By Jennifer Rohen and Jack Rybicki and Chastity Wilson CLA Contact
- Evaluate employee retention credit eligibility prior to filing your PPP forgiveness application.
- IRS issues guidance on surplus wages used for PPP forgiveness.
- IRS issues guidance to help clarify whether a government order constituted a partial shutdown.
Claiming the employee retention credit could have an impact on your PPP loan. We’re breaking down what you need to know about the latest IRS guidance.
Background on new guidance around PPP loans and the employee retention credit
On March 1, the IRS released Notice 2021-20, which provides guidance on the employee retention credit (ERC) as it applies to qualified wages paid after March 12, 2020, and before January 1, 2021. Prior to issuing Notice 2021-20, the IRS shared most of its ERC guidance through frequently asked questions (FAQs) on IRS.gov.
Notice 2021-20 incorporates many of those FAQs and addresses changes made by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), which was part of the Consolidated Appropriations Act, 2021.
Many employers are frequently asking:
- How does the ERC work with PPP loan forgiveness?
- What qualifies as a partial shutdown?
These and other common questions are discussed below.
Interaction with PPP loans
Prior to passage of the Relief Act in late December 2020, an employer that received a PPP loan could not claim the ERC. The Relief Act changed this rule retroactively so now employers that received a PPP loan in 2020 may claim the ERC for qualified wages paid after March 12, 2020, and before January 1, 2021, if they are otherwise eligible for the credit.
An employer, however, cannot claim the ERC on wages it uses to receive PPP loan forgiveness. This double dipping is prevented because an eligible employer is deemed to make an election not to consider qualified wages reported on the employer’s PPP Loan Forgiveness Application for purposes of claiming the ERC. This deemed election has raised a lot of questions, and the notice addresses some of them.
It is not uncommon for an employer to have submitted its PPP Loan Forgiveness Application and reported only payroll costs despite having paid other eligible expenses. In many cases, employers did this for administrative ease, because employers that submitted their application prior to the Relief Act couldn’t claim the ERC credit.
Example: Employer A received a PPP loan of $200,000. Employer A is an eligible employer and paid $200,000 of qualified wages that would qualify for the ERC during 2020. Employer A also paid other eligible expenses of $80,000. Employer A must report a total of $200,000 of payroll costs and other eligible expenses, with a minimum of $120,000 of those costs being payroll costs, to receive full forgiveness of its PPP loan.
Employer A submitted its PPP Loan Forgiveness Application and reported $200,000 of qualified wages as payroll costs but did not report any of the $80,000 eligible expenses. Employer A received a decision from the SBA forgiving the PPP loan in its entirety. [This example is adapted from an example in the Notice, Q&A #49]
In this example, the question is whether Employer A can use $80,000 of qualified wages to the claim the ERC since it could have used $80,000 of other eligible expenses on its PPP Loan Forgiveness Application. The IRS says no portion of the qualified wages reported as payroll costs may be treated as qualified wages for purposes of the ERC. That is, Employer A cannot reduce its deemed election by the amount of other eligible expenses that it could have reported on its PPP Loan Forgiveness Application.
Another common scenario is where an employer reported payroll costs greater than the amount of the PPP loan.
Example: Employer B received a PPP loan of $200,000. Employer B submits a PPP Loan Forgiveness Application reporting $250,000 of qualified wages as payroll costs. Employer B received a decision from the SBA forgiving the PPP loan in its entirety.
In this example, the question is whether Employer B is deemed to have made an election not to take into account the entire $250,000 of qualified wages for purposes of the ERC, even though it only needed $200,000 to receive forgiveness. The IRS says Employer B is only deemed to have made the election with respect to $200,000 of qualified wages. That means Employer B can use $50,000 of qualified wages to claim the ERC.
Yet another common scenario is when an employer submits a PPP Loan Forgiveness Application reporting a combination of qualified wages as payroll costs and other eligible expenses that exceed the amount needed to receive full forgiveness.
Example: Employer C received a PPP loan of $200,000. Employer C submits a PPP Loan Forgiveness Application reporting $200,000 of qualified wages as payroll costs and $70,000 of other eligible expenses (total of $270,000). Employer C received a decision from the SBA forgiving the PPP loan in its entirety.
The question is whether Employer C is deemed to have an election not to take into account the entire $200,000 of qualified wages for purposes of the ERC, even though it only needed to report $130,000 of qualified wages as payroll costs to receive PPP forgiveness. The IRS says Employer C is only deemed to have made the election with respect to $130,000 of qualified wages for purposes of ERC. That means Employer C could claim $70,000 as qualified wages for purposes of the ERC.
How do you claim the retroactive ERC?
Many employers may now claim the ERC retroactively in 2020 but are unsure how to get a refund for the credit. Some hoped the IRS would allow employers to claim the retroactive credit on their first quarter 2021 using Form 941, but unfortunately, this is not the case.
The notice provides an eligible employer that received a PPP loan and did not claim the ERC may file a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the quarter in which the employer paid qualified wages.
This is not great news for employers looking to get cash quickly. The IRS does not accept electronic filing of Form 941-X, which means employers must paper file Form 941-X. As of February 17, 2021, the IRS confirmed it is still processing returns it received over the summer due to the extended July 15 tax filing due date. In fact, the IRS says is it still processing tax returns dated as early as July 15, 2020. The IRS is shifting work among locations to help minimize delays. The IRS also confirmed tax returns are opened in the order received. The reality is it may take the IRS several months to process the influx of Forms 941-X it could receive because of the retroactive provisions of the ERC pursuant to the Relief Act.
Further compounding the negative impact of the delay, from an income tax perspective employers are required to reduce their deduction for qualified wages, including qualified health plan expenses, by the amount of the employee retention credit (excluding the employer’s deduction for the employer’s share of Social Security and Medicare taxes). Accordingly, an employer must consider whether to reduce its 2020 deduction for qualified wages for the ERC it has claimed or will claim on a 2020 Form 941-X when filing its original income tax return. If the employer does not reduce its deduction for qualified wages and subsequently files Form 941-X to claim the ERC, the employer may also have to file an amended income tax return to reduce its deduction for qualified wages.
Objective test for partial suspension of operations due to a governmental order
The ERC is available only to employers that are eligible employers. An eligible employer is defined as an employer carrying on a trade or business during calendar year 2020, with respect to any calendar quarter, for which:
- Operations are fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meeting due to COVID-19, or
- Had a significant decline in gross receipts.
Another common area of ERC confusion is surrounding what qualifies as a partial suspension of operations. Prior to the notice, the only IRS guidance on this topic was found in the FAQs, which did not provide specific objective tests to determine whether an employer experienced a partial suspension of operations.
The notice provides some objective tests. If more than a nominal portion of an employer’s business operations are suspended by a governmental order, that is considered a partial suspension. For purposes of the ERC, a portion of an employer’s business operations will be deemed to constitute more than a nominal portion of its business operations if either:
- Gross receipts from that portion of the business operation is 10% or more of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or
- The hours of service performed by employees in that portion of the business is 10% or more of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).
The gross receipts test is rather mechanical. The hours of service performed is a little more complex. The notice does not contain any examples that show how the application of the hours of service works. If an employer does not require its employee to keep track of hours based upon the specific business operation, it may be challenging for the employer to determine whether specific operations account for 10% or more of total operations.
Comparable operations by requiring employees to telework
In the IRS’s original FAQs, it discussed the concept of an employer being able to continue operations comparable to its operations prior to closure by requiring its employees to telework. The IRS’s position is if a governmental order requires an employer to close its workplace, but the employer is able to continue operations comparable to its operations prior to the closure by requiring its employees to telework the employer is not considered to have a full or partial suspension of operations.
The prior FAQs did not provide any guidance as to what factors to consider in determining if an employer is able to continue comparable operations. The notice, however, provides a non-exclusive list of factors to be considered.
- Employer’s telework capabilities — Whether employer has adequate support to continue operations from another location.
- Portability of employees’ work — Whether employees’ work is portable or otherwise adaptable to be performed from a remote location.
- Need for presence in employee’s physical workspace — An example of this factor is manufacturing involving special equipment that cannot be accessed or operated remotely.
- Transitioning to telework — If employer previously did not allow telework, or only allowed minimal telework, then some adjustment period is expected and during this period of adjustment the employer is not considered fully or partially suspended. If the employer, however, experience a significant delay, which the IRS defines as a beyond two weeks, in transitioning to comparable telework, then the employer is considered subject to a partial suspension during such transition period.