Today is one of the most challenging times to be a business owner in recent memory. In order to help business owners and incentivize companies to keep employees on the payroll, the IRS introduced the Employee Retention Credit.
To break this down, I will use two companies to illustrate the different rules and applications of the Employee Retention Credit. Let’s call the first business “Red Company,” which has less than 500 employees.
The second business we’ll name “Blue Company,” which has more than 500 employees. As will be explained, the distinction between the number of employees in each company is important.
The Employee Retention Credit “is a refundable tax credit against certain employment taxes equal to 50% of the qualified wages an eligible employer pays to employees after March 12, 2020, and before January 1, 2021.” However, under the Consolidated Appropriations Act of 2021 ("CAA"), the paycheck protection program and the employee retention tax credit were expanded.
The initial employee retention credit allowed employers a tax credit for 50% of qualified wages of up to $10,000 per employee, which meant the maximum credit a business could claim was $5,000 per employee. The CAA expands this amount and now allowed employers to claim 70% of qualified wages up to $10,000 per employee per quarter.
For both companies, up to $10,000 of qualified wages (including certain health plan costs) for each employee can be counted to determine the total tax credit. Therefore, the employer using the program can now get a payroll tax credit of up to $14,000 per employee for the period from January 1 to June 30 (the first two calendar quarters).
Who is Eligible?
“Employers, including tax-exempt organizations, are eligible for the credit if they operate a trade or business during calendar year 2020 and experience[d] 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 full or partial suspension of business engagement should be easy enough to understand. Many companies did suspend operations and unfortunately some continue to remain shuttered in this financial limbo.
For companies that operated at a loss, gross receipts will need to be tallied up to obtain the Employee Retention Credit.
The IRS defines “gross receipts” in this context as an employer’s 2020 gross receipts being less than 50% of its gross receipts for the same calendar quarter in 2019. However, the "CAA expands eligibility by lowering the necessary gross receipts decline from 50% to 20%.
For example, if in Q1 of 2019, a business had $10,000 in gross receipts, but in Q1 of 2020 a business had $8,000 in gross receipts, that business would be eligible, opposed to needing gross receipts of $5,000 or less under the CARES Act.
For Red Company and Blue Company to qualify, they will have had to either shut down, or partially shut down, due to COVID-19, or witness a decline of 20% in gross receipts for at least one quarter in 2019. These eligibility requirements are the same for all businesses, regardless of number of employees.
A former hang-up that impacted an employer’s eligibility is whether or not they have taken other COVID-19 relief. Under the original CARES Act, employers who took a Paycheck Protection Program loan were not eligible to claim an Employee Retention Tax Credit. But, “the new law also permits employers who received a PPP loan to claim the retention tax credit moving forward if they meet the other qualification criteria.”
“The stipulation for these businesses is they cannot claim the retention credit for any wages they paid out previously using forgiven PPP proceeds.” This rule prevents businesses from “double dipping.”
The elements of eligibility are not dependent on number of employees, but the number of employees plays a large part on qualified wages.
Defining Qualified Wages
In short, qualified wages means: wages and certain health care expenses paid to an employee during the period of suspended operations or declined gross receipts.
As mentioned previously, qualified wages depend on how many employees an eligible employer has. Accordingly, “if an employer had 100 or fewer employees on average in 2019, the credit is based on wages paid to all employees, regardless of whether the employees worked. However, under the new law, that rule now includes all employers with 500 or fewer employees.
If an employer had more than 100 employees on average in 2019, the credit is allowed only for wages paid to employees who did not work during the calendar quarter.” Similar to the standard above, this rule now applies to companies with 500 employees or more on average.
Red Company vs. Blue Company
To help illustrate how this works, the IRS gives a few examples of health plan expenses that are counted towards qualified wages with different sized companies.
For the purpose of this article, Red Company will represent companies with less than 500 employees, and again, Blue Company will represent companies with more than 500 employees.
- Red Company averaged less than 500 employees in 2019 and was forced to suspend its operations in 2020.
- Due to the suspension, Red Company reduced all employee’s hours by 50%.
- In addition, Red Company only paid wages to the employees for the time the employees provided services but continues providing its employees with full health care coverage.
- Red Company’s health plan expenses allowable to wages paid during the period its operations were partially suspended may be treated as qualified wages.
In this example, if the amount of qualified wages to employees was $10,000, then Red Company can get a credit for 70% of the $10,000, which is $7,000.
Remember, the maximum amount that can be counted to determine the amount of the 70% credit is $10,000, (i.e., a $7,000 credit maximum) per employee for each of the first two calendar quarters, or $14,000 per employee for the period from January 1 to June 30.
- Assume similar facts but this time Red Company lays off its employees during the suspension and does not pay them wages but continues to pay the employee’s health care coverage.
- The health plan expenses allocable to the period Red Company’s operations were partially suspended may be treated as qualified wages.
- For employers with 500 or more employees like Blue Company, the only health plan expenses that are allowable as qualified wages are those taken at the time its employees are not working.
- Assume the same facts from “Example 1” above, but this time we’ll focus on Blue Company with more than 500 employees.
- It continues to pay wages only for time worked but provide full health care coverage.
- Blue Company’s health plan expenses allowable for the time that employees are not providing services may be treated as qualified wages.
- It may not treat health plan expenses allowable at the time for which the employees are receiving wages for providing services as qualified wages.
Blue Company suspends operations and pays full health care coverage but:
- It only reduces its employees’ hours by 50%; and,
- It reduces its employees’ wages by 40%; so,
- The employees receive 60% of their wages for 50% of their normal hours.
Here, Blue Company may treat the 10% of wages employees are being paid for the time the employees are not providing services, plus 50% of the health care expenses because the health plan expenses are allowable to the time that employees were not providing services.
Hypothetically, if the total wages for the period were $10,000 and the total health care expenses were $5,000, then the qualified wages for that employee would be $3,500. The tax credit is 70% of the qualified wages, which is equal to $2,450.
Claiming the Credit
"In order to claim the new Employee Retention Credit, eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns.
This will be Form 941 for most employers, beginning with the second quarter. The credit is taken against the employer’s share of social security tax, but the excess is refundable under normal procedures.”
The refund-ability factor of this bill give a big boost to companies who have been hit hard by COVID-19.
Paycheck Protection Program (“PPP”)
As mentioned above, the Consolidated Appropriations Act implemented changes to the original terms of PPP loans. The IRS issued a news release that will now allow “deductions for the payments of eligible expenses when such payments would result (or be expected to result) in the forgiveness of a loan (covered loan) under the Paycheck Protection Program (“PPP”).”
According to a new, guidance the CARES Act was amended to say, “that no deduction is denied, no tax attribute is reduced, and no basis increase is denied by reason of the exclusion from gross income of the forgiveness of an eligible recipient’s covered loan.”
The previous guidances that disallowed deductions for the payment of eligible expenses when the payments resulted (or could be expected to result) in forgiveness of a covered loan are now obsolete.
If your business was forced to suspend its operations, or saw a steep decline in gross receipts, the Employee Retention Credit could shore up your finances until the pandemic is over. If you have more questions about how these policies may impact your business specifically, call the Brotman Law offices – we are here to help.