The employee retention credit was enacted under section 2301 of the CARES Act.  The credit is a refundable credit allowed against an eligible employer’s share of social security taxes.  As originally enacted, the amount of the credit was equal to 50% of qualified wages with respect to each employee and a maximum of $10,000 of qualified wages could be taken into account for each employee.  Only wages paid from March 13, 2020 through December 31, 2020 were eligible.  One of the most significant roadblocks to eligibility for the credit was that employers that received a paycheck protection program loan (aka PPP loan) were ineligible to claim the credit regardless of whether or not the loan was forgiven.

The Taxpayer Certainty and Disaster Relief Act of 2020 (TCDR), which was signed into law on December 27, 2020 as part of the larger COVID-19 relief bill known as the Consolidated Appropriations Act, 2021, makes some substantial changes to the credit that will result in many more employers being eligible to claim the credit.  

Probably the most significant change made by the TCDR is the elimination of the PPP loan exception.  This change applies retroactively back to the original enactment of the credit so eligible employers that were not previously able to claim the credit due to having received a PPP loan may now be eligible for the refundable credit.

Additionally, the TCDR extends the credit to wages paid through June 30, 2021 and changes the requirements for claiming the credit with respect to wages paid from January 1, 2021 through June 30, 2021.  The following is a summary of the eligibility requirements as well as a discussion of the PPP loan considerations.

Eligible Employer

An eligible employer is any employer that was carrying on a trade or business during 2020 (or during the first or second calendar quarters of 2021, as applicable) and that satisfies either of the following two tests with respect to any calendar quarter during 2020 (or 2021, as applicable).

  1. The operation of the employer’s trade or business was 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 the coronavirus disease 2019 (COVID-19), or
  2. The employer experienced a significant decline in gross receipts (see below for details).

A tax-exempt organization under section 501(c) of the Internal Revenue Code (IRC) is deemed to be carrying on a trade or business and, thus, can be an eligible employer if it meets either of the two tests above.

The IRS has issued FAQs addressing the types of governmental orders that may be taken into account under the first test as well as what constitutes a full or partial suspension.

For purposes of the second test (i.e. a significant decline in gross receipts), the following rules apply.

- Wages Paid March 13, 2020 through December 31, 2020

The period of eligibility starts on the first day of the first calendar quarter during 2020 in which gross receipts are less than 50% of gross receipts for the same calendar quarter in 2019 and ends on the first day of the calendar quarter after the calendar quarter in which gross receipts exceed 80% of the 2019 amount for the same calendar quarter.  The IRS has issued FAQs addressing the application of this test when a business was started during 2019 or was acquired during 2020.

As an example, an employer had gross receipts of $100,000 for each calendar quarter of 2020 and had the following gross receipts for the four calendar quarters of 2019: 1 - $300,000; 2 - $225,000; 3 - $120,000; 4- $100,000.  Since the first quarter 2020 gross receipts are less than 50% of the first quarter 2019 gross receipts (i.e. $100,000/$300,000 = 33.33%), the eligibility period would start on January 1, 2020 (i.e. the first day of the first quarter) although, as previously mentioned, only wages paid on or after March 13, 2020 would be taken into account.  The quarter in which gross receipts exceed 80% is the third quarter (i.e. $100,000/$120,000 = 83.33%) so the eligibility period would end with the first day of the following quarter (i.e. October 1, 2020).

- Wages Paid January 1, 2021 through June 30, 2021

Eligibility under the gross receipts test applies for the first two calendar quarters of 2021 if gross receipts for such calendar quarter are less than 80% of gross receipts for the same calendar quarter in 2019.  For an employer not in existence on the first day of a calendar quarter in 2019, the comparison for that calendar quarter must be made with respect to the corresponding calendar quarter of 2020.  In other words, if an employer started business on March 1, 2019, it would compare first quarter 2021 gross receipts to first quarter 2020 but would still compare second quarter 2021 to second quarter 2019.

An election is available to use the immediately preceding calendar quarter instead of the calendar quarter in which the wages are paid.  The comparison quarter would be the corresponding calendar quarter of 2019, if the employer were in existence.  In other words, if this election is made with respect to the first calendar quarter of 2021 then instead of using gross receipts for the first calendar quarters of 2021 and 2019, the employer would use gross receipts for the fourth calendar quarters of 2020 and 2019.

Using the same 2019 gross receipts from the previous example - and assuming the employer was in existence on January 1, 2019, does not make the election described above and has $100,000 of gross receipts in each of the first two calendar quarters of 2021 - gross receipts for both the first and second calendar quarters of 2021 would be less than 80% of gross receipts for the same calendar quarters of 2019 and, thus, the employer could claim the credit for qualified wages paid during both such quarters.

Qualified Wages

The determination of qualified wages depends upon the eligible employer’s average number of full-time employees in 2019 (determined under the rules used for the employer shared responsibility payment under section 4980H of the IRC).  In addition to wages, amounts paid under a group health plan (both employer and employee portion) are included.  Any wages for which either the credit for paid sick leave or the credit for paid family leave under the Families First Coronavirus Response Act was claimed are excluded from qualified wages.  Also, special rules may apply if an employee’s wages are used to compute certain other credits (e.g. research credit, work opportunity credit).

- Wages Paid March 13, 2020 through December 31, 2020

If the average number of full-time employees exceeds 100 then only wages paid to employees not working are taken into account.  This would apply if the employer decides to continue paying an employee during a period in which the employee is not working due to either of the two tests discussed under eligible employer (i.e. suspension of operations or significant decline in gross receipts).

If the average number of full-time employees is 100 or less then wages are included regardless of whether an employee is working.

- Wages Paid January 1, 2021 through June 30, 2021

The rules are the same as above except the determination is based upon an average of 500 employees instead of 100.

Computation of Credit

The credit computed for any particular calendar quarter is based upon a percentage of qualified wages paid during that quarter and is limited to a specific amount of such wages.

- Wages Paid March 13, 2020 through December 31, 2020

The credit percentage is 50% and the maximum qualified wages per employee that can be taken into account for all calendar quarters is $10,000 meaning the maximum credit per employee for 2020 wages is $5,000.

- Wages Paid January 1, 2021 through June 30, 2021

The credit percentage is 70% and the maximum qualified wages per employee that can be taken into account for each calendar quarter is $10,000 meaning the maximum credit per employee for 2021 wages is $14,000 (i.e. $20,000 of potential qualified wages multiplied by 70%).

Commonly-Controlled Entities

If a group of entities meets certain relationship tests, the determination of eligible employer status and average number of full-time employees must be made for the group as a whole.  Also, the amount of any allowable credit must be apportioned among the members of the group based upon each member’s share of qualified wages.  These rules are very complex and need to be reviewed based upon each entity’s particular circumstances.

PPP Loan Considerations

As previously indicated, the employee retention credit was not available to employers that received a PPP loan.  Since this exception was removed by the TCDR, effective back to the original enactment of the credit, such employers might now be eligible to claim the credit.  In conjunction with this change, the TCDR included certain amendments to coordinate with the PPP rules.  The PPP rules were modified to provide that any amounts taken into account as qualified wages for purposes of the employee retention credit cannot be taken into account as payroll costs in determining loan forgiveness.  Additionally, the credit rules were modified to provide employers with an election to exclude amounts from qualified wages.  This election would have the effect of allowing such wages to be treated as payroll costs for PPP loan forgiveness purposes.  The objective would be to minimize the amount of qualified wages used in applying for PPP loan forgiveness and, thus, maximize the employee retention credit.

With respect to PPP loans, the COVID-19 relief bill modified the types of expenses that can be used to qualify for forgiveness.  These new eligible expenses include covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures.  Each of these is defined in the bill.  This modification was made effective as if included in the CARES Act so it can be used when applying for forgiveness for the first round of PPP loans.  However, it is not available if the loan was already forgiven prior to December 27, 2020.  To the extent that such costs can be used in applying for loan forgiveness in place of qualified wages, the employee retention credit may be maximized.

Questions remain as to whether relief will be provided to employers that filed an application for forgiveness prior to enactment.  Will such employers be allowed to recompute the amount of wages and other eligible expenses used in the forgiveness application due to the new rules?  Will employers be allowed to change the covered period (e.g. 8 weeks vs. 24 weeks) in order to maximize qualified wages?

Conclusion

Due to the removal of the exception for an employer that received a PPP loan, it is likely that many employers will now be eligible for the employee retention credit.  The amount of such credit can be significant.  Employers should review the eligibility requirements and, if eligible, should file amended payroll tax returns (e.g. Form 941X) to claim any allowed credit for 2020.  For the first two calendar quarters of 2021, an employer can either claim the credit on its timely-filed payroll tax return for such quarter or, if eligible, elect to receive an advance payment of the credit.  Guidance is pending on the process by which an employer can elect to receive an advance payment and only employers with average number of full-time employees not greater than 500 can make this election.

It is important that employers applying for PPP loan forgiveness review the eligible expenses and minimize the amount of qualified wages used to determine payroll costs.