On March 2, 2021, the U.S. Department of the Treasury (Treasury) and IRS released Notice 2021-20 (Notice), providing guidance on the Employee Retention Credit (ERC) under the Coronavirus Aid, Relief, and Economic Security Act. The ERC is a refundable payroll tax credit for employers whose operations were fully or partially suspended due to government orders or who experienced a significant decline in gross receipts due to the COVID-19 pandemic.
For eligible quarters in 2020, the tax credit is equal to 50 percent of an employee’s qualified wages during the period of March 12, 2020, to December 31, 2020. Qualified wages are limited to $10,000 per employee, i.e., maximum credit per employee is $5,000 per year. For wages paid between January 1, 2021, and July 1, 2021, the ERC equals 70 percent of an employee’s qualified wages. Qualified wages are limited to $10,000 per quarter, per employee, i.e., maximum credit per employee is $7,000 per quarter. For more information on the ERC for 2020 and 2021, read this BKD Thoughtware® alert.
Prior to the issuance of this Notice, the only IRS guidance on the ERC was in the form of frequently asked questions (FAQ) on the IRS website. The Notice replicates most of these FAQs, making it authoritative guidance for taxpayers, and provides additional guidance, including the interaction of the ERC with the Paycheck Protection Program (PPP).
Interaction with PPP
Under the 2021 Consolidated Appropriations Act (CAA), employers that received a PPP loan are now eligible for the ERC to the extent they otherwise qualify. However, employers cannot “double-dip” and use the same wages for both PPP loan forgiveness and the ERC. Employers that already submitted a PPP loan forgiveness application prior to the passage of the CAA faced uncertainty to the extent the forgiveness application reported ERC-eligible payroll costs in excess of the amount needed to receive full loan forgiveness. Employers also may have paid nonpayroll costs that could have been used to receive PPP forgiveness but chose to only report payroll on the forgiveness form because the payroll costs alone were enough to receive full forgiveness. Question 49 in the Notice provides guidance on the interaction with PPP loans, including several examples.
An eligible employer that received a PPP loan is deemed to have made the election to not take into account certain qualified wages for purposes of the ERC for wages reported on its PPP loan forgiveness application, not exceeding the minimum amount of payroll costs, together with any other eligible expenses reported on the forgiveness application, sufficient to support the forgiven amount of the PPP loan.
- Example: An eligible employer had a $200,000 PPP loan but reported $250,000 of payroll costs on its forgiveness application (assuming no nonpayroll costs were reported). The eligible employer would still be able to apply the excess $50,000 to the ERC, to the extent they are qualified wages.
If an eligible employer includes both payroll and nonpayroll costs on its PPP forgiveness application that exceed the forgiveness amount, the nonpayroll costs can be applied to the forgiveness first (up to the 40 percent maximum eligible nonpayroll costs that can be used to receive PPP loan forgiveness).
- Example: An eligible employer reported $200,000 of qualified wages as payroll costs, as well as $70,000 of eligible nonpayroll costs on its forgiveness application for a $200,000 PPP loan. In this situation, the employer would only treat $130,000 of the wages as used for PPP forgiveness, leaving $70,000 of wages eligible for the ERC.
If an eligible employer could have included nonpayroll costs on its PPP forgiveness form but chose not to because it had enough payroll costs to receive full loan forgiveness, the employer is still deemed to have made an election to not take into account those wages (up to the loan forgiveness amount).
- Example: An eligible employer had a $200,000 PPP loan, paid $200,000 of eligible payroll costs (that also would be qualified wages for ERC), and also paid $70,000 in eligible nonpayroll costs, but only included the $200,000 of payroll costs on its forgiveness application. Even though the employer could have used the $70,000 of nonpayroll costs for PPP purposes, the employer is deemed to have made an election not to take into account the entire $200,000 of wages, since the nonpayroll costs were not reported on the employer’s forgiveness application.
If an eligible employer paid and reported on its PPP forgiveness application both qualified and nonqualified wages for ERC purposes, then it can apply the nonqualified wages toward forgiveness first.
- Example: An eligible employer had a $200,000 PPP loan and paid $250,000 in payroll ($100,000 of which was not qualified wages for ERC purposes) and $70,000 in nonpayroll costs. On its forgiveness application, the employer reported $130,000 of payroll costs and $70,000 of nonpayroll costs. To the extent the employer can demonstrate the $130,000 of payroll costs included the entire $100,000 of nonqualified wages, it would be deemed to have made an election not to take into account only $30,000 of qualified wages, thereby leaving $120,000 of qualified wages as eligible for the ERC.
Determining Eligibility Based on Government Orders
An employer whose trade or business operations are fully or partially suspended due to a governmental order is eligible for the ERC. In general, an essential business is not considered to have a full or partial suspension of operations if the governmental order allows the employer’s operations to remain open. However, an employer that operates an essential business may be considered to have a partial suspension of operations if, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a governmental order.
Question 11 in the Notice introduces a new objective test in evaluating whether a portion of an employer’s business operations will be deemed to constitute more than a nominal portion of its operations for purposes of the ERC. Under this test, a portion of an employer’s business operations will be deemed to constitute more than a nominal portion if at least one of these criteria is met:
- Gross receipts from that portion of the business operations are not less than 10 percent of total gross receipts (both determined using gross receipts of the same calendar quarter in 2019).
- The hours of service performed by employees in that portion of the business are not less than 10 percent of the total number of hours of service performed by all employees in the employer’s business (both determined using number of hours of service performed by employees in the same calendar quarter in 2019).
The Notice also provides examples of modifications required by a government order and when it may have more than a nominal effect on the employer’s business operations. While this determination is based on facts and circumstances, the Notice provides that a governmental order that results in a reduction in an employer’s ability to provide goods or services in the normal course of business of not less than 10 percent will be deemed to have more than a nominal effect. Modifications that alter customer behavior, e.g., mask requirements, one-way store aisles, etc., or require employees to wear masks and gloves while performing their duties do not result in a more than nominal effect.
This latest guidance also provides a list of factors to consider when determining if an employer can continue comparable operations such that it would not be considered to have a full or partial suspension. This list of factors includes telework capabilities, portability of the employee’s work, how critical an employer’s workspace is to its trade or business, and whether the employer incurred a significant delay, e.g., more than two weeks, in moving operations to a remote environment.
Other Notable Items
- Gross Receipts for Tax-Exempt Employers – The Notice updates its previous FAQ on the definition of gross receipts for a tax-exempt employer to specifically refer to the definition of “gross receipts” under Internal Revenue Code Section 6033 and related Treasury regulations. This corresponds to the definition provided by the U.S. Small Business Administration for purposes of the PPP. Under this definition, the cost of assets sold (capital assets or otherwise) cannot be subtracted from sale proceeds. Gross receipts also include amounts received as contributions, grants, and similar amounts (without reduction for the expenses of raising and collecting such amounts), gross amounts received as due or assessments from members or affiliated organizations, gross sales or receipts from business activities (including unrelated business activities), and gross amounts received as investment income, e.g., interest, dividends, and rents and royalties.
- Claiming Credit – The Notice confirms that an eligible employer that paid qualified wages in a prior calendar quarter in which it may have been entitled to claim the credit but elected not to do so may file Form 941-X to claim a refund. This clarifies that absent the special rule allowed under the CAA to claim certain 2020 Q2/Q3 wages on the 2020 Q4 return, an employer must file an amended return for the quarter in which the qualified wages were paid.
- Substantiation Requirements – The Notice lists out the records an eligible employer should create and maintain to substantiate eligibility for the ERC. This includes documentation to support:
- How the employer determined it was an eligible employer that paid qualified wages
- How the employer determined the amount of allocable qualified health plan expenses
- Whether the employer is a member of an aggregated group treated as a single employer for purpose of ERC, and if so, how the aggregation affects the determination and allocation of the credit
In addition, employers should maintain copies of any completed Forms 7200 (used to request advance payments of the ERC) and federal employment tax returns submitted to the IRS.