The IRS recently published additional FAQs on the refundable Employee Retention Credit (ERC), as well as draft Form 941 for 2020. Employers who were unable to obtain a PPP loan should consider whether they qualify to take the ERC. If an employer had a PPP loan funded, they cannot take the ERC. Taxpayers who are self-employed with no employees cannot take the ERC against SE tax.
The ERC is a refundable payroll credit of up to 50% of “eligible wages” paid between March 12, 2020, and December 31, 2020. The credit is capped at $5,000 per employee ($10,000 of eligible wages).
To be eligible for the ERC, an employer must have an “eligible quarter.” This is defined as any quarter in 2020 in which one of the following two situations occurs:
1. The trade or business was fully or partially suspended. The IRS provides 3 tests, and ALL must be met:
- The orders come from the federal government, or a state and local government that has jurisdiction over the business;
- The orders limit commerce, travel, or group meetings due to COVID-19 ; AND
- The orders affect an employer’s operation of its trade or business.
Example: The governor of State A issues a shelter-in-place order for all of March and April, requiring all non-essential businesses to close. Business B shuts its doors, and its employees are not capable of effectively teleworking. B has had its operations suspended for March and April, and both Q1 and Q1 of 2020 are eligible quarters.
Example. Business C operates a restaurant. Under state order, C must cease in-room dining during March and April, and may offer only take-out. C has had its operations “partially suspended,” and both Q1 and Q2 are eligible quarters.
2. The trade or business’s gross receipts are less than 50% of the same quarter in 2019. You continue to have eligible quarters until the end of the quarter (not to exceed Q4 2020) in which gross receipts are at 80% of what they were in 2019 for that quarter.
Example. Business D had the following gross receipts by quarter in 2020: $100,000, $120,000, $180,000, and $150,000. For the same quarters in 2019, gross receipts were $220,000, $200,000, $200,000 and $250,000. In Q1 of 2020, gross receipts were less than 50% of Q1 2019; thus, Q1 is an eligible quarter. Q2 is also an eligible quarter, because receipts for Q2 2020 have not reached 80% of Q2 2019. Q3 is the final eligible quarter, because receipts for Q3 2020 exceed 80% of Q3 2019.
If either one of the preceding situations apply to an employer, they then must determine how many average “full-time equivalent employees” (FTEs) they had in 2019. FTEs are defined as someone who, in any calendar month of 2019, averaged at least 30 hours of service per week, or 130 hours for the month. Employers add up the number of FTEs, and divide by the number of months they were in business.
If an employer has more than 100 average monthly FTEs for 2019, only the wages they pay an employee to stay home and NOT work are “eligible wages” for the ERC.
Example. Business E operates a restaurant and had over 100 FTEs in 2019. During the time the restaurant was required to be take-out only, E paid wages to its kitchen staff to continue preparing food. In addition, E also paid its waiters, who were not able to work. Because E had more than 100 FTEs in 2019, the wages paid to its kitchen staff are not eligible wages, because the kitchen staff is continuing to work. The wages paid to the waiters, however, are eligible wages because the waiters are not currently providing services.
If any employer has less than or equal to 100 average monthly FTEs for 2019, ALL the wages paid to employees are eligible for the credit.
Example. Assume Business E above had fewer than 100 average monthly FTEs for 2019. The wages paid to both the kitchen staff and waiters would be eligible wages for purposes of the ERC.
Employers who were not in business for 2019 may use the average FTEs for 2020.
The credit is equal to 50% of wages paid in an eligible quarter, up to $10,000 per employee starting after March 12, 2020. It’s important to note that the $10,000 limit is a maximum annual limit and can be exhausted in one quarter if an eligible trade or business pays an employee $10,000 or more. An employer can increase the wages paid to an employee by their share of health care costs, but the wages PLUS the allocable health care costs cannot exceed $10,000. Qualified family leave or sick leave wages paid according to the Family First Coronavirus Relief Act are NOT to be used in computing the ERC.
Any eligible wages for the ERC are NOT deductible.
Employers may claim the credit in one of two ways:
1. By reducing its normal payroll tax deposit by the anticipated credit. It is important to note, while the CARES Act states that the ERC reduces ONLY the employer’s share of Social Security tax, the IRS permits an employer to reduce ALL payroll deposits – including federal income tax withholding – by the anticipated ERC. Also note, an employer who elects to defer its share of Social Security tax to 2021 and 2022 as permitted by the CARES Act defers the tax FIRST, and then the employer claims a credit and/or refund for the ERC.
2. If the anticipated credit reduces the employer’s required payroll deposit, the employer may file Form 7200 to request an advance refund. The employer can request an advance refund for a quarter at any time before the end of the month following the quarter in which it paid the qualified wages. If necessary, an employer can file Form 7200 several times during each quarter. The form is faxed to 855-248-0552. Please review instructions for Form 7200 prior to faxing.
By: Tony Nitti, CPA, MST
Readers should not act upon information presented without individual professional consultation.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.