While the Paycheck Protection Program has been one of the most talked about and popular provisions in the CARES Act, the act also included another program that employers can use to help provide relief from the economic stress caused by the COVID-19 outbreak. The IRS released limited guidance last week on this program, helping to guide employers who may want to utilize this program instead of any PPP Loans.
What is the Employee Retention Tax Credit?
The Employee Retention Tax Credit (ERTC) is a new tax credit, available only for 2020, that allow employers to claim a credit against their share of employer Social Security and is fully refundable. In practical terms, this means employers will first reduce their share of any Social Security tax and any amount above that can be refunded. The credit is calculated on a per employee basis, but the credit against the tax is not on a per employee basis, meaning it will go against the full employer liability for all employees. The credit is given to Eligible Employers paying Qualified Wages to employees.
How Much is the ERTC? How is it calculated?
The credit is up to $5,000 per employee. The credit is calculated at 50% of Qualified Wages, up to $10,000 in wages.
Who Are Eligible Employers?
An eligible employer is one that carries on a trade or business in 2020 (for purposes of the CARES Act only, this includes any 501(c) organization that is carrying out operations) that has experienced one of the two scenarios:
- Governmental entities are not eligible employers
- This credit is not available to self-employed taxpayers
- The 50% decline of revenue criterion does not apply to 501(c) organizations
What defines fully or partially suspended?
To date, the IRS has only provided limited guidance as to what this means via an FAQ on their website. Their focus was more on partially suspended, meaning that an operation can continue to operate but not at its normal capacity. Until any further guidance is given, we would advise any employer that wants to claim this credit to use common English definitions of these words and to document in good faith why they felt they met these criteria. A fully suspended operation would likely mean that the place of business is closed, such as a bar, salon or restaurant and partially suspended meaning that services cannot be provided at normal capacity because of restrictions on travel or commerce – these would largely impact direct service providers. Telework presents an interesting scenario, as for many it allows them to provide services but at a reduced or limited capacity. Lacking clear guidance on this, we would advise a conservative approach where possible and if telework or teleservices are being provided to not consider that partially shutdown where practical and appropriate. Each situation will be unique, considering its overall facts and circumstances. As more guidance becomes available, we will provide updates.
What are Qualified Wages for the ERTC?
The dollar amount of Qualified Wages are wages paid to an employee by an Eligible Employer (see above) for the period of March 12, 2020 – December 31, 2020. This means that wages already paid may be Qualified Wages. To note that Qualified Wages include any qualified health plan expenses paid by the employer. A qualified health plan expense is any amount paid for group health coverage that is excluded from the employee’s gross income. Based on the reading of the FAQ, it is likely the full amount paid for health insurance coverage (regardless of employees) contributions is calculated; that said, we advise to reduce wages by the amount of any employee contribution. The payment should not be double counted.
Beyond the dollar amount of Qualified Wage, the CARES Act has 2 separate rules based on the size of the employer.
The IRS has also indicated that for employees not providing services, the Qualified Wages are limited to what the employee would have been paid for working the same amount in the prior 30 days.
Is the credit optional?
Employers do not have to claim the credit if they do not want. They can claim at any time, so long as they have paid the Qualified Wages.
Are there Any Documentation Requirements?
The IRS has released the following with the instructions for Form 7200 on what documentation is necessary to claim these credits:
- Documentation to show how you figured the amount of the ERTC
- Documentation to show how you figured the amount of qualified health plan expenses allocated to wages
- Documentation to show your eligibility for the ERTC based on a suspension of operations or decline in gross receipts
Based on the above, we recommend the following information be kept:
This listing is based on our interpretations of IRS guidelines, the CARES Act and our experience with other IRS documentation requirements. This list is not exhaustive and other items may be relevant and/or the above may be more than is required but is what we consider to be the best practice for documentation absent any further IRS guidance.
How is the ERTC Claimed?
How does the ERTC Interact with the PPP Loans?
Any employer that claims a PPP Loan will not be eligible for the ERTC. However, the ERTC does provide a mechanism for relief for organizations that were unable to claim a PPP Loan, such as employers with more than 500 employees, non 501(c)(3) nonprofits (501(c)(4) or (c)(6) for example, or employers where affiliation with an investor may have limited their ability to claim a PPP Loan.
Are there any affiliation rules with the ERTC?
The ERTC does have some affiliation rules but they are less broad than the SBA Affiliation rules.
For purposes of the ERTC, the IRS will use an aggregation rule, not an affiliation rule. The aggregation rule is based on IRC Sections 52, parts (a) & (b) or IRC Section 414 part (o) or (m), to treat all persons as a single employer. These rules may be familiar to organizations as they also will impact the provision of group health benefits and retirement plans.
Under the aggregation rules all employees are treated as employed under a single employer when there is a controlled group. A controlled group can exist 3 ways:
A parent-subsidiary relationship will exist when one organization owns 50% or more of another organization. Normal controlled groups are at 80%, however, the language in Section 52 changes this to 50%. Any organizations owned along the chain are aggregated, meaning that if an organization owns 2 organizations at 50% each that in turn own 50% of organizations, they are all connected. In general, these will be far less common.
A brother-sister scenario will be more common and will exist when 5 or fewer persons own more than 50% of the voting power of any 2 organizations. Many business owners will have a few separate organizations, and as a result under these will need to be considered one employer. Note that an attribution of ownership can exist in partnerships (LLC), meaning that a partner can be considered to own what his partner owns in certain circumstances, as well as ownership of direct family (spouse, children).
A combination can occur when both scenarios are satisfied – example a subsidiary of a brother-sister organization.
Section 414 can also make a single employer under the “affiliated service group” regulations, where an organization provides services, usually exclusively or the serves represent a vast majority of their business, and the service provider and the business served are under common ownership. These issues would have come up with any 401(k) plans sponsored by a company, so an organization should generally know if they have this relationship.
The affiliated service group rules and controlled groups require a detailed, mechanical analysis of the individual facts and circumstances of each group and organization; the above is just a quick summary to help identify if you may have such a relationship.
This calculation only matters in the context of the number of employees and any potential duplication of credits. The credits are open to employers of any size but have stricter limitations when above 100.
For employers that would like to take advantage of this credit rather than the PPP Loans or have questions, please feel free to contact us.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.