Given the many compelling political events that occurred during the final months of 2020 (and into 2021), some business owners might not have been as closely focused on the significant changes to the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act[i], that, in many cases, could make a substantial and positive financial impact upon their respective businesses.
The first change—which, amended a prior modification to the original CARES Act provision (I know, it’s the federal government, so bear with me)—was that expenses paid by employers using Paycheck Protection Program (“PPP”) loan funds were legislatively transformed into tax-deductible expenses. This alteration was tantamount to making the PPP loan a tax-free grant from the government provided that the loan is ultimately forgiven. The second change removed the restriction that prohibited employers from simultaneously utilizing the PPP and the Employee Retention Credit (ERC). Moreover, because the lifting of this restriction is retroactive, qualifying employers can actually claim the credit for 2020. In this article, we will briefly cover the changes to the ERC and focus on how employers can take advantage of the credit for both 2020 and 2021.
On December 27, 2020, the Consolidated Appropriations Act, 2021 (“CAA”)[ii], extended the ERC featured in the CARES Act through June 30, 2021. The CAA also amended the CARES Act by modifying the ERC in several ways, some of which apply only to 2021, while others apply to both 2020 and 2021. With respect to CAA’s 2021 modifications to the ERC, eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020, through June 30, 2021. Qualified wages are capped at $10,000 per employee per calendar quarter. Therefore, the maximum ERC amount available is $7,000 per employee per calendar quarter, for a total of $14,000 in 2021.
CAA also amended the CARES Act to allow employers—even those that received a PPP loan that was subsequently forgiven—to retroactively claim the ERC for wages paid after March 12, 2020, through December 31, 2020. Importantly, only those wages not treated as payroll costs in obtaining PPP loan forgiveness can be regarded as “qualified wages” for ERC purposes (i.e., no double counting). Additionally, for 2020, the ERC is limited to 50% of qualified wages up to $10,000. Thus, the maximum amount that can be credited per employee in 2020 is $5,000. Of course, this is an annual limit that can be applied retroactively to March 12, 2020.
How do employers qualify?
Effective January 1, 2021, employers are eligible if they operate a trade or business during January 1, 2021, through June 30, 2021, and experience either:
A full or partial suspension of the operation of their trade or business during this period because of governmental orders limiting commerce, travel or group meetings due to COVID-19, or
A decline in gross receipts in a calendar quarter in 2021 where the gross receipts of that calendar quarter are less than 80% of the gross receipts in the same calendar quarter in 2019 (to be eligible in 2020, the gross receipts were required to be reduced by at least 50%). Significantly, there are additional threshold qualifiers if a business (or a control group of related businesses) had more than 100 full-time equivalent employees in 2020 or, in 2021, more than 500 employees. In either of those cases, an employer could still be eligible for the ERC but only for those employees whom they (essentially) paid NOT to work. Moreover, as mentioned above, provided the business actually paid employees in this context, the ERC cannot be claimed if PPP funds were used for those identical payroll expenses.
Fortunately, if an employer did not exist in 2019, they are able to use the corresponding quarter in 2020 to measure the decline in their gross receipts. In addition, for the first and second calendar quarters in 2021, employers may elect to measure the decline in their gross receipts using the immediately preceding calendar quarter (for e.g., the fourth calendar quarter of 2020 relative to the first calendar quarter of 2021) instead of the same calendar quarter in 2019.
What “orders from an appropriate governmental authority” will enable an employer to qualify for the ERC?
According to the IRS, “orders, proclamations, or decrees from the Federal government, or any State or local government are considered ‘orders from an appropriate governmental authority’ if they limit commerce, travel, or group meetings due to COVID-19 in a manner that affects an employer’s operation of its trade or business, including orders that limit hours of operation and, if they are from a State or local government, they are from a State or local government that has jurisdiction over the employer’s operations (referred to as a ‘governmental order’).”
Clearly, given that a diminution in revenue (i.e., a 20% reduction for 2021 or 50% for 2020) is NOT a prerequisite to ERC eligibility when a business is affected by a government order (for confirmation of this, see the underlined ‘either’ and ‘or’ supra), the above parameters for qualification appear to be extremely broad. For example, here in the Northeast, to my knowledge, every non-essential (who makes that call, btw?) business in New England has experienced some form of limitation attributable to government mandate. In response to the moral hazard ostensibly created by this broad qualifier, the IRS has reigned in and clarified what constitutes a ‘limitation’ for ERC purposes:
“Statements from a governmental official, including comments made during press conferences or in interviews with the media, do not rise to the level of a governmental order for purposes of the Employee Retention Credit. Additionally, the declaration of a state of emergency by a governmental authority is not sufficient to rise to the level of a governmental order if it does not limit commerce, travel, or group meetings in any manner. Further, such a declaration that limits commerce, travel, or group meetings, but does so in a manner that does not affect the employer’s operation of its trade or business does not rise to the level of a governmental order.
A governmental order allows employers to qualify as Eligible Employers for purposes of claiming the Employee Retention Credit without regard to the level of enforcement of the governmental order.”
In deciphering the above language, it is clear that the IRS is gently bringing you down the decision ‘funnel’ of whether you, as a business owner, qualify for the ERC even in the absence of a Q-over-Q revenue reduction. For example, the Service admonishes that an “order” is not what a governor says at a press conference—it must be an actual written and published order from the government. And, even if a state of emergency is declared, unless it affects the actual operation of your business, it really isn’t a government order per se. Finally, if there is an order that would affect the operation of your business, but you decide to defy it and/or the government (police, board of health etc.) decides not to enforce it (either full or partially), it still counts as an order that gave rise to a Credit-able “limitation”. Surprisingly, in the absence of context, the above parameters seem to make sense. However, as the example in the next paragraph demonstrates, the logical can deftly move to the non-sensical in the ‘real world.’
Based on the above, let’s explore a hypothetical scenario that appears to demonstrate the law of ‘unintended consequences.’ Assume that there is an industrial office cleaning company with 60 employees located in the state Y, whose clients are all located in that state as well. The company received a $700,000 PPP loan in June of 2020. Also assume that, in 2020, a government order in state Y that forced many non-essential businesses who are clients of the cleaning company to close. Despite this order, due to increased overall demand for its services, the cleaning company acquired many new clients during the partial shut-down. In addition, several of the cleaning company’s larger clients refused to comply with the order and instead, remained open. As a result, the cleaning company ultimately grew its quarter-over-quarter revenue by 50% in 2020 relative to 2019. Because it is flush with cash from having such a successful year, the company awards a $500 Holiday bonus to all of its employees on December 24th and the Zoom company Christmas party was an absolute ‘blow-out’.
Based on the CAA changes to the ERC, it would appear that, despite its roaring success, the cleaning business would be eligible for the ERC in 2020. In the example given, the government order clearly limited commerce. Moreover, it directly affected the company’s business (the cleaning company could not serve much of its established clientele who complied with the order). Therefore, despite the fact that the company’s top-line had increased substantially, it could still conceivably qualify for the ERC. And, provided that the bean-counters were able to find enough wages between March 12th and December 31st, 2020, that were not cited as justification for PPP loan forgiveness, the company would receive an ERC credit for 2020 of $300,000 ($5,000 x 60 employees).
For those of you keeping track at home, between their PPP and ERC funds, the cleaning company is eligible for a cool $1 million of government assistance in 2020 alone despite the fact that they experienced their best year ever. Hold on, there’s more…
While the cleaning company would have to file a Form 941-X in order to claim the credit on 2020 qualification, for 2021, they would not have to wait until after each of the first two quarters has concluded to apply for the ERC. Rather, in anticipation of claiming the ERC, the company can retain a corresponding amount of the employment taxes that otherwise would have been deposited. Withheld amounts can include federal income tax, the employees’ share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes for all employees, up to the amount of the credit, without penalty. Obviously, this will immediately and appreciably improve the cash flow of the business.
Clearly, like all government programs, understanding the rules of the game is critical to determining whether it makes sense for a business owner to undertake the task of applying for the ERC. Even more important, however, is being mindful that continued financial success is not necessarily a barrier to qualification.
[i] P.L. 116-136
[ii] P.L. 116-260