Legislation Extends and Expands the Employee Retention Tax Credit

On Sunday, December 27, 2020, the President signed the Consolidated Appropriations Act, 2021 (CAA), which includes (i) over $900 billion for pandemic-related relief, (ii) government funding of about $1.4 trillion, and (iii) myriad tax provisions. It is a long read, nearly 5,600 pages in total, but there is a handy 29-page summary online for those with more pressing things to do.

This article discusses the major changes to the employee retention tax credit (ERTC), which was originally enacted as part of the CARES Act back in March 2020. Recall that the ERTC is a fully refundable tax credit equal to 50% of wages paid to employees up to a maximum amount of $10,000 per employee. The maximum ERTC for wages paid to any employee is $5,000 (50% of $10,000). Employers can claim the ERTC by reducing their employment tax deposits by the amount of the anticipated credit, rather than depositing the required employment taxes with the IRS, and if the amount of the credit exceeds such employment tax deposits, then employers can apply for an advance payment of the credit on IRS Form 7200. A reconciliation is later made by the employer on its 2020 employment tax return (Form 941). The credit applied to wages paid between March 13, 2020 and December 31, 2020.

The first changes is that the CAA extends the wage period so that it applies to qualified wages paid during the first two calendar quarters of 2021.

It also lifts the ban on claiming the ERTC if an employer also obtained a loan under the paycheck protection program (PPP), and this change is retroactive to March 13, 2020. Thus, qualified wages paid from March 13, 2020 through June 30, 2021 can give rise to an ERTC even if the taxpayer obtained a PPP loan, with a proviso against double dipping – any wages upon which an ERTC is computed are not forgivable under the PPP.

This means that PPP borrowers who also qualify for the ERTC can claim the ERTC prospectively in 2021, and they can claim the ERTC retroactively for 2020, even though they were previously barred from claiming it because they obtained PPP loans.

There is a special rule in the CAA that allows employers to capture the retroactive benefit in Q4 2020, and we expect the IRS to issue guidance on this in the near future, presumably by updating its FAQs on the ERTC.

Third, the credit percentage and per-employee limitation have been increased – the new ERTC equals 70% of qualified wages paid in each of Q1 and Q2 of 2021, up to $10,000 of wages per employee per quarter, so the maximum credit per employee in 2021 is $14,000 ($7,000 in Q1 + $7,000 in Q2), versus $5,000 per employee in all of 2020.

Fourth, eligibility has been expanded. Whereas the test for eligibility in 2020 was based on the existence of a partial or full suspension of operations, or a substantial (more than 50%) decline in gross receipts, the 2021 ERTC only requires a decline of more than 20% in quarter-over-quarter (QoQ) “gross receipts” (i.e., the same quarter in 2021 vs. 2019) to be eligible for that particular quarter. Moreover, employers may elect to use the prior quarter’s gross receipts to qualify (i.e., to test Q1 2021 eligibility, an employer can elect to compare Q4 2020 to Q4 2019). The QoQ comparison is 2021 vs. 2020 only if the employer was not in business at the beginning of the relevant quarter in 2019. Gross receipts means “gross receipts” as defined in §6033, which is a very broad definition that applies to tax-exempt entities. See Treas. Reg. §1.6033-2(g)(4).

Fifth, the hurdle for 2021 qualified wages has been moved to make it more favorable for employers with up to 500 full-time employees (FTEs). The 2020 rule counted wages for all employees for companies that averaged 100 or fewer FTEs, and for larger employers it included only wages for employees who were not providing services due to the suspension of operations or decline in gross receipts. Now, the 2021 threshold has been raised to 500 or fewer FTEs, so that wages of all employees in 2021 can be included for employers with up to 500 FTEs.

Sixth, the CAA prevents larger employers from obtaining advance payments of the ERTC (i.e., advance payment for the ERTC to the extent it exceeds the amount of employment tax deposits for the relevant quarter) in 2021. Advance payments can only be obtained if the average number of FTEs employed by the employer during 2019 was not greater than 500, and in these cases the advance payment is limited to 70% of the average quarterly wages paid by the employer in 2019.

Last, group health care cost now count as qualified wages even if no other wages are paid to an employee. This is helpful for two reasons: (i) it brings the cost of furloughed employees into the calculation of the ERTC and (ii) this change is retroactive to March 13, 2020.

The combined effect of all these changes is significant for employers both large and small. There are new benefits to be had in 2021 as well as retroactive ones for 2020 in the case of PPP borrowers and those with furloughed employees.