The Employee Retention Credit (ERC), which was created to encourage employers to keep their workforces intact during the COVID-19 pandemic, has been with us for a year. But questions about it remain for many employers. With the new American Rescue Plan Act (ARPA) extending the credit and expanding eligibility — and the credit worth as much as $28,000 per employee for 2021 — employers should brush up on the details.
The original credit: CARES Act
As originally introduced under last year’s CARES Act, the ERC was a refundable tax credit against certain employment taxes equal to 50% of “qualified wages” — including health care benefits — up to $10,000 per eligible employee from March 13, 2020, through December 31, 2020. An employer could qualify for the ERC if, in 2020, there was a:
- Full or partial suspension of operations during any calendar quarter because of governmental orders limiting commerce, travel or group meetings because of COVID-19, or
- Gross receipts dropped more than 50% compared to the same quarter in the previous year (until gross receipts exceed 80% of gross receipts in the earlier quarter).
The definition of “qualified wages” depends on staff size. If an employer averaged more than 100 full-time employees during 2019, qualified wages are generally those paid to employees who aren’t providing services because operations were suspended or due to the decline in gross receipts. Qualified wages may include certain health care costs and are capped at $10,000 per employee. These employers could count wages only up to the amount that the employee would’ve 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, also including health care costs and capped at $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 employees are providing services.
The first extension: CAA
The Consolidated Appropriations Act (CAA), which was enacted in December of 2020, extended the credit for eligible employers that continue to pay wages during COVID-19 closures or recorded reduced revenue through June 30, 2021, as well as expanded the ERC rate of credit from 50% to 70% of qualified wages.
Those weren’t the only changes the CAA made to the ERC, though. Additionally, the law further expanded eligibility by:
- Reducing the required year-over-year gross receipts decline from 50% to 20%,
- Providing a safe harbor that allows employers to use previous quarter gross receipts to determine eligibility,
- Increasing the limit on creditable wages from $10,000 in total to $10,000 per calendar quarter (that is, $10,000 for first quarter 2021 and $10,000 for second quarter 2021), and
- Raising the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees (meaning wages qualify for the credit even if the employee is working).
Under the CARES Act, Paycheck Protection Program (PPP) loan borrowers weren’t allowed to claim ERCs. The CAA also provided that employers that receive PPP loans still qualify for the ERC for qualified wages not paid with forgiven PPP funds. (This provides an incentive for PPP borrowers to maximize the nonpayroll costs for which they claim loan forgiveness.)
LATEST UPDATES: ARPA
Most recently, the ARPA further extended the ERC from June 30, 2021, until December 31, 2021. The 70% of qualified wages is also extended for this period, as is the allowance for up to $10,000 in qualified wages for any calendar quarter. This means an employer could potentially have up to $40,000 in qualified wages per employee through 2021. It also makes some changes that apply solely to the third and fourth quarters of the year. For example, the credit will be applied against an employer’s share of Medicare taxes, rather than Social Security taxes; excess credits continue to be refundable.
The new law expands the pool of employers who can take advantage of the credit by establishing a third path — beyond the suspension of operations or decline in gross receipts — to eligibility. Now, so-called “recovery startup businesses” may also qualify for the ERC.
A recovery startup business generally is an employer that:
- Began operating after February 15, 2020, and
- Has average annual gross receipts of less than or equal to $1 million.
While these employers can claim the credit without suspended operations or reduced receipts, it’s limited to $50,000 total per quarter.
The ARPA also targets extra relief at “severely financially distressed employers,” meaning those with less than 10% of gross receipts for 2021 when compared to the same period in 2019. Such employers can count as qualified wages any wages paid to an employee during any calendar quarter — regardless of employer size. Otherwise, the ARPA continues to distinguish between large employers and small employers for purposes of determining qualified wages.
For large employers that averaged more than 500 full-time employees during 2019 (or 2020 if the employer didn’t exist in 2019), qualified wages are those paid to an employee who isn’t providing services because of the circumstances that made the employer eligible for the ERC. For smaller employers, qualified wages include wages paid — regardless of whether the employee was working — during the period of suspended operations or the calendar quarter in which the gross receipts test was satisfied.
Qualified wages can’t include wages used to compute other credits, loan forgiveness or certain grants received from the Small Business Administration. This applies to all eligible employers.
Note that the ARPA extends the statute of limitations for the IRS to evaluate ERC claims. The IRS will have five years, as opposed to the typical three years, from the date the original return for the calendar quarter for which the credit is computed is deemed filed.
IRS guidance on “partial suspension of operations”
In early March 2021, prior to passage of the ARPA, the IRS issued additional guidance on the ERC. Among other things, it provides some help for determining whether operations were partially suspended because of a COVID-19-related government order.
The IRS has previously stated that “more than a nominal portion” of operations had to be suspended. In Notice 2021-20, it explained that this criterion is met when:
- Gross receipts from the suspended operations are 10% or more of total gross receipts,
- Hours of service performed by employees in the suspended operations are 10% or more of total hours of service, or
- Modifications to operations result in a reduction of 10% or more of the employer’s ability to provide goods or services.
The notice provides additional guidance, but it’s applicable only for the ERC in 2020.
A complicated calculation
The precise amount of your ERC will vary depending on the period, your number of employees and other factors. We can help ensure that you properly calculate your credit and don’t leave money on the table.
We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you.