The IRS Clears up Employee Retention Credit Questions
Like many aspects of the Coronavirus Aid, Relief and Economic Security (CARES) Act, the Employee Retention Credit (ERC) has created confusion for employers since it was rolled out on March 27, 2020. This is a refundable payroll credit of 50% of up to $10,000 in wages paid by eligible employers whose businesses have been financially impacted by Covid-19.
Questions related to eligibility quickly followed, along with concerns about applying for multiple stimulus packages, tax consequences and what constitutes qualified wages.
To clarify these points, the IRS issued an initial set of FAQs on March 31 followed by additional FAQs on April 29. Combined, these FAQs address several topics, including how the ERC credit relates to Paycheck Protection Program (PPP) loans, aggregation rules, family and medical leave credits and third-party payers.
Employers that have been deemed essential and have not been ordered to shut down by a governmental order are generally not eligible for the ERC. Exceptions will be made for businesses whose operations have been suspended due to supply chain issues and the inability to obtain critical goods and materials. Some exceptions are also being made for businesses whose hours of operation have been greatly reduced thanks to a governmental order.
If a business has been forced to close its physical location, but is still able to maintain operations remotely, they do not qualify for the ERC.
For employers eligible for the ERC due to suspension of operations, qualified wages are limited to the time the order is in force and are determined on a pre-tax basis.
Employers with more than 100 employees cannot count vacation, holidays and sick days as qualified wages. Healthcare expenses treated as qualified wages are limited to the percentage of an employee’s taxable wages that are treated as qualified.
Claiming the Credit
Eligible employers will report their total qualified wages related to the ERC on their federal employment tax returns, usually Form 941, Employer’s Quarterly Federal Tax Return.
Aggregation of Multiple Entities
When employers have multiple entities aggregated and treated as one for the purpose of the ERC, each individual entity should separately report the credit on their employment tax return. Each credit will be the amount of the credit apportioned among the members of the aggregated group based on their share of the qualified wages related to the credit.
PPP Loan Recipients are Ineligible for ERC
It doesn’t matter when PPP loan recipients received their funds or whether the loan is ultimately forgiven. Businesses that have received PPP funds cannot also benefit from the ERC. However, if an employer repaid their PPP loan by May 7, 2020, which many did, they will be treated as though they never received a PPP loan and will be eligible for the ERC.
Related to the aggregation rules, if one entity in an aggregated group received a PPP loan, no other entities in the group qualify for ERC.
Paid Family and Medical Leave Credit
Employers can qualify for both ERC and paid family and medical leave credits (IRS code section 45S). However, any qualified wages which an employer claims for the ERC cannot be used when determining a 45S credit.
Income and Expenses on Your Federal Tax Return
In FAQ 85, the IRS makes it clear that qualified wages cannot be excluded from a taxpayer’s gross income. While payments related to “qualified disaster relief” are typically excluded from gross income, qualified wages related to the ERC don’t count. They are considered to be what an individual would have otherwise earned as compensation, not payments to offset expenses related to the Covid-19 disaster.
FAQ 86 goes on to explain that the ERC reduces the expenses that an employer can deduct from its federal income tax return. Basically, an employer’s deduction would be reduced by the amount of the credit.
Third Party Payers
FAQs 88-93 deal with issues related to employers that use a third party to report and pay employment taxes. Those employers are still eligible for the ERC with certain rules and forms for claiming the ERC depending on the type of third-party payer the employer uses.
May 8, 2020 Update
Changes may soon be made to some of the thresholds of the ERC. Congress is considering a measure that would increase the ERC to 80% of qualified wages and raise the limit on each employee from $10,000 to $15,000 per calendar quarter. In addition, the large-employee threshold would increase to 1,500 employees or gross receipts exceeding $41.5 million.
Another proposed change relates to Paycheck Protection Program (PPP) loans. This adjustment would allow business to claim the ERC and borrow through the PPP, which businesses currently cannot do.
For a complete look at all 94 IRS FAQs, go to: https://www.irs.gov/newsroom/faqs-employee-retention-credit-under-the-cares-act
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