the period of the decline in gross receipts, regardless of whether or not its employees are providing services.
Employee Retention Tax Credit of 2021
1st and 2nd quarters of 2021
As a result of the new legislation, eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020, before October 1st, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. Thus, the maximum ERC amount available is $7,000 per employee per calendar quarter, for a total of $14,000 for the first two quarters of 2021.
Effective January 1, 2021, employers are eligible if they operate a trade or business during January 1, 2021, through June 30, 2021, and experience either:
A full or partial suspension of the operation of their trade or business during this period because of governmental orders limiting commerce, travel or group meetings due to COVID-19, or
A decline in gross receipts in a calendar quarter in 2021 where the gross receipts of that calendar quarter are less than 80% of the gross receipts in the same calendar quarter in 2019.
Employers that did not exist in 2019 can use the corresponding quarter in 2020 to measure the decline in their gross receipts. In addition, for the first and second calendar quarters in 2021, employers may elect in a manner to measure the decline in their gross receipts using the immediately preceding calendar quarter (i.e., the fourth calendar quarter of 2020 and first calendar quarter of 2021, respectively) compared to the same calendar quarter in 2019.
In addition, effective January 1, 2021, the definition of qualified wages was changed to provide:
For an employer that averaged more than 500 full-time employees in 2019, qualified wages are generally those wages paid to employees that are not providing services because operations were fully or partially suspended or due to the decline in gross receipts.
For an employer that averaged 500 or fewer full-time employees in 2019, qualified wages are generally those wages paid to all employees during a period that operations were fully or partially suspended or during the quarter that the employer had a decline in gross receipts regardless of whether the employees are providing services.
Interact Between PPP loans and ERC
Retroactive to the March 27, 2020, enactment of the CARES Act, the law now allows employers who received Paycheck Protection Program (PPP) loans to claim the ERC for qualified wages that are not treated as payroll costs in obtaining forgiveness of the PPP loan.
3rd and 4th quarters of 2021
American Rescue Plan Act of 2021 extended the ERC for the period of July 1, 2021 to December 31, 2021。For the 3rd and 4th quarters of 2021, the law amended to make the credit available to "recovery start up business", employers who otherwise do not meet eligibility criteria (full or partial suspension or decline in gross receipts)
"Recovery Startup Businesses" are employers: that began carrying on any trade or business after 02/15/2020, that had average annual gross receipts (as determined under rules similar to the rules under section 448(c)(3) of the code) under 1 million for the 3 taxable year period ending with the taxable year that precedes the calendar quarter for which the credit is determined, and do not meet the other eligibility criteria.
The way to calculate the employee retention credit for "Recovery Startup Businesses" is the same as previous discussed. The maximum credit is $7,000 per employee per calendar quarter, but "Recover startup businesses" are limited to $50,000 credit per calendar quarter.
For 3rd calendar quarters of 2021, the law also added that “severely financially distressed employers” may treat all wages as qualified wages during the calendar quarter in which the employer is severely financially distressed; “Severely financially distressed employers” are eligible employers due to a decline in gross receipts, but with gross receipts that are less than 10% of the gross receipts in a calendar quarter as compared to the same calendar quarter in 2019 or 2020, if the employer was not in existence in 2019.
Infrastructure Investment and Jobs Act amended the employee retention credit and only recovery start up business can claim the credit for the fourth calendar quarter of 2021.
Can I still claim the credit after 2021
Despite the expiration date of October 1, 2021, you can still take advantage of the employee retention tax credits if your business is eligible.
If you didn't claim the credit in 2021 or 2020, you may file an amended payroll tax return retroactively to claim the ERTC as a refund. You have 3 years to claim this credit from the date of your original filing of your payroll tax return.
Is the ERC taxable?
Yes and no. The ERC is not includible in gross income, but it is subject to expense disallowance rules, which effectively make it taxable. See Notice 2020-21, Q&As 60-61; IRS FAQs 85 & 86. For example, if an employer received $200,000 in ERCs, then it would be required to reduce its deductible wage expenses, including qualified health plan expenses, by $200,000, thus subjecting it to tax on an extra $200,000 of income (or causing less of a loss if it was in a net loss position). The expense reduction rules apply to the wages, including qualified health plan expenses, paid or incurred in 2020 and that were reimbursed by the ERC. There is no reduction in the employer’s deduction for its share of Social Security and Medicare taxes by any portion of the ERC.
Further, while not mentioned by the IRS in the Notice or its published list of FAQs, the expense disallowance rules likely also require taxpayers to reduce depreciation or basis for any capitalized wages or wages included in inventory under the full absorption method of costing. See Treasury Regulations Sections 1.280C-1; 1.280C-3(b).
IRS guidance on ERC for Majority Owner's Wages
The IRS's release of Notice 2021-49 on Aug. 4, 2021, provides employers with additional guidance on issues of the employee retention credit (ERC), including whether majority owners' wages can be qualified wages for purposes of the credit. The new guidance clarifies that, in a majority of cases, the answer is no (see Section IV.D of the notice, "Related Individuals").
The wages paid to employees with the following relationships to a majority owner of a corporation or of a partnership or other entity are not qualified wages:
A child or a descendant of a child
A brother, sister, step-brother, or stepsister
The father or mother, or an ancestor of either
A stepfather or stepmother
A niece or nephew
An aunt or uncle
A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; and
An individual (other than an individual who at any time during the tax year was the spouse of the taxpayer) who, for the tax year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.
Section 267(c) of the Code provides rules regarding the constructive ownership of stock for purposes of determining whether an individual is considered a majority owner of a corporation.
Applying the rules of sections 152(d)(2)(A)-(H) and 267(c) of the Code, a majority owner of a corporation is a related individual for purposes of the employee retention credit, whose wages are not qualified wages, if the majority owner has a brother or sister (whether by whole or half-blood), ancestor, or lineal descendant. That is, applying the constructive ownership rules of section 267(c), the direct majority owner’s ownership of the corporation is attributed to each of the owner’s family members with a relationship described in section 267(c)(4); further, because each of those family members is considered to own more than 50 percent of the stock of the corporation after applying section 267(c), the direct majority owner of the corporation would have a relationship as defined in section 152(d)(2)(A)-(H) to the family member who is a constructive majority 29 owner. Therefore, the direct majority owner is a related individual for purposes of the employee retention credit.
The spouse of a majority owner is a related individual for purposes of the employee retention credit, whose wages are not qualified wages, if the majority owner has a family member who is a brother or sister (whether by whole or half-blood), ancestor, or lineal descendant (and thus is deemed to own the majority owner’s shares under section 267(c) of the Code) and the spouse bears a relationship described in section 152(d)(2)(A)-(H) of the Code to the family member.
In the event that the majority owner of a corporation has no brother or sister (whether by whole or half-blood), ancestor, or lineal descendant as defined in section 267(c)(4) of the Code, then neither the majority owner nor the spouse is a related individual within the meaning of section 51(i)(1) of the Code and the wages paid to the majority owner and/or the spouse are qualified wages for purposes of the employee retention credit, assuming the other requirements for qualified wages are satisfied.
Example: Corporation C is owned 100% by J. J is married to K, and they have no other family members as defined in Sec. 267(c)(4). J and K are both employees of C. Pursuant to the attribution rules of Sec. 267(c), K is attributed 100% ownership of A, and both J and K are treated as 100% owners. However, J and K do not have any of the relationships to each other described in Secs. 152(d)(2)(A) through (H). Accordingly, wages paid by C to J and K may be treated as qualified wages.
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