The ERTC is a refundable tax credit equal to 50% of qualified wages (including allocable qualified health plan expenses) paid to employees from March 13, 2020 to December 31, 2020. In terms of administrative guidance, the IRS has published Notice 2020-22 and 94 frequently asked questions concerning various aspects of the ERTC, and even reversed itself on a key aspect in determining the meaning of qualified wages (but more on that later).
The ERTC is a fully refundable tax credit equal to 50% of wages paid to employees up to a maximum amount of $10,000 per employee, so the maximum ERTC for wages paid to any employee is $5,000. Employers can claim the ERTC by reducing their employment tax deposits by the amount of the anticipated credit, rather than depositing the required employment taxes with the IRS. The employment taxes that can be reduced in this manner include the employee’s federal income tax, the employer’s share of social security and Medicare taxes, and the employee’s share of social security and Medicare taxes with respect to all of the employer’s employees. If the amount of the anticipated ERTC exceeds the amount of these employment taxes, then employers can apply for an advance payment of the credit on IRS Form 7200. A reconciliation is later made by the employer on its 2020 employment tax return (Form 941).
Alternatively, if the employer does not file Form 7200, it can wait to get a refund after it claims the ERTC on its Form 941.
The IRS recently re-issued Form 941 and the related instructions with a note to account for the ERTC. To claim the ERTC, employers report first and second quarter qualified wages on their second-quarter Form 941, Form 940-PR, or Form 940-SS, as relevant, even if some of the wages were paid in the first quarter – from March 13 to March 31.
Employers using a third-party payer such as a payroll service provider, professional employer organization (“PEO”), or certified professional employer organization (“CPEO”) also can claim the ERTC. These payers typically complete Schedule R to Form 941, which allocates the aggregate information on Form 941 among the payer’s various clients. Employers can use the information on that schedule to request an advance payment on Form 7200 even though their tax return information is included on an aggregate basis, but they will need to notify the payer and provide them with a copy of the Form 7200 so it can reconcile the credits.
Any employer engaged in a trade or business and that does not obtain a loan under the paycheck protection program (PPP) (subject to the safe harbor exception below) can claim the credit, i.e., there is no size or revenue limit that determine who can claim the ERTC. Employers must meet one of two criteria in order to qualify for the ERTC: (i) there is a partial or full suspension of operations due to orders from a governmental authority limiting commerce, travel or group meeting due to COVID-19 or (ii) there has been a significant decline in gross receipts relative to the same quarter in 2019. For this purpose, a significant decline in gross receipts begins with any quarter in which gross receipts are less than 50% of what they were in the same calendar quarter in 2019, and it ends with the quarter after the one in which gross receipts are greater than 80% of what they were in the same calendar quarter in 2019.
Regarding suspension-of-operations test, the “orders” that permit employers to claim the ERTC include orders, proclamations, and decrees from the Federal government, or any State or local government, but they do not include statements from a governmental official, including comments made during press conferences or in interviews with the media. They also does not include states of emergency that do not limit commerce, travel, or group meetings in any manner.
Employers are eligible for the ERTC if they have not obtained a loan under the PPP; however, if a PPP loan was obtained and is repaid by May 14, 2020 under an SBA safe harbor, then the ERTC can still be claimed. PPP loans generally are more favorable to employers than the ERTC because they provide loan forgiveness in amounts that generally exceed $5,000 per employee, but the PPP has restrictive eligibility criteria that excludes many employers.
Tax-exempt organizations can claim the ERTC if their operations are fully or partially suspended due to a governmental order related to COVID-19 (as described in more detail below), but the test relating to a significant decline in gross receipts does not apply to them.
The definition of qualified wages is different for employers that averaged more than 100 full-time employees (“FTEs”) during 2019 than it is for employers that averaged 100 or fewer FTEs during that period.
For employers that averaged more than 100 FTEs in 2019, qualified wages include those wages paid to employees for time that they are not providing services due to the suspension of operations or decline in gross receipts. For hourly and non-exempt salaried employees who do not have a fixed schedule of work, the hours for which the employee is not providing services may be determined using any reasonable method other than one that is based on an assessment of the employee’s productivity levels during the hours the employee is working. FAQ #54.
The definition of qualified wages is broader for employers that averaged 100 or fewer FTEs in 2019. For these employers, qualified wages include those wages paid to all employees during the suspension of operations or decline in gross receipts.
Qualified wages include an employer’s expenses to provide and maintain a group health plan to the extent these amounts are excluded from the employee’s gross income and are allocable to wages. This includes both the employer’s costs and only the portion of the cost paid by the employee with pre-tax salary reduction contributions, not amounts paid with after-tax contributions.
For employers that sponsor a self-insured group health plan, qualified health plan expenses can be determined and allocated using any reasonable method, including (1) the COBRA applicable premium for the employee typically available from the administrator, or (2) any reasonable actuarial method to determine the estimated annual expenses of the plan. FAQ #68. If the Eligible Employer uses a reasonable actuarial method, then rules similar to the rules for insured plans are used to determine the amount of health plan expenses allocated to an employee. See FAQ #67. In that case, the estimated annual expense is divided by the number of employees covered by the plan, and that amount is divided by the average number of work days during the year by the employees (treating days of paid leave as work days and any day on which an employee performs any work as work days). The resulting amount is the amount allocated to each day of qualified wages. Adjustments should be made for employee after-tax contributions.
The IRS recently changed is view on whether qualified wages include these expenses during times where no wages are being paid to employees, such as when they are on furlough. The IRS initially said no, but after it received pushback from a bipartisan group of members of Congress, it reversed itself earlier this month. Now, in FAQs #64 and #65, the IRS states that qualified wages include allocable health plan expenses even if the employees are not working and the employer does not pay them any wages during the time they are not working. However, for employers with more than 100 FTEs in 2019, the IRS includes these expenses in wages only during the time the employees are not providing services.
To prevent a double tax benefit, qualified wages do not include wages for which the employer receives a credit for qualified paid sick/family leave under the Families First Coronavirus Response Act. But employers can still claim both the ERTC and the credit for qualified paid sick/family leave as long as they relate to different wages. FAQ #14.
For employers that averaged more than 100 FTEs in 2019, qualified wages to not include wages paid to employees for paid time off for vacations, holidays, sick days and other days off because they represent benefits accrued during a prior period. For employers that averaged 100 or fewer full-time employees in 2019, the rule is different; such wages are qualified wages even if paid under a pre-existing vacation, sick and other leave policy. FAQ #56.
The ERTC is not available if an employer obtained a PPP loan, as explained above, but the ERTC is available if an employer obtained a PPP loan and repays it by May 14, 2020. FAQ #79. Note that the ability to claim the ERTC is unrelated to loan forgiveness under a PPP loan because once a PPP loan is obtained (and not returned within the safe harbor period), the employer no longer qualifies for the ERTC.
Employers can claim the ERTC in combination with the employer payroll tax deferral provision in section 2302 of the CARES Act. They do this by deferring payroll taxes before determining whether they are entitled to the ERTC.
If multiple entities are treated under the aggregation rules as a single employer for purposes of the ERTC, then no member of the group can claim the ERTC if any member of the group obtained a PPP loan (and did not return it within the safe harbor period). FAQs #80 and #25.
The ERTC is available if an employer receives a credit under §45S (the paid family and medical leave credit) only if the two credits do not apply to the same wage payments. FAQ #82. Note the credit under §45S is different than the refundable tax credits available under the Families First Coronavirus Response Act – the qualified paid sick/family leave provisions.
The ERTC is available if an employer receives credits under §51 (the Work Opportunity Tax Credit) only if the two credits do not apply to the same employee for the same period of time. FAQ #83.