It’s not too late to take advantage of the employee retention credit (ERC) for either 2020 or 2021. The ERC is a tax credit available for eligible employers to claim against qualified wages paid after March 12, 2020, through December 31, 2021. Eligible employers may claim a refundable tax credit against their share of Social Security tax equal to 50% of qualified wages paid to employees after March 12, 2020, and through December 31, 2020, and 70% of qualified wages paid to employees after December 31, 2020, and through December 31, 2021. Qualified wages for 2021 are limited to $10,000 per employee per calendar quarter, meaning the maximum ERC is $7,000 per employee per quarter.
Determining Eligibility
In general, there are two ways to qualify for the credit. An eligible employer is an employer carrying on a trade or business operation that was fully or partially suspended due to a government mandate or order or a business that experiences a decline in gross receipts, according to specific threshold requirements. Employers can elect to qualify for ERC based on the previous quarter’s gross receipts test. In addition, once elected, you aren’t required to use said election consistently for the remaining quarters.
For the purposes of determining 2020 ERCs, a small business is one with 100 or fewer average full-time employees in 2019, and a large employer is one that employed more than 100 full-time employees in 2019. For 2021 ERCs, a small business is one with 500 or fewer average full-time employees in 2019, and a large employer is one that employed more than 500 full-time employees in 2019. To determine full-time employees for ERC purposes, include only employees with an average of at least 30 hours of service per week or 130 hours of service in the month in any calendar month in 2019.
Recovery Startup Businesses – Recovery Startup Businesses may be eligible for ERC, even if they don’t meet the full/partial suspension of operations or gross receipts test. A recovery startup business is an employer:
- that started the business after February 15, 2020;
- has average annual gross receipts for the 3-taxable-year period ending with the taxable year that precedes the calendar quarter being tested that do not exceed $1 million; and
- that is otherwise ineligible for the ERC due to a full/partial suspension of operations or a decline in gross receipts.
This requirement is evaluated separately for each quarter. The ERC is calculated at the group level, including affiliates, so aggregation rules apply. For these businesses, the ERC cannot exceed $50,000 for the third or the fourth quarter in 2021.
Family Attribution Rules – Business owners owning more than 50% should review the guidance in detail. Family attribution rules may come into play, limiting the owner, spouse, and family member’s wages that may qualify for ERC.
Calculating Gross Receipts
An eligible employer must demonstrate a reduction in gross receipts for a calendar quarter in 2021 of at least 20% when compared to the same calendar quarter of 2019. A reduction in gross receipts of at least 20% in the fourth quarter of 2020 compared to the fourth quarter of 2019 would also qualify for the ERC for the first quarter of 2021.
Similarly, a business can use the prior quarterly election to determine eligibility. For example, a reduction in gross receipts of at least 20% in the first quarter of 2021 compared to the first quarter of 2019 would qualify the business for the ERC for the second quarter of 2021. These elections are independent by quarter, meaning if you choose to use the prior quarter election for the first quarter of 2021, you do not need to use the prior quarter election for the second quarter of 2021.
Qualified Wages
In general, qualified wages include healthcare expenses to the extent that they are excluded from employees’ gross income. Businesses may also use healthcare costs paid on behalf of furloughed employees. Both the employer and employee pre-tax portion of health plan expenses are qualified wages; however, HSA contributions are not considered eligible health plan expenses.
Aggregation rules apply for determining employee counts and eligible wages. If you own other businesses or have common ownership, review the aggregation rules.
Wages claimed on your income tax return must be reduced by the ERC in the tax year in which the period the ERCs were claimed falls. For example, if you claimed ERCs for any quarter in 2020, you must reduce wages deducted on the 2020 income tax return by the amount of the ERC, which may mean filing an amended income tax return.
For larger employers that do not meet the ERC definition of a small business, qualified wages include wages paid to employees when they did not provide services and exclude vacation, or other leave paid pursuant to the employer’s existing leave policy.
For the purposes of determining 2020 ERCs, a small business is one with 100 or fewer average full-time employees in 2019, and a large employer is one that employed more than 100 full-time employees in 2019. For 2021 ERCs, a small business is one with 500 or fewer average full-time employees in 2019, and a large employer is one that employed more than 500 full-time employees in 2019. To determine full-time employees for ERC purposes, include only employees with an average of at least 30 hours of service per week or 130 hours of service in the month in any calendar month in 2019.
Double Dipping
While the Paycheck Protection Program (PPP) forgiveness income may be excluded from gross income when calculating gross receipts for determining ERC eligibility, employers cannot use the same wages for both ERC and PPP forgiveness.
Additional Resources
- IRS Notice 2021-20 (guidance for qualified wages paid after March 12, 2020 & before January 1, 2021)
- IRS Notice 2021-23 (guidance for qualified wages paid after December 31, 2020 & before July 1, 2021)
- IRS Notice 2021-49 (guidance for qualified wages paid after June 30, 2021 & before January 1, 2022)
- IRS ERC FAQ Webpage
While the ERC is currently set to expire on December 31, 2021, the program may be ending earlier than expected. Proposed legislation in the latest iteration of the Infrastructure Bill calls for the program to end on October 1, 2021.
ARB will keep a close watch on the situation and any updates as the Infrastructure Bill and other legislation unfolds. If you have any questions, contact me today.
by Holly Ferguson, CPA
Holly Ferguson is a principal at ARB and the Practice Leader of the firm’s Accounting & Attest, Manufacturing, and Credit Union Services Teams. She provides industry-specific services for manufacturers, distributors, credit unions, businesses, and nonprofit organizations. Throughout her career, Holly has provided manufacturers with financial reporting consulting services, assisted with transactional accounting and consulting related to business acquisitions/sales, and analyzed implications and strategic implementation of new accounting standards. She is the former Treasurer on the Board of Directors and Finance Committee of the Manufacturers Association of Maine.
