The revamp of the employee retention credit under the Consolidated Appropriations Act, 2021 (CAA, P.L. 116-260), has turned an underused relief option into the most potentially powerful credit available to struggling businesses. The mainstream media has not highlighted the positive effect of this provision, much less explained its complexity. I’d like to examine this credit in-depth, especially since the House recently proposed its extension in the upcoming COVID-19 relief bill. This move could translate into many businesses keeping their doors open, and in turn could allow more working Americans to stay on payroll.
In the midst of the pandemic last year, then President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) to provide distressed businesses with multiple avenues to claim government funds so that they could stay operational and continue to pay their employees during lockdown. By far, the most popular of these avenues was the Paycheck Protection Program because of its favorable terms and loan forgiveness provision.
The ERC was launched alongside the PPP with the caveat that the two were mutually exclusive. Because most businesses claimed PPP relief, they were barred from claiming the ERC, and the incentive was largely ignored.
In an attempt to further increase the relief funds available to businesses, Congress is now allowing businesses that have claimed PPP assistance to also claim the ERC. This requires showing that the business was affected by COVID-19, either by:
• a reduction in quarterly gross receipts relative to the corresponding quarter in 2019;5 or
• a partial or full suspension of operations caused by a government mandate.
Once either of those requirements is satisfied, the employees whose wages can be qualified depends on whether the company had more than 500 full time employees in 2019.
The IRS has yet to offer updated guidance on how to handle the ERC, and in particular its interaction with the PPP, and I suspect we may not receive clarity on the matter for a couple of months. The American Institute of CPAs has already requested this guidance, but as we saw with the PPP, regulations may take time to materialize and will probably arrive in piecemeal fashion.
To provide some guidance to businesses that may be grappling with these unanswered questions, I want to highlight some of the overlooked complexities involved in claiming the credit.
Many businesses are assuming that if they did not have a significant drop in gross receipts relative to 2019, they cannot claim the ERC. However, even if a business’s revenue is up, it can still claim the credit, as long as it had to suspend a material portion of its operations because of a government order.
Using the suspension of operations to demonstrate a business was affected by COVID-19 opens the ERC to a lot more businesses, but it also complicates matters.
For starters, if a suspension of operations is a taxpayer’s basis for claiming the credit, the business can only capture wages paid for the duration of that suspension. To add to the confusion, there are still questions about what may be considered a qualified shutdown. What if there are conflicting mandates at the state and local levels? In some states, like Texas, we’re seeing a court ordered lockdown followed by a governor’s declaration that those lockdowns will not be enforced.
Further, the mandated shutdown test is not a binary, yes or no. Instead, the IRS may be looking at whether a business’s commerce was affected by a government order and to what extent.
For example, consider a business that ordinarily operates 24 hours a day. If government-mandated cleaning and disinfecting forces the operation to close for a number of hours at night, that could qualify as a partial shutdown. If the cleaning takes five hours, then that may qualify as a partial shutdown. But what if that cleaning takes less than that? Where is the line drawn? What effect is enough to properly claim the credit?
For another example, consider a pharmaceutical company that has been deemed essential. At first glance, that business may not qualify because it was not subject to a mandate, but what if its suppliers and vendors were closed because of a mandate? If the business could not reasonably find alternative suppliers and its production was limited, it could still qualify for the ERC.
The question then would be, how much was it affected? If the business continued to operate at nearly full capacity, then it may fail the suspension test, but it is unclear where exactly the line rests on whether or not there was a partial suspension.
Regardless, a close study of the facts (and a correct application of the statute) can be vital to qualifying for the credit.
Because Congress is now allowing businesses that have claimed PPP loans to also claim the ERC, businesses have the chance to significantly increase the amount of federal funds available to them. Not only can the ERC be claimed alongside PPP relief, but it could also be combined with other payroll-based incentives, including the credit for increasing research activities under section 41, the work opportunity tax credit under section 51, and the employer credit for paid family and medical leave under section 45S.
Of course, an employer cannot claim multiple credits for the same underlying expense or wage. That is, an employer cannot double dip to claim multiple credits on a single dollar of wages. Congress, however, clearly foresaw scenarios in which claiming multiple incentives would be beneficial to taxpayers — why else would it remove restrictions on claiming both PPP loans and the ERC? Taxpayers can take advantage of multiple incentives; they simply need to be mindful of the interplay between them.
We’ve seen that a large number of employers are mistakenly disqualifying themselves from taking the ERC because they have already claimed a payroll incentive and believe the two to be mutually exclusive.
This scenario plays out most commonly for businesses that have taken PPP loans. But many of these businesses and their return preparers have failed to realize that even loans forgiven under the PPP last year may not eliminate each employees’ wage base.
In a typical first draw PPP loan, an employer should have received about two and a half months’ worth of wages in loans to be spread out over 24 weeks, leaving three months of wages eligible to be claimed. So, a company with 10 employees that pays each employee $2,000 a month would be eligible for $50,000 in PPP loans. Even if that loan is fully forgiven, there could still be as much as $70,000 in eligible wages that can be put toward the ERC. This example does not account for the fact that loan funds could also be used on other expenses, not just wages.
The PPP is not the only program that would interplay with the ERC. If a company has claimed the work opportunity tax credit, research and development credit, or section 45S credit, there is an opportunity to increase the value of the relief benefit claimed — but there is also even more risk of double dipping. To muddy the waters even further, there is no formal method on how an employer is to earmark whether or how PPP funds were attributed to an employee’s wages.
Surprisingly, many payroll providers are asking their clients to earmark employees for the ERC themselves. But if an employer did not earmark how PPP funds were attributed, how can the onus be placed on them to earmark who can claim the ERC without risking double dipping? The tangle of laws calls for a sophisticated analysis performed employee by employee. With so many variables involved, it may be necessary to use artificial intelligence assisted modeling to maximize the incentive’s value.
To throw another wrench into things, remember that wages are defined differently among incentives. For instance, the PPP treats retirement and healthcare costs as payroll. Meanwhile, incentives like the work opportunity tax credit have varying tiers of qualified wages based on eligible population.
I expect that the next set of guidelines and regulations from the IRS will be focused on the ERC. It is an understandably complicated provision, but the relief it provides is certainly welcome — this incentive is already helping businesses stay afloat and keeping American workers employed.
The ERC continues to have bipartisan support in Congress, with the most recent COVID-19 relief bill in the House having a six-month extension (through the end of the year). I expect the Senate to accept this provision and include it in the final bill. It’s time for practitioners and business owners to sharpen their pencils on this major incentive for job retention.
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington, D.C. office. Prior to joining alliantgroup, Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman of the Finance Committee, Senator Charles Grassley, on tax legislation. During his tenure on the Finance Committee, Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law, including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform) and the Pension Protection Act.