The ERC was introduced by the CARES Act in 2020, expanded under the Consolidated Appropriations Act of 2021 (CAA), and extended under the American Rescue Plan Act of 2021 (ARPA). It is designed to encourage employers (including tax-exempt entities) to keep employees on their payroll and continue providing health benefits during the coronavirus pandemic.
The ERC is a refundable payroll tax credit for wages and health plan expenses paid or incurred by an employer whose operations were either fully or partially suspended due to a COVID-19-related governmental order or where the employer experienced a significant reduction in gross receipts. The CAA extended the eligibility period of the ERC to June 30, 2021, increased the ERC rate from 50% to 70% of qualified wages and increased the limit on per-employee wages from $10,000 for the year to $10,000 per quarter ($50,000 per quarter for start-up businesses). In addition, employers that received a Paycheck Protection Program (PPP) loan and were previously prohibited from claiming the ERC may now qualify and can retroactively claim the ERC for 2020. The ARPA extended the ERC for another six months to December 31, 2021 under similar terms as provided in the CAA. NOTE: There has been congressional discussions that the 2021 ERC may end as of September 30, 2021, instead of under existing Law which allows the ERC through December 31, 2021.
How can I maximize the employee retention credit while still achieving full PPP loan forgiveness?
Section 2301(g)(1) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as amended by the Tax Certainty and Disaster Tax Relief Act of 2020 (Relief Act), allows recipients of PPP loans to also claim the ERC for qualified wages as long as the same expenses are not used for both benefits. IRS Notice 2021-20, issued on March 1, 2021, provides guidance for employers claiming the ERC and indicates that an eligible employer generally makes the election to use payroll costs for PPP loan forgiveness by not claiming the ERC for those qualified wages on its federal employment tax return.
The general rule is fairly easy to apply for PPP borrowers who have not yet applied to have a PPP loan forgiven, because they can make the election on an original or amended federal employment tax return (typically a Form 941). ERC qualified wages are limited to $10,000 for calendar year 2020 and $10,000 for each of Q1 and Q2 of 2021 (note that the American Rescue Plan Act of 2021 (ARPA), which was signed into law on March 11, 2021, extends the ERC through December 31, 2021).
The determination of the ERC wage amount for each quarterly return begins with an employee-by-employee analysis of qualified wages paid during each quarter before and after the PPP loan covered period. If the maximum qualified wage amount is paid or projected to be paid outside the PPP loan covered period, then the analysis is complete for that employee and all wages paid to that employee during the covered period can be used for PPP loan forgiveness. If, however, the ERC maximum qualified wage is not reached with respect to wages paid outside the PPP loan covered period, additional analysis is needed to determine whether wages paid during the PPP loan covered period can be designated as ERC wages without affecting total loan forgiveness. It is important to note that total loan forgiveness can be achieved with payroll costs that equal only 60% of the PPP loan as long as there are eligible non-payroll costs paid during the covered period to cover 40% of the loan.
This process works differently for PPP loan borrowers that have already filed a forgiveness application for a 2020 PPP loan. When these borrowers filed 2020 Q2 and Q3 federal employment tax returns, they were not eligible for the ERC and, at the time the 2020 Q4 return was filed, they had very little information on how to claim the credit. As a result, borrowers generally did not include an ERC qualified wage election on their originally filed 2020 employment tax returns.
To address this issue, Notice 2021-20 provides that an eligible employer is deemed to have made the election under section 2301(g)(1) of the CARES Act for the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the application, sufficient to support the amount of the PPP loan that is forgiven. Wages and health care costs covered by this deemed election cannot be considered qualified wages for purposes of the ERC.
For example, to simplify the forgiveness process a 2020 PPP borrower with payroll costs of $100,000 and nonpayroll costs of $50,000 reported only payroll costs of $100,000 on its PPP loan forgiveness application. Under Notice 2021-20, the borrower may not include any of the $100,000 of payroll costs as qualified wages in its ERC calculation, notwithstanding that 100% PPP loan forgiveness could have been achieved by reporting only $60,000 of payroll costs and $40,000 of nonpayroll costs.
If the PPP borrower had reported payroll costs of $100,000 and nonpayroll costs of $40,000 on its PPP loan forgiveness application, the deemed election would apply to only $60,000 of payroll costs.
Key takeaway: Unfortunately, borrowers who have already received PPP loan forgiveness do not have the same planning opportunities that are available to borrowers who have not yet filed the loan forgiveness application.