What is the Employee Retention Tax Credit (ERTC)?
by Brittany Malidore
When originally introduced in 2020, the ERTC was a refundable tax credit that allowed businesses that did not receive a Paycheck Protection Program (PPP) loan to take a credit for 50% of qualified wages paid between March 12, 2020 and December 31, 2020, up to a maximum of $10,000 of wages per employee for the entire year. After the Consolidated Appropriations Act 2021 was signed, the ERTC received major revisions.
Critical ERTC Changes
First, the tax credit has been extended through June 30, 2021. Business should consider evaluating their operations for 2020 and 2021 to see if eligible to retroactively or proactively claim the ERTC credit.
Secondly, businesses that received a PPP Loan are now eligible to claim the ERTC retroactively to March 12, 2020. This is a reversal of the original law, which opens the tax credit to many more businesses. Learn more about how ERTC plays with PPP in a subsequent section.
Thirdly, the tax credit has been increased for 2021 (NOTE: the 2020 amounts remain applicable for the 2020 wage calculations):
- For 2020, the credit was and still is 50% of qualified wages and the qualifying wages were capped at a maximum of $5,000 per employee for the year.
- For 2021, the credit has been bumped to 70% of qualifying wages and the qualifying wages are capped at a maximum of $10,000 per employee per quarter.
- For example, if an employee were paid $10,000 in both Q1 & Q2 of 2021, the resulting credit would be $7,000 for each quarter (using the 70%), for a total of $14,000 for that employee. Contrast this with 2020, where the total credit would have only been $5,000.
Lastly, the employee thresholds have shifted from 100 to 500 full-time employees (FTE), meaning employers with up to 500 FTE in 2019 may claim the ERC for 2021 on wages paid for working or nonworking periods.
Interaction with PPP
Even though PPP borrowers may now receive the credit retroactively, they can’t use the same wages claimed for PPP Loan forgiveness to also claim the ERTC. This prevents businesses from “double-dipping.” While there are differences in the definition of wages for each purpose, we want you to understand when to use wages to apply for full forgiveness of your PPP loan versus claiming the partial tax credit.
This is important considering there is some flexibility in the PPP loan forgiveness period. For example, you may want to prioritize the ERTC for quarters in which you experienced a shutdown or 50% decline in your gross receipts as long as sufficient wages and non-payroll expenses still remain in the PPP covered period to maximize your full PPP loan forgiveness.
If there is an overlap in timing, it’s possible to have enough wages for both the ERTC and PPP loan forgiveness. Careful calculations and supporting documentation will be needed to verify that you aren’t “double-dipping” by using the same wages.
Once we have run the calculations to determine eligible wages during a qualifying period, we can work together to go back and claim the ERTC by filing an amended Form 941X return. Since it is a payroll tax credit, it is possible to amend 2020 payroll tax filings to receive the credit even if the business had tax losses. It is unknown at this time how long it will take the IRS to process and refund 2020 ERTC Credits at this time.
What Employers Qualify?
Employers, including tax-exempt organizations, are eligible for the credit if they operated a trade or business during calendar year 2020 and experienced either:
- Full or partial suspension of operation during any calendar quarter in 2020 due to orders from a governmental authority limiting commercial, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19; or
- A significant decline in gross receipts during the calendar quarter.
Self-employed individuals are not eligible for this credit for their own self-employment earnings, though they may be able to claim the credit for wages paid to their employees.
What is “a significant decline in gross receipts?”
For 2020, a significant decline in gross receipts begins with the first calendar quarter in 2020 in which an employer’s gross receipts are less than 50% of its gross receipts for the same calendar quarter in 2019.
The significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter in which the employer’s 2020 quarterly gross receipts are greater than 80% of its gross receipts for the same calendar quarter in 2019.
For 2021, the Consolidated Appropriations Act 2021 expanded the gross receipts test for eligible employers in 2021 to broaden the eligibility for businesses.
- An employer will satisfy the gross receipts test if quarterly gross receipts decline by more than 20% compared to the same calendar quarter in 2019. By utilizing 2019 as the baseline period this will be more favorable for employers whose gross receipts declined during 2020.
- For an employer that was not in business as of the beginning of the same calendar quarter in 2019, the baseline period is the corresponding calendar quarter in 2020.
- An employer may elect to apply the gross receipts test for 2021 using gross receipts for the prior calendar quarter, compared to the corresponding calendar quarter in 2019. For example, an employer can satisfy the gross receipts test for the first quarter of 2021 in the following two ways:
- First-quarter 2021 gross receipts fall by more than 20% compared to first-quarter 2019 gross receipts, or
- Fourth-quarter 2020 gross receipts fell by more than 20% compared to fourth-quarter 2019 gross receipts. Currently, it is not clear whether an employer can use this rule to qualify for the ERC in the first two quarters of 2021 based solely on a decline in gross receipts during the first quarter of 2021. We expect the IRS to respond within the next 30 days.
What is Included in Qualified Wages?
When performing calculations for the ERTC, qualified wages are considered wages and compensation that are subject to FICA taxes (the combined taxes withheld for Social Security and Medicare) as well as qualified health expenses. Generally, qualified health expenses include the employer and employee pre-tax portion and not any after-tax amounts. Note: Only wages paid after March 12, 2020 and through June 30, 2021 would be eligible.
Calculating Your FTEs
To begin determining the qualified wages that can be included, you first need to calculate the number of full-time employees you had in 2019.
For the purposes of the ERTC, a full-time employee is defined as one that worked at least 30 hours per week or 130 hours in a month (the monthly equivalent of 30 hours per week) for any calendar month in 2019. Once you’ve determined all your FTEs in 2019, calculate the following:
- If you were in business the entire calendar year in 2019: Take the sum of the number of FTEs in each calendar month and divide by 12.
- If you started a business in 2019: Take the sum of the number of FTEs in each full calendar month in 2019 that your business was operational and divide by that number of months.
- If you started a business in 2020: Take the sum of the number of FTEs in each full calendar month in 2020 that your business was operational and divide by that number of months.
- If you have more than 100 FTEs (this threshold increased to 500 beginning in 2021), you can only use the qualified wages of employees not providing services because your business was suspended or experienced a decline in business.
- If you paid employees while they were taking vacation or sick days, these wages can’t be included in qualified wages for the larger employers.
- Essentially, you can only use this credit on employees who were or are not working.
- If you have less than 100 FTEs (this threshold increased to 500 beginning in 2021), you can use all employee wages — including for those employees who are or were working, as well as any time paid not being at work (with the exception of paid leave provided under the Families First Coronavirus Response Act).
- There’s no double-dipping for credits. If you take the ERTC, you can’t take credit on those same qualified wages for paid family medical leave.
- If you’re included for the Work Opportunity Tax Credit, you may not be included for the ERTC.
- We recommend evaluating all your credit options to take advantage of the credit that is most advantageous for your business.
Claiming the Credit
In order to claim the ERTC, you’ll report your total qualified wages and the related health insurance costs for each quarter on your quarterly employment tax returns, which will be Form 941 for most, beginning with the second quarter in 2020, and/or first quarter 2021 accordingly. The credit is taken against the employer’s share of social security tax, but the excess is refundable under normal procedures.
In anticipation of claiming the credit, the business can file a Form 7200 for the corresponding amount of the employment taxes that otherwise would have been deposited, including federal income tax withholding, the employees’ share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes for all employees, up to the amount of the credit, without penalty, taking into account any reduction for deposits in anticipation of the paid sick and family leave credit.
We’re Here to Help
The expansion of the ERTC is incredibly complex. We can help you calculate and determine the best path forward for your business to maximize the amount of funding you receive. Please contact us today.
Call us at (360) 734-4280 or fill out the form below and we'll contact you to discuss your specific situation.
Senior Manager, Consulting Director
Brittany Malidore is a Senior Manager and leads the Consulting Line of Business for the firm, including Business Advisory and Client Accounting Services.