Yuko Tsuchida, HITO, LLC
Our thanks again to Yuko Tsuchida, CPA, MBA is founder of Hito, LLC, a comprehensive tax advisory and consultancy based in Newport Beach, CA
2020 was an equally tumultuous time for much of the world. It could be said that much of the world shared a similar experience due to the onset of the Covid-19 pandemic. The complexities of a worldwide shut down to slow the spread of the virus seemed to be overwhelming enough on their own. However, a new set of issues labored over by lawmakers throughout 2020 and 2021, becomes enlightened to the public. These issues are the drastic effects which the shutdown imposed on the tax picture of many American workers and business owners. Below, we walk through one of the many incentives offered to mitigate the effects of the shutdown, and common mistakes made when calculating and claiming said incentive.
What is the Employee Retention Credit (ERC)?
The Employee Retention Credit (ERC) is a tax credit offered by the IRS designed to incentivize employers to retain their employees during the 2020 economic shutdown. This credit is fully refundable, meaning that employers can essentially receive cash back from taxes paid in 2020 for eligible employees. This credit applies to qualified wages which were paid from March 12, 2020, to January 1, 2021, originally. However, through the American Rescue Plan Act of 2021, the deadline has been extended to December 31, 2021.
To qualify for the ERC, a business must either have been fully or partially suspended or gross receipts for any 2020 quarter were less than 50% or for 2021 quarters were less than 20% of their gross receipts for the same quarter in 2019. The shutdown must be the result of a governmental order and the business only must meet one of these standards to qualify.
1. Businesses can’t claim the ERC and receive PPP (Paycheck Protection Program) loan funds.
For the tax year 2020, business owners may claim the Employee Retention Credit if they did not receive the Paycheck Protection Program (PPP) as authorized under the CARES Act. However, the Consolidated Appropriations Act of 2021 expanded the eligibility to include PPP recipients. Now, the small businesses who received the PPP loan can claim the ERC going back to 2020 as well as 2021. The wages paid with the PPP loan cannot be included in the ERC computation basis. More specifically, wages paid to employees for purposes of the ERC may not be considered in application for PPP loan forgiveness.
Employers may not use the same wage base to claim the Work Opportunity Tax Credit in conjunction with ERC, as there will be no “double dipping”. Additionally, they may receive the family and medical leave credit as well as the ERC but simply not on the same wage base.
See the link below and read heading I. “Purpose”, subsection D and myth 5 for more specifics on claiming ERC when PPP loan funds are in consideration.
2. Businesses are not eligible for the ERC if they experience a decline in revenue in 2020 alone.
Employers can qualify for the ERC when they experience a significant decline in gross receipts. In general, a significant decline is measured by determining the first calendar quarter in 2020 in which gross receipts were 50% less than (this amount is 20% for the year 2021) that same quarter in 2019. Then, the employer must determine the calendar quarter in which their gross receipts became 80% of the same calendar quarter in 2019. The period between gross receipts being 50% of prior year respective quarter gross receipts, and the time when gross receipts increase to 80% of gross receipts for the respective corresponding prior-year quarter, is the time frame in which a business experiences a significant decline in gross receipts. If the decline in gross receipts does not meet these standards, then the business does not qualify. See the link to the IRS website below for more information relating to ERC eligibility.
There are other considerations in regard to this aspect of the ERC. See the IRS link below for ERC information on defining gross receipts, calculating ERC for businesses not in existence prior to 2020, acquired business and considerations for tax-exempt and non-profit organizations. Contact your CPA or an ERC professional to learn how your business can qualify for ERC.
On important note for this aspect of the ERC is that your business does not need to prove that the decline in gross receipts is directly related to the Covid-19 pandemic. However, an explanation of why and how credits were calculated are necessary for audit purposes.
3. Businesses are not eligible for the ERC if they shut down for only a portion of the year.
Businesses which were shut down due to governmental order are considered to have been partially or fully shut down, and therefore are eligible to claim the ERC, assuming they meet all other requirements. Essential businesses which were not required to shut down, may meet this standard of qualification for the ERC if their operations were affected by their suppliers.
If a business discontinued operation due to a governmental order but was still able to conduct portions of the business remotely, then this would be considered a partial shutdown. However, if the business simply had to make modifications to operations, such as implementing items that would satisfy social distancing requirements, but remained fully operational, then they do not qualify for ERC under the full or partial shutdown rule.Follow the link below for more in-depth information on partial and full shutdowns by governmental order.
Please note that when businesses operate under different entities or branches in which one entity or branch was considered essential and another not considered essential they could qualify for ERC. In this circumstance, a business may be considered to have had a partial shutdown if due to a governmental order, if the non-essential portion of the business which was shut down is considered more than a nominal portion of business operations. If the business is considered essential and does not experience a full or partial shutdown, they may be eligible for the ERC if they experienced a significant decline in gross receipts.
4. Parent companies don’t need to worry about how their subsidiaries handle the ERC or PPP loan funds.
Employers will need to carefully determine whether or not they will be aggregated and seen as a single taxpayer though operating under multiple entities. This may already be determined for other tax code purposes. Specifically, a group of related entities will be aggregated and seen as a single taxpayer as defined under section 52(a) or (b) of the Internal Revenue Code (IRC) or section 414(m) or (o) of IRC.
The reason that the aggregation may already be determined under these codes is that section 52(a) and (b) are used to determine when a group of related entities is treated as a single taxpayer for the purpose of use of certain tax credits. Section 414(m) and (o) are used to determine when related entities are aggregated and treated as a single employer for retirement and certain other employee benefit rules. See the link below for more specifics on how to determine if a business should be aggregated based on these rules and for consideration of the ERC.
Ultimately, the impact of the aggregation is having to view all related entities as one when determining eligibility for the ERC based on these guidelines:
- Determining if the business was subject to a full or partial government shutdown.
- Determining whether the business sustained a significant decline in gross receipts.
- Determining whether the employee had 100 full-time equivalent employees (500 full-time equivalent employees in 2021).
- Determining ineligibility for the ERC if one of the affiliated groups received PPP loan funds.
5. All wages are eligible for the ERC calculation regardless of their source or purpose.
Businesses must be certain that they are classifying the proper wages in their calculation of the ERC. First, the period in consideration is March 12, 2020, to December 31, 2021 for wages paid relating to ERC. The IRS has then determined that the wages paid to employees will be eligible depending upon the average number of employees in 2019.
For employers that averaged more than 100 full-time employees in 2019, wages are qualified when they are paid out to employees when they are not providing services. This time in which they are not providing services can be due to full or partial shutdown or suspension of operations, or due to a significant decline in gross receipts.
For employers that averaged less than 100 full-time equivalent employees in 2019, wages are qualified when they are paid to any employees during such time that business operations are fully or partially shut down due to governmental order, or due to a significant decline in gross receipts. The credit is up to $5,000 for 2020 that is 50% of qualifying wages up to $10,000. There are several other considerations to this aspect of the ERC, including wages paid to related parties of business owners, aggregation rules and how they affect the determination of the 100 full-time employee rules, as well as other wage items such as taxes which may or may not qualify towards the ERC. See the link to the IRS website below for more comprehensive information on this portion of the ERC.
For employers that average less than 500 full-time equivalent employees in 2019, wages are qualified when paid to any employees during such time that business operations are fully or partially shut down due to governmental order, or due to a significant decline in gross receipts. The credit is up to $7,000 for each quarter in 2021. The credit is 70% of qualifying wages up to $10,000 per quarter.
One additional note regarding qualified wages has to do with health care plan expenses. Be aware that qualified health care plan expenses qualify for the wages paid portion of the ERC. Essentially, qualified health care plan expenses are those paid by the employer to help maintain a group health care plan. These expenses are only qualified if they are excluded from the gross income of employees under the plan.
The amounts of qualified health care plan expenses which will be qualified are those paid by both the employer and employees. However, the employee portion can only be counted in this amount if they are pre-tax contributions. After-tax contributions are not eligible as pertaining to the ERC. As well as each of these mistakes, several other considerations require careful attention when determining the number of wages paid for the ERC. See the link below for more comprehensive information.
The Employee Retention Credit is one of the many ways in which the government is making attempts to ease the financial burden of economic shutdowns induced by the Covid-19 pandemic. The eligible employer can qualify for up to $33,000 refundable credits from March 2020 through December 2021.. Be sure to read the IRS updates and guidelines carefully, and enlist the help of qualified and trusted professionals.
If you want to learn more about maximizing tax credits with adherence to IRS laws and regulations, contact us at hitollc.com for a free consultation.
Update to ERC: https://www.irs.gov/pub/irs-drop/n-21-20.pdf
ERC Update Notice: https://www.irs.gov/pub/irs-drop/n-21-20.pdf