On March 1, 2021, the IRS issued Notice 2021-20 providing guidance on the 2020 employee retention credit (ERC). Originating in the CARES Act and altered by the Consolidated Appropriations Act (CAA), the 2020 employee retention credit (ERC) is available to employers who experienced a reduction in gross receipts of more than 50% compared to 2019 or if they were subject to partial or full shutdown of their operations. You can read more about the ERC here.
Interaction with PPP loans
This new IRS guidance has been anticipated since December 27, 2020, when the Consolidated Appropriations Act was signed into law, expanding the ERC to recipients of Paycheck Protection Program (PPP) loans.
The employee retention credit (ERC) was signed into law in March 2020 as part of The CARES Act and provided that the credit was not available for recipients of PPP loans. However, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (The Relief Act), one of the smaller acts within the CAA, struck that rule, allowing eligible businesses to benefit from both programs.
IRS guidance was needed due to some complications that surfaced because of the way in which provisions of the CARES Act were written; provisions which were not modified by the Relief Act in December. Specifically, clarity was needed to determine which wages qualify for the ERC when certain wages were already used to secure PPP loan forgiveness.
The same wages cannot be used for both PPP forgiveness and the ERC. The March 1, 2021, IRS Notice clarifies that for wages reported on the PPP forgiveness application and for which forgiveness is secured, the taxpayer is deemed to make an election to not claim the ERC for those wages. In other words, the taxpayer is waiving the right to use the wages it used to secure PPP loan forgiveness. The amount reported on the forgiveness application is critical.
PPP and ERC example
A business received a PPP loan during April 2020 for $200,000. During the loan’s covered period, the business incurred $250,000 in qualified payroll, $50,000 in qualified rent and $10,000 in qualified utilities costs, and those costs were fully expended by September 2020. In October, the business applied for loan forgiveness. Although it could have reported $60,000 in non-payroll costs, for simplicity and since the ERC was not available, it opted to report just the payroll costs of $250,000. The company received full forgiveness in December 2020.
Because the company reported only payroll costs on its PPP loan forgiveness application, $200,000 of payroll costs incurred during the covered period are not eligible for the ERC, even if those wages otherwise qualify for the credit. The company is deemed to have waived its rights to claim the ERC on that $200,000 of wages, even though it did incur other eligible costs. The $50,000 of excess wages can be used for the ERC, since those wages were not necessary to secure forgiveness.
What if the company had reported $250,000 in wages, but also reported $60,000 in other payroll costs? In that case, the company only utilized $140,000 of payroll for PPP loan forgiveness. $200,000 total costs were needed, and $60,000 of non-payroll costs were used, leaving $140,000 of payroll (note that this is more than 60% of $200,000). Since only $140,000 of payroll was used, the other $110,000 of wages can be used for the ERC, assuming other criteria for that credit are met.
Claiming the credit
The IRS Notice makes it clear that to secure the credit, an employer should file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the quarter in which the qualified wages were originally reported. Qualified wages and health plan expenses for the credit are captured on Worksheet 1 of Form 941 and the results are then transferred to the appropriate lines on Form 941-X.
Keep in mind that wages used for COVID sick and leave pay credits cannot be used to claim the ERC either, since the government essentially reimbursed those amounts to the employer.
Given the complexities of the ERC, we recommend that you consult with your payroll service provider or your accountant to discuss determining eligibility for the credit and filing Form 941-X to claim it.
Income tax effect
The Notice indicates that expenses must be reduced by the amount of the credit. Also, even though a credit for the 2020 tax year is not secured until this year, existing laws referenced in the CARES Act indicate that the reduction in expenses must be made in the year the credit is earned. Qualified health plan expenses used to secure the credit should also be reduced. This reduction has the effect of taxing the credit, since a reduced deduction increases taxable income.
For example, let’s say a company that has a December 31 year-end incurred a total of $200,000 of payroll expense during 2020. In March of 2021, it files a 941-X for the 2nd quarter of 2020 to claim an ERC of $25,000 stemming from that quarter’s payroll expense. In April of 2021, the IRS issues the $25,000 refund. The company’s 2020 tax return should reflect a net payroll expense of $175,000. Even though the $25,000 was not received until 2021, since it relates to 2020, the 2020 expense should be reduced.
The Notice provides a rather long list of documentation that should be retained by the business to support the credit. Specifically, documentation of eligibility should be maintained, such as proof of meeting the required reduction in gross receipts or documents showing that its operations were subjected to partial or full shutdown. For businesses claiming full or partial shutdown, copies of relevant government orders, including effective dates and when those restrictions were lifted, will be important.
The Relief Act extended the credit through the 2nd quarter of 2021, and eligibility requirements were relaxed. Now that PPP loan recipients are eligible, it’s important to note that the credit can reduce required Federal payroll tax remittances. This is preferable to waiting until after a quarter ends to secure a refund, which is the only option for securing the 2020 credit.
To learn more about how the 2020 and 2021 ERC provisions work, click here.
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Asheville Boone Marion
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