The good news: The extended and expanded employee retention credit (ERC) from the Consolidated Appropriations Act (CAA) could have significant benefits for you and your business. The somewhat confusing news: The guidance surrounding the ERC tends to be fact-specific and tedious.
However, any confusion or questions you may have about the credit can be sorted through with expert help.
Baker Tilly has a put together set of comprehensive resources available to assist businesses that are considering taking advantage of the ERC. The guidance we currently have is not always clear, which is why it is important to call in the experts when it comes to this hot tax topic.
The CAA made several significant employer-friendly changes to the ERC and has effectively created two separate versions of the credit, one for 2020 and another for 2021. The American Rescue Plan Act (ARPA), signed into law in March of 2021, made additional prospective changes. Specifically, for the third and fourth quarters of 2021, the ARPA created two new classes of employers:
- Recovery Startup Businesses, which are businesses that started operations after Feb. 15, 2020, and whose average gross receipts determined using certain 3-year look-back rules do not exceed $1 million; and
- Severely Financially Distressed Employers, which are businesses whose gross receipts in the third or fourth quarters of 2021 fall below 10% of the comparable quarter in 2019.
Baker Tilly developed a flowchart that outlines the differences between the two and guidance on how to determine eligibility.
Signed into law in late 2020, the CAA comprises several bills that provide continued economic relief from the COVID-19 pandemic. Chief among this relief is an extended and expanded employee retention credit featuring sweeping changes impacting its availability both retroactively and prospectively. Due to the prospective nature of notable changes to the now extended ERC, the CAA, in effect, creates an entirely new credit for 2021 that is separate and distinct from the ERC available in 2020. “It appears to offer a significant opportunity for many employers,” says Chase Murphy, Partner, Baker Tilly. “Employers are strongly encouraged to work with their tax advisors to explore eligibility to ascertain if one or more opportunities are presented.”
The Coronavirus Aid, Relief, and Economic Security (CARES) Act incentivized employee retention by offering a payroll tax credit based on employee wages paid or incurred from March 13, 2020, through Dec. 31, 2020. However, the CARES Act prohibited the Paycheck Protection Program (PPP) loan recipients from also taking an ERC. Given the immense popularity of the PPP, this limitation excluded numerous employers from eligibility for the credit. The CAA changes this by striking this prohibition from the CARES Act and allowing employers to potentially benefit from both the PPP and the ERC. The CAA also codifies certain guidance previously provided by the Internal Revenue Service pertaining to gross receipts for tax-exempt entities and treatment of certain allocable healthcare expenses such as qualified wages.
For employers that already received a PPP loan in 2020 and are looking to take advantage of the ERC, it is important to understand both how the credit works and that the rules remain unchanged for 2020. Broadly, the ERC is a refundable quarterly payroll tax credit against certain employer payroll taxes. The ERC is available to employers of all sizes that have experienced either a full or partial suspension in their operations as a result of governmental order or a significant decline in gross receipts due to COVID-19.
Qualified wages are limited to $10,000 per employee for the entire year, allowing up to $5,000 in credit per employee. Wages that can be treated as “qualified” hinge on whether an employer is a large or small employer. Specifically, large employers may only count as qualified wages those wages paid for services not rendered, whereas small employers can count all wages paid as qualified.
The ERC available to employers in 2021 should be viewed as a different credit from its 2020 counterpart, a distinction drawn as a result of the sweeping changes that the CAA made to the ERC for 2021 only. These changes, paired with the lifting of the prohibition on PPP recipients, present an opportunity for employers meeting certain eligibility criteria to obtain refundable payroll tax credits of potentially significant dollar value.
Takeaways for 2021
- The large employer threshold increased to 500 from 100. The prior rules permitted employers with 100 or fewer 2019 average full-time employees to count all eligible wages paid as qualifying wages. That limit increased to 500 average full-time employees in 2019, greatly expanding the amount of wages many employers can treat as qualified. However, keep in mind that aggregation rules apply.
- The limit on the amount of qualifying wages per employee increased to $10,000 per calendar quarter in 2021 from $10,000 per calendar year, for total potential qualified wages of $40,000 per employee — four times the limit in 2020.
- The amount of the credit increased to 70% from 50% of qualifying wages, entitling employers to up to $7,000 per employee per quarter in 2021 ($28,000 in total). This is a significant increase of the $5,000 limit for 2020.
- As many employers found eligibility under the Gross Receipts Test out of reach due to the greater than 50% decline in gross receipts requirement, lawmakers reduced the threshold by requiring employers to a greater than 20% decline in gross receipts compared to the same quarter in 2019. Under this change, an employer may elect to have the test determining eligibility for the quarter measure whether the gross receipts for the immediately preceding quarter are less than 80% of the gross receipts for the same calendar quarter in 2019. What is currently unknown is whether the election, once made, is permanent, requiring employers to look at the prior quarter to determine eligibility for the current quarter. Employers may still rely on the Suspension Test to show eligibility in 2021.
- Recovery Startup Businesses can be eligible for the credit without passing the aforementioned gross receipts or suspension tests. The total credit for these employers is limited to $50,000 per quarter (rather than based on a per-employee limit).
- All eligible wages paid by a Severely Financially Distressed Employer are qualifying wages, regardless of their number of average full-time employees.
“Based on these changes to the credit for 2021, a remarkable opportunity is presented to employers that can show they qualify as a small employer for 2021 and experienced a greater than 20% decline in their gross receipts in the fourth quarter of 2020 and/or the first quarter of 2021 compared to the comparable quarter in 2019,” Murphy says. “We encourage you to reach out to your advisor regarding how the above may impact your tax situation.”
Click here to learn more about Baker Tilly and how to maximize the extended and expanded employee retention credit (ERC) from the Consolidated Appropriations Act (CAA) for you and your business.