This is part 3 of a 3-part series that reviews the latest developments of the Employee Retention Credit (ERC), which was first introduced as part of the CARES Act in the Spring of 2020.
Questions continue to come up for business owners seeking an Employee Retention Credit (ERC) refund, as there are many aspects to consider. Additionally, there are portions of the ERC calculation that still need clarification, but there are no assurances any IRS guidance will be provided. Below is our summary of the most common questions we see. This is followed by ways to determine if sufficient documentation exists to support a company’s ERC refund claim.
In reviewing whether an employer experienced a significant decline in gross receipts or encountered a full or partial suspension of its operations under a government shutdown, the following entities are aggregated and treated as a single employer for ERC purposes:
- Members of a controlled group of corporations or trades/businesses under common control according to IRC Sections 52(a) or (b);
- Members of an affiliated service group under IRC Section 414(m); and
- Members otherwise aggregated under IRC Section 414(o).
This can be a complicated and tedious process. The following documentation is recommended to comply with the above aggregation rules:
- The ownership structure and percentages owned of all entities in the related group;
- A formalized organizational chart of each entity;
- A spreadsheet that summarizes the gross receipts of all entities in 2020 and 2021 by quarter and compares these to corresponding quarters in 2019, and then reports the percentage decline in total aggregate receipts; and
- A spreadsheet that combines the full-time employee headcount of all entities for 2019 to determine whether the aggregate group is considered a small or large employer in 2020 and 2021.
Significant Decline in Gross Receipts Test
Whether qualifying under the aggregation rules or as a stand-alone entity, the documentation needed to satisfy the gross receipts test is the same, as follows:
- Copies of income tax returns that support the same basis of gross receipts being tested. For this test, gross receipts include interest, dividends, rents, royalties, and proceeds received from asset sales (not the gain or loss itself). If the tax returns do not readily agree with the gross receipts’ amounts being tested, a reconciliation should be prepared; and
- Confirm that PPP loan proceeds or other COVID-relief funds are not included in gross receipts for purposes of this test.
ERC Eligible Wages
Qualifying ERC wages are determined as follows:
- If qualifying for ERC under the significant decline in gross receipts, all wages paid in the qualifying quarter are considered in the ERC calculation;
- If qualifying for ERC under a full or partial suspension due to a government order, then only wages paid during the period of government shutdown are considered in the ERC calculation. The wages of the entire quarter are not used;
- Exclude wages paid to majority owners (> 50%) of the entity, as well as wages of any employee related to such owners in the following manner:
- Spouse, child, parent, sibling, cousin, aunt/uncle, niece/nephew;
- For determining ERC in 2020, a large employer is defined as an employer with more than 100 full-time employees based on the 2019 year. But, a large employer for 2021 is defined as an employer with more than 500 full-time employees, again, based on the 2019 year. If an employer is considered a large employer for 2020 or 2021, only wages paid when the employee was not working are eligible for ERC. Statements and records should be maintained that support if an employee was laid off or otherwise paid for leave while they were not working; and
- ERC wages also consist of employer-paid healthcare costs. Do not overlook these amounts.
Excluded from the ERC definition of wages are any wages that were also used for PPP loan forgiveness (discussed further below), or are otherwise reimbursed through other grants. The resulting net ERC wages are capped at:
- For 2020 ERC: $10,000 per employee for the entire year.
- For 2021 ERC: $10,000 per employee per qualifying quarter or qualifying portion of quarter under the government shutdown rules (noted above).
Interaction of ERC with PPP Loan Forgiveness
The interaction of the ERC with PPP loan forgiveness is a critical part of the ERC calculation. While an employer can now qualify for both loans, the same wages cannot be used for both ERC and PPP loan forgiveness. Likely, the IRS will very closely scrutinize the overlap of ERC and PPP wages. The following should be considered when applying this restriction on the use of wages:
- Retain the PPP loan application, PPP loan forgiveness application and actual PPP loan forgiveness confirmation from the SBA and financial institution;
- From the PPP loan forgiveness application, find the “covered period” and the related payroll costs submitted. Other non-payroll costs that are listed on the loan forgiveness application will support a less than 100% use of wages needed to satisfy full loan forgiveness. Non-payroll costs can account for up to 40% of total costs submitted for PPP loan forgiveness;
- Only wages falling within the covered period may be used for PPP loan forgiveness. Detailed payroll reports are needed to accurately quantity these PPP/ERC wages; and
- Since wages of majority owners and employees related to those owners are not ERC eligible, their wages may still be used to satisfy PPP loan forgiveness. The PPP wages, though, cannot exceed the $100,000 per employee annual limitation to satisfy PPP loan forgiveness.
While there are several other aspects to the ERC, the above represents the main considerations to ensure business owners can seek and substantiate their ERC refund claim. Please contact your Sikich tax advisor below to discuss the ERC eligibility and claim process.
Click here to read part 1.
Click here to read part 2.