On-Demand | The Improved Employee Retention Credit
Our panelists gave a detailed analysis of the ERC program and how it could potentially benefit your company.
Jeffrey Kelson:Welcome, I'm Jeffrey Kelson, I co-lead the firm's tax practice and I'm glad to have Ben and Carey here to discuss the pay retention credit which I think is a major, major development. And over 30 years of tax practice, I don't think I've seen something affect such a broad swath of taxpayers entities to this magnitude. So hopefully, we can clarify some of the confusion around it, show the value and the opportunities, and discuss the rules, most importantly.
So today's overview, we're going to talk about encouraging employers to retain employees and their salaries which is really at the heart of what the employee retention credit, hence to mean, pretty simple. This came about in the CARES Act in 2020, but what you'll see today is it wasn't really thought that highly of in 2020 because it couldn't coexist with the PPP for instance, and it was limited to 5,000 employees, maximum 100 employees. So it really didn't get much attention especially for those who were borrowing the PPP. But in the Consolidated Appropriations Act of 2021, that changed everything and you'll see why. Ben and Carey will take you through why this is so much more valuable, exponentially more valuable for 2021.
The credit reduces payroll taxes after any qualified family and sick leave credits to fully refundable tax credit. I think some of the myths about the employee retention credit is you only get back you employ a FICA and that's not true at all, it's just a mechanism of how you get access to the cash through your payroll tax returns, and you'll see how valuable this credit really is. The only thing I will mention, the last thing here is that no deduction is allowed for any wages that you get the credit on. So if you do get a credit to that extent, you reduce your payroll tax deduction, your wage tax deduction, of course, you'll be glad to do that. So let's turn it over now to Ben Aspir, he'll take you through employers eligible for the ERC.
Ben Aspir:Thank you, Jeff. And like Jeff mentioned, the ERC was largely ignored for almost the last eight, nine months because if you took $1 PPP funds, you weren't able to take the retention credit. So among, there are many improvements to the retention credit, almost all of them retained to the 2021 cover period. But one of the biggest changes is to the PPP recipient. So now, the change is retroactive, it's 2020, employers that receive PPP funds are allowed to claim the employer retention credit, the ERC, assuming different wages that are not paid for forgiven PPP proceeds. They don't obviously want you double-dipping by receiving the benefit of PPP forgiveness and also the benefit of the employee retention credit.
So what are the benefits of the employee retention credit? So for all of 2020, the cap was 50% of the first $10,000 in wages per employee for the entire year, so it's a $5,000 of credit. If you look on your size now for the first two quarters, it's 2021, it's 70% of the first $10,000 of wages per quarter. So for the first half of 2021, you can get potentially, a $14,000 tax credit per employee for the first half, you're essentially almost tripling the credit for the entire 2020. So clearly, if a company is eligible for the retention credit, it could be extremely lucrative.
So we have this wonderful credit, what's step number one, how do we qualify for it? So you have to satisfy one of the following two scenarios. You either have to have a significant declining in gross receipts in the quarter that you're measuring. And we'll talk about this optional look back, but that's for later. Let's say you measuring the first quarter of 2021, you looked at the first quarter of 2019, you'll see a theme here, all roads lead back to 2019, you're measuring your employees, which Carey we'll talk about to 2019. So the same thing with gross receipts, you're going to measure it back with 2020, and we'll go into further detail what a significant decline is.
If you don't have a significant decline in your receipts, you have another option. If the company experiences fully or partially suspended operations during any calendar quarter in 2020 of the first quarter or the first quarter or second quarter of 2021 due to orders from a governmental authority, limiting commerce travel or group meetings due to COVID-19 sounds pretty straightforward, it can actually be pretty nuanced and facts and circumstances-based.
So in today's webcast, we'll walk through some examples and hopefully it'll clarify some of that. I'm going to turn it over to Carey to talk about the full-time employee limitations.
Carey Gertler:Thank you, Ben. So as we set the table for 2020 and 2021, it's important to note that this employee retention credit is available to employers of any size, it's not limited to employee size of an organization. However, based upon the number of employees that a company has, will determine how to calculate the credit for that year. So 2020, the cutoff was if you had 100 of full-time employees, as Ben had previously said, you were eligible for up to a credit on $12,000 of annual qualified wages at 50% or $5,000.
One of the beneficial changes to the law for 2021 is that threshold was increased to 500 employees that were eligible for the credit. Now, for either of these two situations, if you had employees that were over 100 or 500 employees, it didn't mean that you were ineligible except the calculation work differently. So if you were under 100 or 500, you did it as we had said. If you're above that number, the qualify wages would depend upon if you were paying people not to work.
So in 2020, if you're more than 100 full-time employees and you pay people not to work for various reasons, those would be the qualified wages for the calculation. And for 2021, that number has increased to 500. So if you had employees more than 500, anything above that, you would be able to only get a credit only for wages paid to people not to work. Now, wages, which we'll get into later on, can also encompass group health insurance, for example, if you had furloughed someone and you paid for their health insurance.
Now, trade or business, so the IRS defines a trade or business under the technical regulation or code 162. So any business that falls within that definition would qualify for this employee retention credit. Also, household employees would not be eligible or self-employed individuals, so you would have that for guaranteed payments for partnerships and other sources. So you have to have W-2 wages in order to claim this. So K-1 ordinary income or guaranteed payments are in K-1 would not qualify for the ERTC, but if you're a Nat. corporation or some other organization, W-2s would be eligible.
Also, this is eligible for tax-exempt organizations both for '20 and '21. For 2020, governmental agencies were not eligible for this. How would that got changed? In the 2021 calculation where it expanded the eligibility allowing institution and other organizations to be eligible for the credit. So it's important to note that you really need to be getting W-2 wages in order to be eligible for the employee retention credit.
The next important thing, and I think this is almost a first determination, is the aggregation rules. So the internal revenue service, I said that you kind of need to look at the ownership and ownership test for an organization. So if you have multiple organizations that are related, and related can be a combination of situations, it could be consolidated, it could be a brother and sister and other types of organizations. So it's important to note that, we'll go through that calculation in a second, but if you are a part of a group, and so you can look at this in a silo, if you're part of an overall group in determining the number of full-time employees, the gross receipts, you would look at the whole group not individual companies. So first you got to determine, "Am I a standalone entity, or am I part of a larger group through common ownership or a consolidation?"
One thing I wanted to know is that, and I think Ben will also touch about this, the calculation for the 100 or the 500 full-time employees is based upon the 2019 average number. So that number is already fixed and that's the benchmark that you use either for 2020 or for 2021. So if you're a part of a consolidated group or an affiliation group, if one company is eligible, the whole group is eligible for the employee retention credits.
So under the aggregation rules, they're looking at a parent, or sub or common ownership that is a 50% ownership threshold. So if you fall into one of these buckets as a control group, brother, sister, or a combination or an affiliation, you got to look at your calculations as one organization. And as I said, if you are a part of a controlled group or an affiliate group, if one of those companies in our example here, if one of 15 or two of 15 portfolio companies that have the common ownership test qualify, then all of the entities would qualify for the employee retention credit based upon whether you're looking at a gross receipt or a shutdown standard.
Jeffrey Kelson: Hey, and while we're entering to polling, we're getting a lot of questions in do S Corp shareholders wages qualify? We haven't gotten to this yet but let me just answer it now. They do not if they own more than 50%, so whether you own it yourself or you own it with a related party and it adds up to more than 50, no, but if you own less than 50% of an S Corp, then your wages would count. So there is a distinction, I'm getting a lot of questions.
Carey Gertler:So Jeff, on that question, so if you are above 50% ownership as you had mentioned, if they are related family members that are working in the company-
Jeffrey Kelson:No, related parties you don't claim as well, Carey, you're right there.
Carey Gertler:Right, we'll get to that but just as it’s brought it up.
Jeffrey Kelson:But it's just not you, attribution applies.
Ben Aspir:So as the polling question stated today, the answer was true, you either have to have a fully or partially suspended operations or a significant decline in gross receipts. So I'm going to walk everyone through the fully or partially suspended operations. So what does that mean, partially or fully suspended operations? So the operation of a trade or business is partially suspended if all three of the following conditions are met. A, an appropriate governmental authority imposes restrictions on the employer's operations, seems pretty straightforward, we'll walk through an example on that. B, the order limits commerce travel or group meetings due to the COVID-19, seems fairly straightforward. And C is the one that's the most nuanced and most facts and circumstance-based, the order affects an employer's typical operations.
So what is a governmental order? It's an order from the city's mayor stating that all non-essential businesses must close for a specified period. It doesn't have to be any of these ones listed, these are just examples. A state's emergency proclamation that residents must shelter in place for a specified period. An order from a local official posing a curfew on the residence that impact the operating hours of a trade or business. And an order from a local health department mandating a workplace closure for cleaning and disinfecting. What wouldn't be counted on this is if a city official or a township official just goes on the 10 o'clock news and says, "We suggest you don't go into the office, it's not safe." It's not an official proclamation, it's not an official government order, it's just a mere suggestion, that wouldn't fall under the governmental order requirement.
So an example on a non-essential business and governmental orders, so if a state governor, and it doesn't have to be state governor, it could be any government official, issues in order that all essential businesses must close from March 29th, 2020 until April 30th, 2020. The order provides a list of non-essential businesses. Employers that provide essential businesses may remain open. So for the nonessential businesses, it dissatisfies the three tasks that I previously mentioned, it's an order from a governmental authority that limits commerce and it affects the operations of the employer trade or business.
So right, you have this non-essential business that could be eligible now, they meet this requirement, so they have eligible quarters. So what that means is, is that from the period of March 29, 2020 until April 30th of 2020, they could potentially count those wages. But once the order is lifted by the government, if the state governor says, "We're going to open up and everyone can go back to the office. They can open their businesses, their factories." You can't count those wages once the order is lifted. Whereas when Carey talks about the significant decline of gross receipts, you could get the whole quarter, whereas, if you have a significant climb you can get the entire first quarter of 2021.
So what about with essential businesses? With the government suspension of operations, there were also businesses that were not required to close. So for example, auto mechanics. So Mechanic Inc is an essential business and is not required to close its locations or suspend its operations. However, Mechanic Incs business has declined significantly. So this will not be considered a full or partial suspension of operations due to a governmental order. I mean, to me, this doesn't seem fair that they were deemed essential and they're almost being penalized. However, you still have this out and they could potentially be considered an eligible employer if they have a significant decline of those receipts. So even though they may not meet the definition for partial suspension operations, if they are adversely affected enough, they could still maybe potentially meet the declining gross receipts requirement.
An example on a non-essential business. So what about companies, this is a question we receive a lot with teleworking, so ABC company maintains an office in a location where the mayor has ordered that all essential businesses may operate. ABC company is within non-essential and under the mayor's order, notice it's a governmental official and it's an official order, deems that ABC company must close. The company has ordered mandatory telework for all employees and limited client meetings to telephone and video conferences.
So at face, you would think, "Okay, they're partially suspended operations." But it's really a case by case basis that needs to be evaluated because, let's say, give an example of EisnerAmper, we're an accounting firm, 98% of the work we can do remotely, fortunately, we have the infrastructure and the resources that the ones, especially for me, I work in New Jersey, when Governor Murphy ordered all non-essential businesses to work remotely, we were able to pick up one day and the next day, basically do almost everything we're doing in the office without limitations, that would very likely not be a partial suspended operations.
Whereas if you have another company that they're a laboratory and they're performing R&D operations, so yeah, so some of the administrative staff can work from home but there's a lot of work that cannot be done, all the research and development in the lab cannot be done from people's basements. So that would likely be a partial suspension of operations. It's important to note, if a company has multi-state operations, multi-jurisdiction operations, if one location has a partial suspension operations, then the entire entity get the benefit of this partial suspension acquirement.
So if it's a multi-state restaurant operation and they have restaurants in California and Southern California isn't allowing sit-down service inside the restaurants but they have restaurants in other states that are completely open, they aren't requiring restaurants to closed. So even though it's just one location or a few locations, the entire entity, you get the benefit of the partial suspension of operations.
Carey Gertler:Okay, so as we kind of now figure out, okay, who is eligible and how do we do it, what quarters are we eligible for? So if you are eligible based upon qualified gross receipts, that would qualify you for a quarter one way. But if you're, as Ben just went through, fully or partially suspended, only the wages that were for the period of suspension would be eligible for that quarter, you don't get that entire quarter. So if you are a company that's in an area where there's an order in effect, you would be a qualified employer but you can only claim the credit for the period that the order was in effect, which is a different calculation if you're falling under the gross receipts test.
So for the gross receipts test, we have to look at all gross receipts not just trade or business sales. You have to look at if you have interest, dividends, rents, royalties anything that would fall under the definition. So I've seen clients that sometimes just look at their sales or revenue but don't realize they have a lot of investment income, and that can really skew the numbers. So it's important to identify gross receipts. Now, this is either for a profit or for a nonprofit organization. So if you have a tax-exempt organization, you might have to look at dues, or membership, or tuition, voluntary revenues, but you got to look at all of your inflows of cash.
Now, in determining the decrease, it doesn't have to be documented that it's due to COVID-19, it just has to be a decrease from one period to another period. So a significant decline in gross receipts for the 2020 rule was that you have to have at least 50% decline from the 2020 quarter compared to the 2019 quarter. And once you hit that quarter, that 50%, you were actually eligible for the whole quarter.
And as the footnote below says, now, in 2020, as you kind of move to the next quarter, you didn't necessarily have to maintain that 50% decrease but long as you maintain a 20% decrease, you were able to get the next quarter. So you can kind of move from quarter to quarter, still have a decrease not 50% but still be eligible for the ERTC under the gross receipts method. Now, if you qualify for one quarter, you automatically get the next quarter. So there's like a two-quarter qualification once you are eligible under the gross receipts.
Jeffrey Kelson:Yeah, I think that's a big thing of the 2021 is that you compare the first quarter of 2021 to the first quarter of 2019, but you can go back a quarter, I'd like to go back a quarter, safe harbor. So you have two shots at the apple, two bites, you have the first quarter which hasn't ended yet, nobody knows or the fourth quarter of 2020 versus the fourth quarter of 2019. Everything is against 2019 because that's a pre-pandemic world, so you obviously look at the comparable quarter.
Carey Gertler:Right, so for the 2021, which is where the rules changed, they made it more beneficial for employers to take the credit is that they reduced the credit from 50% to a 20% decrease from a quarter. And as Jeff said, you compare the quarter that you're into the prior quarter of 2019, and then there's an option where you can look at the prior quarter. So for the first quarter of 2021, you can look at the fourth quarter of 2020 compared to the 2019, and if you have a 20% decrease in that quarter, regardless of what happens in Q1 of 2021, you're eligible for the employee retention credits. And after the close of the first quarter of 2021, if you qualify with at least a 20% decrease in gross receipts, then you will automatically qualify for the first and the second quarter. As Jeff has said, a two for one opportunity to claim the credits.
Jeffrey Kelson:Right, and if you don't qualify in the first quarter or the fourth quarter, you could still qualify for the second quarter on the 2021 second quarter versus 2019 second quarter. Again, 2019 is always the benchmark when you're comparing quarter.
Carey Gertler:Right, so in this example, if we look at the first quarter of 2021, we see we have a 21% decrease in our gross receipts. So we qualify for Q1 employee retention credit and by the mere fact of the safe harbor, we also qualify for the second quarter because we had a prior quarter that was eligible. However, if you look at that on a standalone basis on the second quarter of 2021, we had a 25% decrease. So each quarter qualified independently, but the first quarter qualified both Q1 and Q2. All right, we have to polling question two.
Jeffrey Kelson:We're getting questions about pre-revenue companies, which is a hot button question because how do you go from measure zero to zero? It's an open question. You might have some interest income in the bank, maybe rates gone down and that's gone down, but even then, let's say, I mean, it can get really into weeds if you have like a $1000 of interest income, now you have 400, did you experience a 20% decline? Technically. Is that the intent? Don't know, but you can still qualify under the partial suspension rules, if you qualify under that, you would be okay. We're looking for guidance from the IRS on some open issues such as that.
Carey Gertler:So, Jeff, another question we've seen recently is if you had foreign subsidiaries as part of the parent, part of the ownership and affiliation rules. Right now, we're waiting for additional guidance but it appears that those foreign subsidiaries would go into the gross receipts' calculation but not for the full-time employee calculation.
Jeffrey Kelson: Correct, and looking at your worldwide income, if you have through affiliation, you own more than 50% of a foreign sub, that would count whether you experienced a decline in your gross receipts both in the measuring period of '19 and '21, what you're comparing it to. But for full-time employees, if those foreign subsidiary workers worked for the foreign subsidiary and not for the US company, they would not be counted in the 500 full-time employee that's for 2021, so a lot of nuances.
Jeffrey Kelson:7,000, that's the winner. Actually, 14,000 each quarter, so far, we'll tell you why it's at so far, it's at 14,000. By the way, say you had 500 employees, multiply that by 14,000 and tell me if this credit isn't a big number. So yeah, this is so gigantic.
Carey Gertler:So Jeff, one thing to know, so it's the calculation, as we said before, is based upon the 2019 average numbers, so that's full-time employees. When you're doing the calculation, and I think we'll talk about this as we come up, you're going to do the calculation based upon the full-time employees and potentially, part-time employees so the credit can be more meaningful.
Ben Aspir:Right, the wage is from the part-time employees but you don't need to count the part-time employees when you're calculating the threshold for 100 versus the 500 limit.
Jeffrey Kelson:Good point, so you might have Full-time employees in 2019 and qualify, but then you really have 300 part-time employees, and let's say you've retained them all, so you have 700, you can claim 700 times up to 7,000 because remember 70% of 10,000. So as long as you're paying your employees more than 10,000 a quarter, you can get the full 7,000, good points.
Ben Aspir:So as I like to point out, so Carey just walked us through the significant decline gross receipts and I previously discussed the partial suspension operations. So like Carey mentioned, whereas the significant decline gross receipts, it doesn't have to be related to COVID to help the client, and the company could have lost a big customer had it declined. It doesn't matter why the decline happened, whereas with the partial suspense of operations, it obviously has to be related to COVID.
And if it's determined that a company is eligible under the partial suspension of operations requirement, they should still look to see if they had a significant decline in gross receipts like we mentioned earlier, because if you have a decline in gross receipts, you get the whole quarter, you can use the way just for the entire quarter, obviously, subject to the cap on wages, whereas when you have a suspension of operations, if you take that route, it's only wages paid during the time period of the suspension.
So let's talk about what qualified wages are. So qualified wages also include the employer paid health insurance premiums and they are probably allocable to wages, that can count. Another restriction though is, and this only applies to 2020, they didn't want manipulation of the wages for the ERC, it cannot exceed the amount the employee would have been paid for working the same duration during the 30 days preceding period. They were concerned with wage manipulation artificially inflating wages to claim the retention period. The other-
Carey Gertler:And that was only applicable for 2020. For 2021, there is no look back.
Ben Aspir:Correct, and then wages that are exempt from FICA, let's think about if you have a Dependent Care Flexible Spending plan, Health FSAs, HSAs, those are generally taken out pre-tax at the wages but they're not subject to self-security and Medicare taxes. So those wages will not be eligible for the ERC.
So we're talking about the full-time employee limit, what is a full-time employee for the ERC? So unlike the PPP, we're not going to have 1.2 full-time employees, we either have a full-time employee or we don't. So a full-time employee is in any 2019 calendar month that an average of at least 30 hours of service per week or 130 hours of service in a month. If the employee meets that criteria, they count as one full-time employee. And you see, the company calculates per month, how many full-time employees they had under this definition, they add it all up and they divide it by 12.
This is obviously very important in determining the number of full-time employees because if you're over the threshold, which is over 100 employees for 2020, like Carey said, you can only claim it for employees that did not work. For the tax period of 2021, it's five-fold, it's over 500 employees, which obviously allows significantly more companies to be eligible. So it's 500 or less assuming you have partial suspension operations or a significant decline of gross receipts, you can claim the retention credit on wages paid to employees at work and that didn't work. If you over that, you could only claim the wages for employees that did not work.
Carey Gertler:Right, as we said, this is only for the qualification to determining whether you're above or below the threshold, not for who you're incorporating into the actual calculation for the credit.
Ben Aspir:Right, so it's important maybe, even though if the company is over the threshold, you can still claim it, it's just for employees that didn't work though they got paid to work. If there's been a reduction in hours, if an employee is getting paid 100% of their pay but they've had a 40% reduction of hours and they're getting paid their full salary, you can still claim the credit for 40% of those wages.
Let's walk through an example on the $10,000 cap. So ABC company has eligible quarters in the first two quarters of 2021. Note, they have under 500 full-time employees based on 2019, and during those quarters, ABC company pay a salary in the following amount. So looking at the first quarter of 2021, employee A was paid 8,000. Remember the cap is $10,000 per employee per quarter of 2021. So that's fine, there's no cap on that. B was paid $12,000, so they can claim the credit on the first $10,000. C and D are all paid under $10,000. So that totals up to $24,000 in qualified wages. A is 8,000 of wages, B is 10,000 wages, C is 4,000 in wages and D is 2000 in wages. So they can potentially claim a 70% credit on that which comes out to 70% of 24,000 is 16,800.
Now, let's look at the second quarter of 2021. A is has 7,000 wages, that's fine. B gets paid $22,000 a week. Again, you cap that at the first 10,000 wages. C, it's 10,000 wages, you're fine, and D, you must also cap at the first $10,000. So the total wages seven plus 10 plus 10 plus 10 is 37,000. So 70% of that so they could potentially get a payroll tax credit, an ERC credit of 25,900.
What about a company that has over 500 full-time employees in 2019 for the 2021 credit? So you have a state, the state forced a restaurant to discontinue service, sit-down service, as we've seen in many states, they're allowed to have take out but sit-down service to the first two quarters of 2021 was not allowed. That's a partial suspension of operations. The restaurant continues to pay its kitchen staff because they still have take out that people are come coming in to pick up. The restaurant pays its waiter staff to stay at home and not work, they have no need for waitstaff, however, they still decide to pay its waitstaff. Since they're over 500 employees and it had a partial suspension of operations, they can claim ERC for the wages paid to the waitstaff.
If the restaurant had less than 500 or less than full-time employees in 2019, for purposes of the 2021 credits, they could have claimed the wages for the waitstaff, for the kitchen staff that are currently working for the cashier. If anyone's still working in the restaurant, they will still be able to claim the credit. So the key is how many full-time employees a company had in 2019 and measuring which employees are eligible for the retention credit. Let's move on to our next polling question.
Carey Gertler:So while we're waiting for that, in Ben's previous example when he had an employee that was an excess of the qualified wages in one quarter but less than another quarter, you can't carry forward or carry back wages from a previous quarter, each quarter stands on its own for the calculation purposes.
Jeffrey Kelson: Right, just to let you know, we've got over 100 questions, so we're trying our best. Well, there's a lot of interplay here with the PPP and the ERC which I don't think we touched on yet. But for 2021, you can have both, actually for 2020, but if you're getting forgiveness on payroll, you can't claim an ERC, you can't double that, you can't ask the government to pay for your payroll and then you kind of have a credit on it on top of that.
By the way, the PPP forgiveness is slightly better than the ERC because as you know, the PPP is not taxable, the forgiveness, and the expenses are deductible whereby in a play retention credit, the extent you get the credit, you reduce wages. So if you take them one by one, the PPP is better, but you can have both as long as it's not the same wages. So if you have an eight week covered period and it's a 13 week quarter, it's five weeks of ERC and also you might be able to claim some of the eight week period for the PPP where you're not counting that payroll for the PPP because the PPP has a 60/40, so maybe you have wages in excess of what you're claiming for forgiveness and that might claim in for the play retention credit. That's a big, big change, by the way.
Ben Aspir:Yeah, I mean, with the PPP restriction originally, so many people wrote off the ERC because it took the PPP funds, they couldn't find the ERC. So I'm discussing with people, "Let's discuss the ERC." And they say, "Ah, we're not eligible." I said, "No, the rules have completely changed, you could still claim it even if you took PPP if you have excess wages."
Jeffrey Kelson: Yeah, we just got one last question on the same topic. Got a question, is it good to delay applying for PPP 2? I mean, technically, yes, because you'll get all the weeks up to the date you get the new funds to claim your employee retention credit, but you want to make sure some of the banks are not getting; the funds may run at a certain bank, so you got to be mindful as a business here too, so just be cognizant of that.
Ben Aspir:So the correct answer is false, if you have more than 500 full-time employees, you could only claim the ERC for employees that did not work.
Jeffrey Kelson:Or partially didn't work. You might've had a receptionist that's doing some other job 50% of the time, you can claim that receptionist half of their salary. So it's not 100% to zero, it could be partial.
Ben Aspir:Right, or if there is employees who furloughed and the company was paying their health insurance premiums, they can claim that as well. Carey.
Carey Gertler:Okay, thank you, as we mentioned prior, so there are some other limits in determining what qualified wages would be eligible for the employee retention credit, and these are some of the other limits incalcating what would fall into a qualified wage? So if someone's currently receiving qualified sick or family leave wages, those wages would not be eligible for the employee retention credit so they would not fall into what we call qualified wages. In addition, we also talked about this earlier is that if you are an owner, 50% or greater of an organization, your relatives that work in the company, their wages would not be eligible for the employee retention credit. If you look at the attribution rules under Internal Revenue Code 267, those would be applicable. However, if you were under the 50% ownership test, those relatives' wages would be eligible for the employee retention credit. Also, if you are regetting a work opportunity credit, that would also reduce the qualified wages for calculation purposes.
The other thing to keep in mind is that, even though you might have compensation in a period, for example, like severance, if the employee is no longer working for the company, those wages are not eligible. So even though you might have W-2 wages with no reductions for any of these other type of credit or leave wages, severance paying is an example of something that would not be eligible because the person is no longer working for the company.
Another thing, which changed in 2020, and it's also applicable to 2021 is the ability to include qualified health plan expenses as qualified wages. And people say, "Well, if I have wages, why do I need health insurance? This can be relevant for someone that you might have furloughed." So if someone's furloughed and you're paying for their health insurance, and it's what they call a group health insurance plan, that would be eligible wages and would be eligible for the employee retention credit.
Typically, anything that is pre-tax would be considered in the calculation for the qualified wages. Anything that you're using after-tax money for to pay for health insurance and other items would not be eligible for the employee retention credit. We haven't said it earlier, but there's a really good guy, and I think we have a link on our website to the internal revenue services frequently asked questions and they updated this at one point for the inclusion of the qualified health insurance expense, which is a big help for furloughed or definitely lower compensated people.
So how do you claim the employee retention credit? So here's where everything comes to the end. So the internal revenue source has a couple of methodologies in order for the employer to get this credit. So if someone has determined that they're eligible for the employee retention credit, first, they can reduce payroll tax deposits that they're making that will be eligible for 941. So whether it's social security, Medicare, both employer or employee, also federal withholding tax dollars. So instead of remitting it to the government, the IRS and treasury says, "No, hold on to those." This way you're kind of getting the money today as opposed to waiting for an actual refund.
The second way is to amend the 941. So if you already have, let's say, remitted everything or you're entitled to additional funds, what you do is you would file a 941, claim the credit, and this is a refundable tax credit. Now, you're eligible for that credit whether you file your own 941 or if you're part of a PEO, so-
Jeffrey Kelson:There's a lot of questions on that, PEO.
Carey Gertler:The PEO would be you have to communicate with your PEO and work with them to which wages are qualified, obviously, on an ongoing basis, and if you are looking to amend the 2020 because, let's say, now that I'm eligible, because the PPP funds don't exclude me or if I took PPP funds, I'm not excluded from taking the credit, you would have to amend your 941. And so, if you're working with a PEO, you'd have to coordinate that amendment with them, or if you're filing your own, you would have to file a 941.
Now, the guidance says in amending the 941 for 2020, two methodologies. One is if you were a PPP recipient, so if you received funds from PPP and whether or not you've gotten forgiveness or not, you're allowed to amend the fourth quarter 941 and record your cumulative adjustment in the fourth quarter. If you did not take PPP funds, you were not a recipient of that program and you want to go back now when amend 2020, you would have to amend each quarter, the applicable quarter for where the credit was calculated and file that for each of the quarters.
And the third way, if you need to, or want to, or have to accelerate your refund, there's an interim filing prior to filing a 941, it's called Form 7200. And this allows you to claim a quick refund from the IRS, it's as a one or two-page form. But this form is not a standalone entity. This form then would be used to follow your quarterly 941 and a true-up at that time. The concern is that if you follow a Form 7200, and let's say there was a mistake or error in that calculation, those penalties would not be abatable because you filed this form. So we want to be careful in filing this form, do it based upon the relevant information.
Ben Aspir:Today's February 18th, and the 941's due at the end of March. If you think you're going to get it, maybe just wait a month and a half, and follow on your 941, and not worry that you might've overshot.
Jeffrey Kelson:And you can only file the 7200 if the 941 has been filed. And so, if it's determined that you are due a credit 2020, you can not file the 7200. It's only just looking for 2021 credits.
Carey Gertler:Right, so for example, today is February 18th, if you felt you were entitled to a credit and you've already remitted your payroll deposits to the Internal Revenue Service and you want those back or you need them back today, you would follow the 7200, but when you follow the quarterly, that would be in the part of the true-up process.
Ben Aspir:Someone asked a good question, I was asked this previously as well, what's the filing deadline to claim the ERC? It's the statute of limitations on the 941 which is generally three years from the filing date. So just be aware, it's three years from the original 941 filing date to claim the retention credit. But obviously, if you can claim it now, you don't have to go back and amend, and then you also have to adjust the deduction on the entry return, that's obviously sooner the better.
Carey Gertler:So that's an important thing to note is that if you're filing an amended return, you have three years to file that. It has to be coordinated with your income tax, the entities filing, because there is a non-deductible piece that has to be considered in that calculation. So you can't just amend one without the other, there has to be coordination between the two so that they are in agreement.
Okay, here is a kind of a summary of everything that we talked about today as it relates to the 2020 and the 2021 credit. It kind of just summarizes on a high-level kind of what the rules are, the 50%, 70%, the qualified wages decline. So the 2020 credit calculation is the same credit that was prior except that the one major change that came out was that if you got PPP funds, you're eligible for the employee retention credit. Where in 2021, they made it a little easier with a lower benchmark going from 50%-20% decline in gross receipts and upping the credits up to $14,000 for the first half of 2021 versus $5,000 of 2020.
Jeffrey Kelson:Yeah, let's do the math just to show you the difference in 2020 versus 2021. Assuming you had 100 employees unqualified and that was the max, in 2020, at 5,000, the max you can get for the year, the most you could've gotten was 500,000, that's assuming you're not double-counting with a PPP figure, 500,000. I know it's a big number, but let's compare it to 2021 where it's $14,000. Because two quarters at seven and up to 500 employees, maybe even having more than 500 because you have part-time, now you're talking seven million or more, so 14 times as much, it's gigantic.
And I don't know if we've mentioned this yet, but there's a bill in Congress right now to extend the ERC through the end of 2021 which might make an even 28000 employee. So then the math gets doubled on there, it's big numbers.
Carey Gertler:Also, one thing to note is there's a lot of guidance that we're going to hopefully come out in the next couple of weeks that will clarify some of the things. And one of the bigger questions that we've had is, "If I've applied for forgiveness," just an easy example, "If I had a million-dollar PPP loan, if I had wages of 1,000,005 and I just, for ease of calculation, included the 1.5 million on my loan forgiveness, am I excluded from using that additional half a million dollars for the employee retention credits?" We don't think so.
However, both the AICPA has acquired to the Internal Revenue Service and the treasury for clarification on that, along with, if you didn't use some other eligible expenses of rent or other items but you had them, can that also reduce the amount of compensation that's available for PPP and then obviously, increase the employee retention credit? So these are a couple of unknowns right now. We're hoping to get some guidance on these by the end of the month.
Ben Aspir:Yeah, there's a big push to get additional guidance.
Jeffrey Kelson:Yeah, the AICPA has requested from the IRS answers to a few questions, especially regarding PPP payroll versus ERC payroll and some other areas. On that note, we're getting a question, "If an employee earned over 100,000," of course, you can only claim up to the first 100,000 for the PPP, "Can you use the excess up to the limit?" There's this thinking in the accounting community that, yes, because he technically didn't use that salary for your PPP and then any excess then would be able to be claimed by the employee retention credit. But like I said, there's guidance forthcoming. So right now that's how it works.
Carey Gertler:So there was a question that I see, someone asked a question about the reduction of the salary expense for the employee retention credit. Does that affect QBI? So that would in fact impact the QBI wage number for the tax return purposes.
Ben Aspir:I was going to say with the PPP proceeds, a few people ask, does that get calculated into your significant decline gross receipts calculation? They haven't released guidance yet but I would think not because the PPP proceeds are not taxable, so they wouldn't be under tax return, it wouldn't be in gross receipts, they would be treated sort of like taxes and income. So I don't think PPP loan proceeds would be factored into that calculation.
Carey Gertler:Another thing to note, and I think we've said this before, but I just wanted to clarify that the gross receipts test is based upon the methodology that you use to file your income tax return. So if you have a cash basis, it would be on the cash basis. If you're on the accrual basis, that would be on the accrual basis.
Ben Aspir:So it's important to remember just after today's presentation, looking at the chart that we have up now, 2020, the old rules is still in effect. Obviously, the big change is PPP, if you took PPP, you may still be able to claim it. I'm not saying to write-off 2020, 2020 should definitely be evaluated. But like Jeff pointed out, quantifying how big of credit could potentially be for 2021, it opens it up to more employers, the credit percentages increase, the credit per quarter is significantly increased and it may be extended even further into 2021, but we'll have to wait to see.
Jeffrey Kelson:There's questions around the deferred FICA. Right now, the IRS is kind of messed up with that, they're offsetting the deferred FICA. Deferred to the end of 2021 and 2022, there was a rule that you can put 50% in each offsetting against in the ERC refund. So yeah, as you can imagine, it's growing pains on this and administering this and the IRS standpoint.
Ben Aspir:What was that?
Carey Gertler:Go ahead, Ben.
Ben Aspir:I was going to say, if a company has elected deferral, I would highly recommend waiting to claim the ERC because clearly, the IRS software has not been updated yet.
Carey Gertler:So one thing to note on the 941 refund, so if you're eligible for a refund, the IRS will be refunding you those amounts, you can't apply it to the next quarter to help subsidize that quarter's payroll taxes. And what the thought is that they want you to have the money as opposed to applying it for another quarter. So any refund as it relates to the Employee Retention Credit is refundable, not applicable to another period.
Jeffrey Kelson:And there's a question, "If a business has partially shut down, but it did better, does it qualify?" If you meet the partial suspension. And look, there's some vagueness in it because they use FAQs and the IRS, they give you some examples, but if you can operate comparably. So just technically, your answer is yes, you still qualify even though you grew in revenues if you do meet the partial suspension, just wanted to get that up there.
Carey Gertler:So there was a question regarding, we talked about severance not being eligible, unused vacation payout, that would fall into the same bucket. If the person is no longer our employee, those payments would not be eligible for the Employee Retention Credit.
Jeffrey Kelson:And that is false, that's absolutely true. We have another question, "How do you reduce payroll deposits for the first quarter of this quarter, 2021, given the eligibility depends on gross receipts?" Well, one, you can look back to the fourth quarter of 2020 and if you know you're already qualified when you compare to fourth quarter of 2020, so the fourth quarter of 2019, you can definitely hold it back. And if you think you're going to qualify for 2021, you can hold it back. But if you don't know because the first quarter hasn't ended yet, we're in February 18, you've got a month and a half to go, you can just offset it against your new 941, get a reduction. So there's many ways to the promised land on this, you can also do it in advance of the 7200, some interpretation on that for the penalties if you overstate it.
Carey Gertler:So there was a question about bonuses, bonuses would be eligible as long as the person is still employed with the company. Once again, not like a severance payment.
Jeffrey Kelson:Yeah, people keep asking about the 50% ownership. If you own 50% or more, either directly or through related parties, your salary is not eligible for ERC nor any of your related parties, and that's the rule on that. "Do you still qualify?" It's an interesting question, "If revenues are down 20% but earnings are up?" Yes, they're looking at revenues, they're looking to top line.
Ben Aspir:Gross receipts less-
Jeffrey Kelson:Gross receipts, not net receipts gross receipts, not net income.
Carey Gertler:And cost of goods sold is not included.
Jeffrey Kelson:"Would a law firm that specializes in litigation qualify?" Why not?
Carey Gertler:Yeah, but you would have to look at the whole firm, not just one aspect of it.
Jeffrey Kelson:Right, assuming you made it under the test side of the partial suspension for the decrease in gross receipts. There's a lot of questions on this and look, "What PPP wages can't be double-counted, the wages used to determine the PPP loan or the forgiveness?" We believe it's the forgiveness, but they're all a lot of questions because if you're not forgiven a loan on payroll you paid, then you had to pay it back, so basically you paid it. That's the way we interpret it, there will be guidance probably in the next two or three weeks. Who knows what the IRS is saying? So stay tuned. Yeah, but 10 questions on that question, so glad we got through it before time ran out.
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