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Employee Retention Tax Credits: Another Potential Benefit for Economically Challenged Businesses

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| Legal Advisory

After the passage of the CARES Act last year, the focus of many small businesses was on the Paycheck Protection Program (the “PPP”). A less reported feature was the tax credit available for the retention of employees (the “ERC”), largely resulting from the prohibition on utilizing both the PPP and the ERC. When the Coronavirus Response and Relief Supplemental Appropriations Act (“Relief Act”) was passed in December 2020, the ERC was extended and expanded and the limitations surrounding the use of the ERC by PPP borrowers were effectively eliminated. Then, on March 11, 2021, President Biden signed the American Rescue Plan Act of 2021 (the “American Rescue Plan”), which further expands and extends the ERC on a limited basis.

The ERC is designed to aid employers that experienced a significant decline in revenues or were otherwise forced to shut down during the COVID-19 pandemic, but nonetheless retained their employees during that time. Eligible employers that pay qualified wages to some or all employees may use the ERC against applicable employment taxes. In this advisory, we outline considerations when applying the ERC.

1. For what period is the ERC applicable?

The amount and applicability of the ERC to which a business may be entitled depends on what tax year the employer was eligible to claim that credit and which act covered that period of time.

The CARES Act covers qualified wage payments made by employers from March 12, 2020 through December 31, 2020. However, the Relief Act permits an employer to amend their 2020 Form 941 filings to retroactively claim an ERC if the employer would have qualified for the ERC but did not apply because the employer was participating in the PPP.

The Relief Act applies to qualified wage payments made after December 31, 2020 and before July 1, 2021.  The American Rescue Plan extends the ERC through December 31, 2021 and makes modifications to the ERC that are only applicable to the last two quarters of 2021.

2. How do I qualify for the ERC?

For wages paid between March 12, 2020 and December 31, 2020, the CARES Act governs the treatment of eligibility for the ERC. Any private-sector business or tax-exempt organization employer that carried on a business during the calendar year 2020 is eligible to claim the credit if it either: (1) had operations fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19; or (2) experienced a significant decline (defined in the CARES Act as greater than 50%) in gross receipts during the calendar quarter compared to the corresponding calendar quarter in 2019 (the “Gross Receipts Test”).

For wages paid between January 1, 2021 and June 30, 2021, the Relief Act governs the treatment of eligibility for the ERC, and for wages paid between July 1, 2021 and December 31, 2021, the American Rescue Plan governs the treatment of eligibility for the ERC.

A significant change to the ERC for all four 2021 quarters is with respect to the definition of “significant decline” in the Gross Receipts Test. For 2021 calendar quarters, employers qualify under the Gross Receipts Test if, in a 2021 calendar quarter, their gross receipts are less than 80% of their gross receipts for the corresponding calendar quarter in 2019. Employers that did not exist in 2019 may use the corresponding quarter in 2020 to measure the decline in their gross receipts.

The American Rescue Plan permits an employer to elect to determine eligibility under the Gross Receipts Test by comparing its gross receipts for the immediately preceding calendar quarter to the corresponding 2019 calendar quarter to determine if gross receipts are less than 80% in the immediately preceding calendar quarter to the corresponding 2019 calendar quarter.

3. What effect does the size of my business have on the ERC?

While the number of employees an employer has does not affect its eligibility to claim the ERC, it does determine what wages will qualify for the credit.

Under the CARES Act, with respect to 2020 calendar quarters, any employer which averaged more than 100 full-time employees during 2019 is considered “large” and may only claim a credit for qualified wages paid to employees who are not providing services due to the slowdown of business. For example, if an employer was closed due to COVID-related safety restrictions but nonetheless kept employees on the payroll, those wages qualify for the ERC. Simply paying wages to employees for their services rendered do not count for ERC treatment for “large” employers.

On the other hand, under the CARES Act, with respect to 2020 calendar quarters, any employer  which averaged 100 or fewer full-time employees during 2019 is considered a “small” employer and may claim a credit for all wages paid to employees during the quarter in which the employer qualifies for the ERC and is not only limited to wages paid to employees who are not performing services.

With the passage of the Relief Act, for 2021 calendar quarters, the decisive number of employees for determining whether an employer qualifies as a “small” or “large” business was increased to 500 full-time employees (as determined based on the average number of employees during 2019).

4. How much is the ERC worth?

For 2020, the credit is worth 50% of qualified wages paid per employee, capped at $5,000 per year. For example, an employer would be awarded a $5,000 tax credit for paying its employee $10,000; a $3,000 tax credit for paying its employee $6,000; and a $5,000 credit for paying its employee $20,000 (due to the cap). Qualified wages are capped at the amount the employee would have received for working an equivalent duration during the 30 days preceding the shutdown or the significant decline in gross receipts.

Under the Relief Act and for 2021, the maximum ERC has been increased to 70% of up to $10,000 in qualified wages that an eligible employer pays per calendar quarter, with a maximum credit of $7,000 per employee, per quarter. The credit is available even if an employer received the $5,000 maximum credit in 2020. The credit may be claimed on pay increases and bonuses paid in excess of what the employee earned prior to the shutdown or significant declined in gross receipts.

While the ERC continues to be refundable, the American Rescue Plan provides that for the third and fourth quarter of 2021 the ERC may only be claimed against the employer’s share of the Medicare tax as opposed to against the employer’s shares of the Social Security tax (1.45% of wages as opposed to 6.2% of wages).  

5. Are there any limitation on the credit?

Several limitations to the ERC as originally enacted have been lessened or removed. For example, while the CARES Act prohibited an employer that received a PPP loan from claiming an employee retention tax credit, the Relief Act expanded the ERC to permit employer recipients of PPP loans to claim the credit—including retroactively for periods beginning as early as March 13, 2020. That said, an employer may not double benefit from the PPP and the ERC. An employer may claim credit for wages that were paid with a PPP loan that was not forgiven but may not claim credit with respect to wages paid with the proceeds of a PPP loan that was forgiven. Employers may also claim a credit for wages that were not paid to employees by the forgiven PPP loan.

In addition, the Relief Act expands to ERC to permit certain public entities to qualify for the credit. This includes colleges and universities, entities with the principal purpose or function of providing medical or hospital care, and certain tax-exempt corporations organized as an instrumentality of the United States.

The American Rescue Plan added two new categories of employers eligible to claim the ERC in the third and fourth quarters of 2021. For wages paid after June 30, 2021, the ERC may be claimed by “recovery startup businesses” and “severely financially distressed employers.” “Recovery startup businesses,” which may claim a maximum ERC of $50,000 per calendar quarter, are those that began carrying on a trade or business post-February 15, 2020 and have average annual gross receipts of less than $1 million – “recovery startup businesses” may claim the ERC even if they do not otherwise meet the ERC requirements including a reduction in gross receipts or a suspension of operations due to government orders. “Severely financially distressed employers,” which may treat any wages paid as qualified wages even if the employer is a large employer, are those that have a decline of more than 90% in quarterly receipts in 2021 as compared to the same quarter in 2019.

Note that the American Rescue Plan increased the statute of limitations for assessments related to the ERC from 3 years to 5 years.

What’s Next?

The ERC may be a potentially significant benefit to employers, particularly for 2021 as a result of the expended benefits pursuant to the Relief Act. Your ability to qualify and the restrictions that may be applicable to your situation could, however, be complicated. Please do not hesitate to contact Shannon Zollo, Josh French, or your Nutter attorney with any questions you may have on your ability to take advantage of the ERC.

This advisory was prepared by Josh French, Laura Marsell, Mary Martin, and Shannon Zollo in Nutter’s Corporate and Transactions and Tax Departments. If you would like additional information, please contact one of the authors or your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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