The CARES Act, passed in March 2020, included the Employee Retention Credit (ERC) and Paycheck Protection Program (PPP) both intended to support employers with payroll expenses during the COVID-19 Pandemic. Initially, businesses were forced to choose between the two programs, as they could only use one. However, when Congress passed the Consolidated Appropriations Act (CAA) in December 2020, eligible organizations were offered more support as they could benefit from both programs, even retroactively.
Paycheck Protection Program: first and second draw loans
With the enactment of the CAA and American Rescue Plan Act (ARPA), eligibility was expanded to allow certain previously excluded nonprofit entities to apply for a first-draw PPP loan while others who received the first-draw loan could apply for a second-draw loan. This expansion provided many nonprofit organizations additional relief from the COVID-19 pandemic.
The program was scheduled to close on March 31; then Congress extended the deadline to May 31. However, on May 5, the Small Business Administration (SBA) announced that lender funding was depleted, closing the application opportunity for most organizations.
PPP forgiveness update
Borrowers should be aware that any “excess loan amount” received will not be entitled to forgiveness. An excess loan amount is defined as a “borrower or lender error made in good faith that caused a borrower to receive a PPP loan amount that exceeds the borrower’s correct maximum loan amount under the CARES Act and the Economic Aid Act.” Excess loan amounts do not include a knowing misstatement, which could result in fraud charges.
The CAA made several changes to PPP loan forgiveness, including making additional nonpayroll costs—certain supplier costs, worker protection expenditures, operations costs, and property damage costs—eligible for forgiveness; permitting borrowers with loans under $150,000 to use a simplified forgiveness application, and giving all borrowers the option to choose a covered period of between 8 and 24 weeks.
Borrowers who have not applied for forgiveness for the first-draw PPP loans may want to prepare to apply. The SBA states that “If the borrower does not apply for loan forgiveness within ten months after the last day of the maximum covered period of 24 weeks, or if SBA determines that the loan is not eligible for forgiveness (in whole or in part), the PPP loan is no longer deferred and the borrower must begin paying principal and interest.” Borrowers should review guidance and forgiveness instructions carefully before beginning the application process. They should also consider benefits applied for and received from other COVID-19 relief programs, such as the Employee Retention Credit (ERC) and Families First Coronavirus Response Act (FFCRA) COVID-19 sick and expanded family leave, to ensure programs are used properly in relationship to one another.
2020 Employee Retention Credit
The ERC is a 50 percent refundable payroll tax credit for eligible employers on up to $10,000 of qualified wages paid to employees between March 12 and December 31, 2020. The credit can be broken into two steps:
• Determining Eligible Employers: Eligible employers are certain organizations that experienced either of the following during a calendar quarter of 2020:
- The organization’s operations were fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings for commercial, social, religious, or other purposes due to COVID-19
- A significant decline in gross receipts during a calendar quarter as compared to the same quarter of 2019. The first eligible quarter is the quarter in which gross receipts are less than 50 percent of the gross receipts for the same quarter in the prior year. Each succeeding quarter is eligible until the following quarter, in which gross receipts exceed 80 percent of the gross receipts for the same quarter in the prior year. For nonprofit employers, the definition of gross receipts has been modified solely for purposes of the ERC to include all operations, investment income, rents, royalties, gross amounts received as contributions, gifts, grants, and similar amounts.
• Determining Qualified Wages: Qualifying wages are wages and allocable healthcare costs. For employers eligible under the first scenario above, only wages paid during the period in which operations were suspended qualify. For employers eligible under the second scenario, all wages paid during the quarter fall within the qualifying period. Employers that did not pay wages but covered healthcare costs are eligible for a credit.
Qualified wages are further distinguished based on the number of full-time equivalent employees (FTE) during 2019:
- For employers with more than 100 FTEs, qualified wages are wages paid to employees not providing services during the qualifying period.
- For employers with 100 FTEs or fewer, qualified wages are any wages paid to employees during the qualifying period.
Claiming both ERC and PPP loan forgiveness
PPP loan borrowers should understand how the PPP interacts with the ERC. The CAA explains:
• Wages and health care costs used to substantiate the ERC cannot be used for PPP loan forgiveness (no double-dipping).
• Wages must be used first to claim the ERC.
• Employers can elect not to include certain wage and healthcare costs in the computation of the ERC, to maximize PPP forgiveness.
• Eligible employers may recalculate the ERC in the event the PPP loan is not forgiven.
In Notice 2021-20, the IRS provided updated guidance and examples of maximizing the ERC while satisfying PPP loan forgiveness. Generally, the guidance allows taxpayers to take the minimal amount of wages required to satisfy PPP loan forgiveness while potentially increasing their ERC.
To claim the ERC for the 2020 tax year, the taxpayer will need to amend their quarterly payroll tax form 941 by filing form 941X for the applicable quarters. If a shutdown impacted the eligible organization in the first quarter of 2020, claim the credit by filing a 941X for the second quarter.
2021 Employee Retention Credit
In addition to permitting organizations that received PPP loans to be eligible for the ERC, the CAA enhanced the ERC through the first two quarters of 2021 as follows:
• The credit was increased from 50 to 70 percent of qualified wages.
• Qualifying wages were increased from $10,000 per employee per year to $10,000 per employee per quarter.
• The “significant decline” in gross receipts was changed from 50 to 80 percent for either quarter as compared to 2019.
• Employers can elect to use the immediately preceding quarter and the matching quarter from the prior year to satisfy the gross receipts test.
• The number of FTEs was increased from 100 to 500 for determining qualified wages.
• The cap on qualified wages using the equivalent duration during the 30-day period immediately before the eligible quarter in which wages were paid was removed.
• Businesses can receive the credit in advance.
American Rescue Plan Act (ARPA)
On March 11, 2021, ARPA became law, creating additional modifications to the ERC for 2021:
• Extends the availability of the credit through December 31, 2021. The ERC and PPP have been modified with multiple changes since their introduction. Employers should consider their options and the relationship between COVID-19 relief programs to maximize their benefits.
• Removes the alternative method allowing employers to use the immediately preceding quarter and the matching quarter from the prior year to satisfy the gross receipts test.
• Adds Recovery Startup Businesses (RSB) to the list of eligible employers. To qualify as an RSB, the business must have been started after February 15, 2020; have less than $1 million in gross receipts; not be subject to a shutdown order, and not have a significant decrease in gross receipts. RSBs are eligible for and limited to a $50,000 credit for the ERC in the third and fourth quarters of 2021.
• Allows “severely financially distressed” employers, those whose quarterly gross receipts declined 90 percent or more compared to the same calendar quarter in 2019, to treat all wages (up to the $10,000 limitation) paid during those quarters as qualified wages. The rule allows an employer with over 500 employees under severe financial distress to treat those wages as qualified wages whether or not its employees actually provide services for the third and fourth quarter of 2021.
Eligible employers have three options for claiming the ERC for the 2021 tax year:
• Report the ERC on quarterly Form 941, and request a refund or apply it as a credit to the following quarter.
• Reduce federal employment tax deposits based on the anticipation of the ERC for the quarter.
• File Form 7200 to request the refund in advance based on a projected credit amount that exceeds the amounts that can be withheld from federal employment tax deposits. Use Form 941 to reconcile the actual amount of the credit to the projected amount to correct any balance due or overpayment.
The ERC and PPP have been modified with multiple changes since their introduction. Employers should consider their options and the relationship between COVID-19 relief programs to maximize their benefits.
We’re here to help. Please reach out to HBK to discuss your situation.