The Employee Retention Credit (also known as ERTC or ERC) is of the more lucrative tax credit opportunities to make headlines this year. The ERTC is a refundable tax credit that was introduced within the CARES Act in 2020. Since it was passed, the ERTC was updated by the Taxpayer Relief Act, the American Rescue Plan, and the Infrastructure and Jobs Act. Among other things, these updates made increased the maximum ERTC credit amounts and made the ERTC available to more businesses.
What is the ERTC?
The ERTC is a refundable payroll tax credit that applies to qualified wages paid to eligible employers during certain periods throughout 2020 and 2021. There are five different periods for which you can qualify for the ERTC:
- 2020: March 13 through December 31
- 2021 Q1: January 1 through March 31
- 2021 Q2: April 1 through June 30
- 2021 Q3: July 1 through September 30
- 2021 Q4: October 1 through December 31
There are two ways to qualify for the Employee Retention Credit, including the gross revenue decline and the suspended operations test.
The gross receipts test for ERTC eligibility
If your gross receipts dropped below specific thresholds in 2020 or 2021, you may qualify for the ERTC. For 2020, if your gross receipts are less than 50% of the corresponding 2019 quarter, you are considered an eligible employer for ERTC purposes. For 2021, if your gross receipts in any quarter dropped over 20% when compared to the same quarter in 2019, you are considered eligible for the 2021 ERTC amount for that quarter.
The alternative quarter election rule
IRS Notice 2021-23 describes how the 2020 Relief Act amended the CARES Act to allow employers to fulfill the gross receipts test in 2021 by comparing the preceding quarter to the corresponding quarter in 2019. Employers who did not exist at the start of that 2019 quarter may use the corresponding 2020 quarter.
A note on “severely financial distressed employers”
In IRS Notice 2021-49, the IRS refers to Section 3134(c)(3)(C)(ii) a “severely financially distressed employer” as an eligible employer who qualifies using the gross receipts test but has gross receipts for a calendar quarter that are less than 10 percent of the same quarter in 2019. If a financially distressed employer was not in existence in 2019, they may use the corresponding calendar quarter in 2020.
The suspended operations test for ERTC eligibility
If a COVID-19-related government order caused you to close or partially close your business in 2020 or 2021, you can qualify under the ERTC suspension test. While the gross receipts test is based on fairly straightforward calculations, the ERTC suspension test involves using professional judgment and reasonable interpretations of available IRS guidance to determine whether your specific circumstances justify ERTC eligibility.
IRS Notice 2021-20 provides two safe harbors for you to use when determining your ERTC eligibility using the suspension test:
- When more than a nominal portion of your operations are impacted by a COVID-19-related government order
- When a COVID-19-related government order has a more than a nominal effect on your operations
#1: Defining a nominal portion of your business operations
If only a portion of your business was closed by a government mandate, you could still qualify for the ERTC if more than a nominal portion of your business was impacted by the mandate. The IRS provides two methods to determine a nominal portion of your business:
- The gross receipts from that portion of your business make up at least 10% of your company’s total gross receipts. This is determined using gross receipts from the corresponding quarter in 2019.
- The hours of service worked by employees within that sector of your business comprise at least 10% of your company’s total service hours. Again, this calculation is determined using service hours from the corresponding quarter in 2019.
#2: Defining a nominal impact on business operations
If your business wasn’t suspended but you made modifications, in compliance with a mandate, that had more than a nominal impact on your business, you may qualify for the ERTC. The modifications must have resulted in a 10% or more reduction in your ability to provide goods or services in your normal course of business. There are other caveats to consider while assessing nominal impact:
- Nominal portion is connected to a nominal impact: Question 17 (Example 3,4, and 5) of IRS Notice 2021-20 determines nominal impact by assessing whether a nominal portion of a business was affected.
- Modifications must have a more than nominal effect: Question 18 in IRS Notice 2021-20 states that modifications to business operations that don’t impact operations, like mask requirements, are not considered as having a more than nominal impact on business operations.
- Parameters must be applied individually: Answer 18 states that nominal impact guidelines must be applied on a case-by-case basis to determine whether an impact of 10% or above occurred on an employer’s operations. Occupancy restrictions, for example, have a more-than-nominal impact on a restaurant with indoor dining, but not on a retailer who can accommodate customers regardless of the occupancy restrictions.
Qualifying shutdowns vs. non-qualifying shutdowns
When you’re examining shutdowns for the purpose of ERTC eligibility, not all shutdowns will be valid for getting the tax credit. Unfortunately, there are many prevailing beliefs about ERTC-eligible shutdowns that are misguided and put taxpayers in danger of heightened IRS scrutiny and tax audits.
- Myth 1: Any government mandate is valid: IRS Notice 2021-20 specifically states that shutdowns must be directly tied to a government mandate that is related to COVID-19.
- Myth 2: OSHA guidance is sufficient: A brilliant CPA named Dan Chodan has nicknamed this the “OSHA argument” and debunked it thoroughly. Here are his key points:
- The COVID-19 page on the OSHA website clearly states that OSHA recommendations are advisory in nature and informational in content. For ERTC eligibility, a shutdown must be based on government mandates, not recommendations.
- The General Duty Clause, which requires employers to provide a workplace safe from known dangers or threats, is based on 1970 law – not in response to COVID-19, as required by IRC Section 3134(c)(2)(A)(ii)(I).
- Myth 3: CDC guidance is sufficient: Notice 2021-20, Question 20 outlines a distinction between an employer operating two locations. The first is subject to a government-mandated suspension and is described as “partially suspended.” The second location makes operational adjustments based on CDC guidelines and is described as “following guidelines” and not considered to be suspended for ERTC eligibility purposes.
The Recovery Startup Business test for ERTC eligibility in 2021 Q4
As noted in IRS Notice 2021-65, the Infrastructure Investment and Jobs Act changed the expiration date of the Employee Retention Credit from December 31, 2021 to September 30, 2021 for all businesses except Recovery Startup Businesses.
Criteria For Identifying Recovery Startup Businesses
The IRS has outlined the criteria for defining a Recovery Startup Business (RSB) on a helpful comparison page between the different versions of the ERTC, entitled “Employee Retention Credit – 2020 vs 2021 Comparison Chart.”
- Began operating or carrying on trade after February 15, 2020
- Had under $1,000,000 in annual average gross receipts for the 3-year period preceding the calendar quarter for which you claim the ERTC
- Do not meet the other ERTC eligibility criteria listed for non-RSB businesses
Calculating qualified wages
Once you’ve determined that you qualify for the ERTC through either the suspended operations or gross receipts decline, you must calculate your total amount of qualified wages, which depends on your headcount of qualifying employees in both years.
Here’s how to determine your qualified wages:
- Determine if you qualify, based on ERTC suspension or gross receipts decline.
- Calculate the number of qualified employees or full-time equivalents in 2020 and 2021
- Apply the appropriate percentage to each qualifying employee’s wages
- Add up the resulting percentages to obtain your total amount of qualified wages
Qualified employees: Full-time staff and full-time equivalents
When determining whether an employee’s wages can be considered when calculating ERTC qualified wages, you can use the following definition (obtained from pages 20-21 in IRS Notice 2021-49):
“The term ‘full-time employee’ means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service during the month (emphasis added).”
Once you’ve determined your company’s number of qualified employees in 2020 and 2021, it’s time to determine the amount of qualified wages you can use to determine your potential ERTC amounts.
Comparison of 2020 and 2021 percentages for qualified wages
|2020 (100 employees or fewer)||Your qualified wages include up to 50% of wages paid to working and non-working staff during eligible periods|
|2020 (over 100 employees)||Qualified wages include up to 50% of wages paid to non-working staff during eligible periods|
|2021 (500 employees or fewer)||Your qualified wages include up to 70% of wages paid to working and non-wokring staff in eligible periods|
|2021 (over 500 employees)||Qualified wages include up to 70% of wages paid to non-working staff during ERTC-eligible periods|
A note about other loans and ERTC qualified wages calculations
When calculating qualified wages for the ERTC, due diligence must be maintained to ensure that only legitimate wages are input into calculations to determine qualified wages. IRS Code Sec. 3134 excludes any wages taken into account under sections 41, 45A, 45P, 45S, 51, 1396, 3131, and 3132 of the Code.
- Loans described in Small Business Act section 7(a)(37) or 7A, which includes wages connected to a first or second draw Paycheck Protection Program (PPP) loan
- Grant covered under section 324 of Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act
- A restaurant revitalization grant (American Rescue Plan Act section 5003)
How to retroactively claim the Employee Retention Tax Credit?
Although the deadline for the ERTC has passed (September 30, 2021 for most businesses and December 31, 2021 for RSB employers), it is still possible to retroactively claim the ERTC by filing an amended payroll return using Form 941X for each qualifying quarter.
The statute of limitations on the ERTC opportunity
The IRS generally gives you three years from the date you filed your original return or two years from the date you paid the tax to file an amended federal employment tax return. However, the 2021 American Rescue Plan Act extended this limitation for ERTC claimed for the third and fourth quarters in 2021.
If you’d like to learn more about the ERTC, you can use the following resources:
- Are you overlooking the Employee Retention Tax Credit opportunity?
- Debunking 4 myths about the Employee Retention Tax Credit
When you’re ready to get the ERTC, MBS Accountancy is ready to help you! You can visit our ERTC services page to view amounts we’ve helped past ERTC clients receive and submit your own application.