Don’t Miss Out on the Employee Retention Credit

Since COVID-19 struck, the government has created free and/or easy money in the form of tax credits and loans that are forgiven.

The employee retention credit (ERC) is one such perk for your small business, and it’s operating in high gear right now. Don’t miss out.

This article is about the small-business ERC, which means:

• When looking at 2020, you had 100 or fewer employees in 2019.
• When looking at 2021, you had 500 or fewer employees in 2019.

If you qualify for the ERC money, don’t think you are taking money from other businesses. You’re not. Unlike the paycheck protection program (PPP), where the money was limited, the ERC has no limits.

Second, don’t think that you had to suffer to qualify for the ERC. You didn’t and don’t. In fact, you can prosper and still qualify for the ERC. The ERC has one purpose: to help make sure that you keep your employees working.

Big Bucks

The ERC allows you to qualify for up to $33,000 in tax credits per employee ($5,000 for 2020, and $28,000 for 2021).1 That adds up.

Let’s say you have 10 employees and you qualify for the ERC on all 10 employees. That’s $330,000 ($33,000 x 10).

It’s Not Too Late

You qualify for the credit based on the wages you paid or will pay. You have already paid your employees for 2020 and the first seven months of 2021. If you qualify based on the tests we are about to explain, you can now amend your payroll tax returns and start collecting on a big chunk of that possible $33,000 per employee. Let’s get started.

Retroactive Change Applies to 2020

When the CARES Act was passed in March 2020, it gave you a choice. You could claim either

1. the ERC or
2. the PPP forgivable loan.

But then on December 27, 2020, lawmakers retroactively allowed the ERC to those business that took the forgivable loan route with the PPP.2

ERC Limit for 2020

The ERC for 2020 is limited to $5,000 per employee. The credit is based on 50 percent of qualifying wages up to a maximum of $10,000.3

Example. Henry has 10 employees who each earn $3,000 a month. In the third quarter of 2020, Henry checks the rules and sees that he qualifies for the ERC on $90,000 of wages. In the fourth quarter, Henry also qualifies, but the rules limit Henry to only $10,000 of the wages, so that his total qualifying wages for the year are $10,000 per employee, for a tax credit of $50,000 for the year ($10,000 x 10 x 50 percent).

Planning point. You may not claim the ERC on wages you used for certain other COVID-19 relief, such as the wages you used for PPP loan forgiveness.4 If you have not applied for PPP loan forgiveness, you have an upcoming opportunity to plan your forgiveness to achieve the best results for both the forgiveness and the ERC.

Qualifying for the 2020 ERC

Let’s start with an assumption. You were in business for all of 2019.

Then, on wages paid from March 13, 2020, through December 31, 2020, you are eligible for this credit if5

• a government order fully or partially suspended your operations during a calendar quarter due to COVID-19 (under this rule, you qualify for the ERC even if you did not lose any money), or
• your gross receipts for a 2020 calendar quarter are less than 50 percent of gross receipts from the same quarter in calendar year 2019. When you qualify for a quarter under the 50 percent rule, you automatically qualify for the following quarter if it’s in 2020.

Example. Your gross receipts in quarter 2 of 2020 were 45 percent of your gross receipts in quarter 2 of 2019. Your wages paid during quarter 2 of 2020 qualify for the ERC, as do the wages paid in quarter 3. Quarter 3 is automatic because of quarter 2.

The ERC qualification when you suffer a full or partial suspension of your activities applies to both 2020 and 2021. Accordingly, we will look at the 2021 rules next, and then we’ll cover the full or partial suspension.

ERC Limit for 2021

On wages paid in 2021, you can qualify for an ERC of 70 percent on wages of up to $10,000 per quarter. That’s $7,000 (70 percent of $10,000) per employee, per quarter.6

Example. Donnie has 10 employees who each earn $10,000 per quarter. Donnie’s maximum ERC for 2021 is $280,000 ($7,000 x 10 employees x 4 quarters). That’s a tidy sum.

Qualifying for the 2021 ERC

Again, let’s start with an assumption that you were in business for all of 2019.

Then, on wages paid from January 1, 2021, through December 31, 2021, you are eligible for this credit if7

• a government order fully or partially suspended your operations during a calendar quarter due to COVID-19 (under this rule, you qualify for the ERC even if you did not lose any money), or
• your gross receipts for a 2021 calendar quarter are less than 80 percent of gross receipts from the same calendar quarter in year 2019, or alternatively
• using the preceding quarter to your 2021 calendar quarter, your gross receipts are less than the comparable quarter in 2019.

Gross receipts example 1. Your gross receipts for quarter 2 of 2021 are 75 percent of your gross receipts for quarter 2 of 2019. Your wages paid during quarter 2 qualify for the ERC.

Gross receipts example 2. Your gross receipts for quarter 3 of 2021 are 117 percent better than your gross receipts for quarter 3 of 2019. No problem. You qualify under the alternative test that allows you to compare quarter 2 where you had the 75 percent result. Thus, your wages paid during quarter 3 qualify for the ERC because of quarter 2.

Government Order

First, if you can qualify under the gross receipts test, go that route. It’s easy to prove. And you get the ERC for the full quarter. With the shutdown because of a government order, you get the ERC only for the days that you suffer a full or partial suspension, as we explain below.

If you can establish that your business was fully or partially suspended because of a federal, state, or local government order, you are eligible on a day-by-day basis for the ERC during those periods of full or partial suspension. Given the possibility of tax credits equal to $5,000 per employee in 2020 and $28,000 per employee in 2021, this is worth pursuing.

It’s hard to think that your business did not suffer due to a federal, state, or local government order during this COVID-19 pandemic. Even if you are an essential business, you likely suffered some. Here’s a short list of how a government order could have caused your full or partial shutdown:8

• You had to limit your hours of operation.
• You had to temporarily shut down operations.
• You had to close your workplace to some or all of your employees.
• Your employees were subject to a curfew and could not work during normal work hours.
• Your business had to shut for periodic cleaning and disinfecting.
• The government order caused a supply chain disruption that caused you to cut back operations.
• The government order imposed limitations on your use of the physical space (e.g., keeping people and tables six feet apart).
• The government order imposed limits on the size of gatherings that affected your business.

Guidance on Partial Suspension

In Notice 2021-20, the IRS in question-and-answer number 11, said that you suffer a partial suspension of operations if more than a nominal portion of your business operations was suspended by a governmental order.

For ERC purposes only, the IRS says that you identify a more than nominal portion of your business operations by looking back to the same quarter in 2019 and asking two questions for that portion of your business suffering the 2020 or 2021 full or partial shutdown:9

1. Are the 2019 gross receipts for the quarter 10 percent or more of total gross receipts for the quarter?
2. Are the 2019 hours of service by employees 10 percent or more than the total number of hours of service performed by all employees during that quarter?

A “yes” answer to either question says you have a portion of your business that’s more than nominal and if it’s suspended, your entire business qualifies for the ERC under the full or partial suspension rule for the days that it’s affected.

The IRS has a great series of examples of how the partial suspension works for various businesses and you should spend a few minutes reading pages 27 to 44 of IRS Notice 2021-20.10

Takeaways

It’s hard to imagine that a small business does not qualify for some or all of the ERC.

And remember, this is a tax credit—one of the very best things that tax law has to offer. True, it’s not as valuable as some other tax credits, because you have to reduce your payroll income tax deductions for the credits, but the ERC certainly puts you money ahead.

And you can be looking at big bucks. The possible ERC is $5,000 per employee for 2020 and $28,000 per employee for 2021. That’s $33,000 per employee.

For 2020, you have two ways to qualify:

• You had a gross receipts drop during a calendar quarter of more than 50 percent when compared to the same calendar quarter of 2019. The 50 percent test is the trigger for the ERC and you automatically qualify in the following 2020 quarter.
• You suffered from a federal, state, or local government order that fully or partially suspended your operations.

For 2021, you have three ways to qualify:

1. You suffered a federal, state, or local government order that fully or partially suspended your operations (under this rule, you qualify for the ERC on the days you suffered the full or partial suspension, even if you did not lose any money).
2. Your gross receipts for a 2021 calendar quarter are less than 80 percent of gross receipts from the same quarter in calendar year 2019.
3. As an alternative to number 2 above, using the preceding quarter to your 2021 calendar quarter, your gross receipts are less than the comparable quarter in 2019.

You can see by the rules that the government wants to help your small business. Take advantage.

One final note. You may not double-dip. Wages you use for the ERC may not be used for the PPP, family leave credit, or similar COVID-19 programs.