The Consolidated Appropriations Act, 2021 (the Act) was signed into law by former President Trump on December 27, 2020. While the Act contains many favorable provisions, one provision businesses should be aware of is the Act’s favorable updates and extension of the Employee Retention Tax Credit (ERTC).
What is the Employee Retention Payroll Tax Credit?
The Employee Retention Payroll Tax Credit is an incentive originally created within the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) intended to encourage employers to keep employees on the payroll as they navigate the unprecedented effects of COVID-19.
The CARES Act, signed into law on March 27, 2020, originally did not allow employers to both obtain a PPP loan and claim the ERTC. The Act provides a much-welcomed modification to the CARES Act by now allowing all eligible employers to claim the ERTC, even if they have received a PPP loan. The Act also extended the ERTC to 2021.
Which Employers are Eligible for the Employee Retention Payroll Tax Credit?
An eligible employer is an employer that actively carries on a trade or business during calendar year 2020 or 2021, including tax-exempt organizations, and meets either of the two following tests:
- Government Order Test: An employer is an eligible employer if it experiences a calendar quarter “in which the operation of the trade or business is fully or partially suspended during the calendar quarter due to order from an appropriate government authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to COVID-19.”
- Reduced Gross Receipts Test: An employer is an eligible employer if it experiences a significant decline in gross receipts.
- For 2020, a significant decline in gross receipts is defined as a decline in gross receipts of at least 50 percent in any calendar quarter in 2020 when compared to the same calendar quarter in 2019.
- For 2021, a significant decline in gross receipts is defined as a decline in gross receipts of at least 20 percent in any calendar quarter in 2021 when compared to the same calendar quarter in 2019.
- If this test is failed, a special rule for 2021 allows the eligible employer to use the gross receipts in the fourth quarter of 2020 compared to the same quarter in 2019 to determine a gross receipts decline of greater than 20 percent.
- One thing to note is there are affiliation rules that apply to commonly owned businesses which could impact eligibility for the credit.
What are Full-Time Equivalents, and How Do I Calculate Them?
The number of full-time equivalent (FTE) employees is important as this determines which wages would be available for the credit. In order to determine eligible wages for the ERTC, the average number of FTEs employed during 2019 must be determined.
The 2019 reference period for the FTE calculation is to be used for both the 2020 and 2021 eligibility period. According to the IRS, “An employer that operated its business for the entire 2019 calendar year determines the number of FTEs by taking the sum of the number of FTEs in each calendar month in 2019 and dividing that number by 12.”
It is important to note FTEs because there are different provisions for small and large eligible employers.
- For 2020 credits, an eligible employer is deemed to be a small employer if they have 100 or fewer FTEs.
- For 2021 credits, an eligible employer is deemed to be a small employer if they have 500 or fewer FTEs.
What are Eligible Wages under the Employee Retention Payroll Tax Credit?
Eligible wages for a small employer are all wages and health insurance benefits paid to an employee during the time period in which the employer is considered an eligible employer.
Eligible wages for an eligible employer that is not considered to be a small employer are wages and health insurance benefits paid to an employee who is not providing services due to the effects of the pandemic. In addition, eligible wages paid to an employee in this category cannot be in excess of the amount such an employee would have been paid 30 days immediately preceding the pandemic.
- For 2020, wages under this provision mean wages paid for employment when the employer is deemed to be an eligible employer from March 13, 2020 to December 31, 2020.
- For 2021, wages under this provision mean wages paid for employment when the employer is deemed to be an eligible employer from January 1, 2021 to June 30, 2021.
Eligible wages can only be incurred when the employer is considered an eligible employer. Therefore, if the employer no longer meets the criteria for eligibility, generally they no longer have eligible wages for the credit.
How is the Employee Retention Payroll Tax Credit Calculated?
In 2020, eligible wages paid to each individual employee that may be used to calculate the ERTC for all calendar quarters may not exceed $10,000. In other words, the employer is allowed a maximum $5,000 ($10,000 x 50 percent) credit per employee for all calendar quarters in which eligible wages are paid.
In 2021, eligible wages paid to each individual employee that may be used to calculate the ERTC may not exceed $10,000 per each quarter. In other words, the employer is allowed a maximum $7,000 ($10,000 x 70 percent) credit per employee for each calendar quarter in which eligible wages are paid. Any eligible wages taken into account in determining the ERTC allowed shall not be taken into account as wages for purposes of various other tax credits and PPP loan forgiveness.
It’s important to note that the ERTC is subject to income tax due to the fact that the employer’s aggregate salary deductions are reduced by the amount of the credit.
How Does My Company Claim the ERTC?
The ERTC is a payroll tax credit (not an income tax credit) and is ultimately to be reported on Form 941. Eligible employers can claim the ERTC by computing the ERTC amount for a pay period and decreasing the required payroll deposit by that amount.
In anticipation of receiving the ERTC, employers can reduce employment tax deposits with the IRS or request an advance of the ERTC from the IRS on Form 7200 Advance Payment of Employer Credits Due to COVID-19. Advance payments are available to small employers (less than 500 full-time employees) due to some limitations including:
- Advance payment shall not exceed 70% of the average quarterly wages paid by the employer in calendar year 2019.
- An employer that was not in existence in 2019 can use the average quarterly wages paid by the employer in calendar year 2020.
- Advance ERTC must be reconciled against the actual ERTC, with a true up or down at the end of the applicable quarter.
In any calendar quarter in which the amount of the ERTC is in excess of the OASDI taxes imposed on the employer, the excess is treated as a refundable overpayment.
What about Items Needing Additional IRS Guidance?
This is a new credit and there are still many questions related to the credit. We are awaiting guidance on many issues including:
- Retroactively applying the ERTC to 2020.
- Interplay of wages deemed paid with PPP loan forgiveness and the ERTC
- Criteria to be used to determine if employees are not providing services
- How the advance of the ERTC works in 2021
Connect With an Advisor
Every business is unique, and each has different needs. The best way to effectively position your business with the benefits of Employee Retention Payroll Tax Credit is to partner with a tax advisor who understands your industry and tax law.
If you believe your business qualifies for the ERTC, reach out to a Warren Averett advisor.
This article was originally published on May 5, 2020 and was most recently updated on February 3, 2021.
This article reflects our views at the time this article was written and should be used as reference only. We recommend that you talk to your Warren Averett advisor, or another business advisor, for the most current information or for guidance specific to your organization.