The Consolidated Appropriations Act of 2021 (CAA) significantly enhances a refundable payroll tax credit for employers that was enacted as part of the CARES Act. The American Rescue Plan Act of 2021 (ARPA) extended and further enhanced this tax credit.
Overview of Employee Retention Credit
The employee retention credit (ERC) was enacted as part of the CARES Act. It provides tax credits to eligible employers whose business operations were suspended because of a COVID 19 related government order, or that had certain reductions in gross receipts compared to 2019. The credit offsets the employer's portion of payroll taxes. The credit is refundable, so if the credit amount exceeds the employer's share of payroll taxes in a calendar quarter, the employer can choose to receive a refund of the excess or apply the excess against future payroll taxes.
Important Updates to ERC in the CAA and ARPA
Organizations That Receive PPP Loans May Be Eligible. Under the CARES Act, an organization that received a Paycheck Protection Program (PPP) loan was not eligible for the ERC. The CAA permits organizations that receive PPP loans to claim the ERC if they meet the other ERC eligibility criteria. However, the CAA provides that the ERC cannot be claimed for wages funded by a PPP loan (i.e., no "double dipping"). Entities that have received or may receive PPP loans may be able to claim the ERC for wages that were not funded by the PPP loan.
Extension of ERC to December 31, 2021. Under the CARES Act, the ERC was set to expire on December 31, 2020. The CAA extended the ERC from December 31, 2020 to June 30, 2021. The ARPA further extends the ERC to December 31, 2021.
Increased Credit Amount for 2021. Under the CARES Act, the ERC was capped at $5,000 for all eligible wages paid in 2020 (maximum of $10,000 in qualified wages times 50% tax credit rate). For 2021, the maximum per-employee credit amount is equal to $7,000 per quarter ($10,000 in qualified wages times 70% credit rate). Thus, the maximum credit for 2021 is $28,000 per employee (if an employer is eligible in each quarter). For a "recovery startup business" the maximum credit amount is capped at $50,000 per quarter.
Eligibility Requirements for Employers. For both 2020 and 2021, an employer is eligible for the credit if its operations were either fully or partially suspended by a COVID-19 government order. In addition, for 2021, an employer is eligible if it experiences a 20% quarter-over-quarter decline in revenue compared to 2019. This is a lower threshold than the 50% quarter-over-quarter decline set forth in the CARES Act. Pursuant to the ARPA, an employer that does not qualify under the foregoing tests is nevertheless eligible for the third and fourth quarters of 2021, if the employer is a "recovery startup business."
A "recovery startup business" is an organization that (i) does not qualify under the full or partial suspension test or the gross receipts decline test; (ii) began operations after February 15, 2020; and (iii) has average annual gross revenues in the preceding three-year period of no more than $1,000,000.
Credit Eligibility for Working Employees. In 2020, an employer with more than 100 full-time employees in 2019 could claim the ERC only for wages paid to employees who were not working or were working a reduced schedule without a corresponding reduction in wages. For 2021, this threshold is raised to 500 employees.1 Thus, for 2021, an employer that had no more than 500 full time employees in 2019 can claim the credit for wages paid to employees who are working.
Wages Eligible for the ERC. Wages eligible for the ERC include an employee's regular salary (typically, gross wages less pre-tax salary reductions for transportation benefits or a dependent care FSA), as well as the employee's share of health benefits paid by the employer. Bonuses are also eligible for the ERC.
Deduction Disallowance. No deduction is allowed for wages reimbursed by the ERC. For example, if an employer pays $10,000 in qualified wages to an employee and received a credit of $7,000, the employer may deduct only $3,000 of wages. The deduction disallowance effectively reduces the value of the credit by the applicable corporate or pass-through tax rate.
Application of Aggregation Rules. Members of controlled or affiliated service groups under Section 52(a) or (b) or Section 414(m) or (o) of the Internal Revenue Code are treated as a single employer for purposes of the ERC. For instance, multiple entities with common ownership could be aggregated for purposes of the 500 employee threshold, or for purposes of determining eligibility as a "recovery startup business." For example, if the owners of an existing business establish a new business with substantially similar ownership, the new business likely would not be eligible as a "recovery startup business." In addition, multiple entities with common ownership could be aggregated for eligibility purposes. If one entity in the group is eligible based on a COVID-19-related government order, all entities in the group, even those not subject to restrictions, could be eligible.
Extended Audit Period. The ARPA extended the statute of limitations period for an ERC audit from three years to five years.
Claiming the ERC. The ERC is claimed on the employer's quarterly payroll tax filings. Alternatively, an employer with fewer than 500 employees can file IRS Form 7200 to obtain an advance payment of the credit, based on 70% of the average quarterly payroll for the same quarter in 2019. An employer seeking to claim the ERC for prior quarters may do so by filing amended payroll tax returns.
[1] The 500-employee threshold does not apply to employers that demonstrate a quarter-over-quarter revenue decline of at least 90%.