Congress passed two bills, the Consolidated Appropriations Act (CAA), in the latter part of December of 2020, and the American Rescue Plan Act (ARPA), signed on March 11, 2021. Both bills give businesses a second round of relief to help deal with the economic setbacks of the pandemic. One significant benefit is the Employee Retention Tax Credit (ERTC). The ERTC is a refundable tax credit for eligible employers based on the amount of qualified wages they paid. Below is a breakdown of the primary modifications to assist our clients, potential clients and any other interested businesses.
- Changes in Disallowed Entities – Before CAA, disallowed entities like local or state colleges, universities or entities giving hospital or medical services were not allowed to take the credit. Starting January 1, 2021 these listed entities and congressionally chartered – entities like credit unions and banks can now claim the credit.
- Additional Businesses Now Eligible – In the first round of pandemic assistance, only existing businesses whose operations were partially or fully suspended because of government orders, or businesses who experienced a significant decline in their gross receipts because of the pandemic were eligible for the ERTC. But what about businesses that started after the pandemic began? The CAA created a new business category, recovery startup business. This is defined as a company that began business after February 15, 2020 and has gross annual receipts of under $1 million. Businesses in this category can now claim the ERTC, do not have to experience a government ordered suspension or shutdown, and do not have to meet the reduced gross receipts requirements. However, the ERTC for recovery startup business is limited to a maximum ERTC of $50,000 per quarter. The CAA also allowed severely financially distressed companies to treat all wages up to the $10,000 limitation as qualified wages, even if the business is a large employer. A severely distressed company is defined as a company with gross receipt reductions of more than 90% as compared to the same quarter in 2019.
- Gross Receipts Test Revised – Under the CARES Act, an employer qualified for the ERTC when business gross receipts during 2020 showed a loss of 50% or more compared to the same 2019 calendar quarter. The CAA, however, modified this rule to permit a business to qualify at the start of the period when business gross receipts show a loss of only 20% or more compared to the same 2019 calendar quarter. This change allows significantly more businesses to qualify for the ERTC.
- Qualified Wages and Employee Threshold Expanded – Initially, the ERTC was available for employers with 100 or less employees, and limitations were placed on employers with over 100 employees. Due to the CAA changes, the “small business” employee threshold is now increased to 500 employees and wages paid to all employees can be considered for the ERTC. In addition, the qualified wages definition has changed. It now allows businesses with 500 or less employees to factor in qualified healthcare expenses, and covers wages paid to employees for work performed and wages paid when employees did not provide services. Employers with 500 or more employees may only take the ERTC on wages paid to employees for not performing services.
- Employee Raises and Hazard Pay – Prior to CAA, employers were not allowed to factor in increased wages when calculating the amount of credit. The CAA modified this rule and it now allows scheduled wage increases and increased pay for hazardous duty to be included as qualifying wages when calculating the credit.
- Wages Limits Expanded – The original rules only allowed businesses to file a credit claim against $10,000 of qualified wages and was limited to $5,000 per employee, per year (the calculation is 50% of qualifying wages up to $10,000). The CAA modified this calculation to raise the limit to $7,000 per employee, per quarter (the calculation 70% of qualifying wages up to $10,000) for the first two quarters of 2021. The ARPA extended the ERTC through December 31, 2021, allowing businesses to take it for all four quarters of 2021. In short, this means the potential employee credit for 2021 has been increased to $28,000 per employee from the original $5,000 per employee in 2020.
- Exempt Wages – Employers cannot use wages that were used to obtain PPP loan forgiveness, amounts used to claim the sick and family leave credits, or wages covered by monies received from the newly created Restaurant Revitalization Fund or Shuttered Venues Grant to calculate the ERTC.
- Claiming ERTC If You Have a PPP Loan – This is the most critical (and beneficial) change. Businesses that received a PPP loan in 2020 were not permitted to claim the ERTC. Now, because of CAA, a PPP loan recipient is permitted to claim the credit. However, it cannot claim the ERTC on wages paid with the proceeds from forgiven PPP loans (both rounds). Since this modification was backdated to March 2020, there is now a pathway to more savings. New Mexico and Texas businesses that did not take the credit in 2020 because of a PPP loan need to assess the qualifications to see if they meet the criteria to now take the credit for 2020 wages. Businesses also need a strategy that considers best utilization of PPP and ERTC wages and expenses going forward, or risk leaving tax credits on the table. A simple illustration:
- Example 1: a company incurred $100,000 in wages between April 1 and December 31, 2020, and received a PPP loan for $35,000. The company took the easy way out and applied for forgiveness using $35,000 in wages and reported no other PPP approved expenses. This reduced the amount of eligible wages for the ERTC to $65,000.
- Example 2: The same company reported 25% of PPP funds used for rent, utilities and other PPP approved expenses ($8,750) and only 75% of funds used for payroll ($26,250) to apply for PPP loan forgiveness. This freed up additional wages ($73,750 vs $65,000 from example 1) that can be applied to the ERTC calculation, thus increasing the ERTC credit and still allowing for potential full forgiveness of the PPP loan.
- If a business has not yet filed for PPP loan forgiveness, we strongly suggest they contact their accountant or The Becerra Group to discuss strategies to maximize both the PPP and the ERTC before they apply for loan forgiveness. Filing for PPP loan forgiveness without looking at the effect the ERTC may result in a significant loss of available tax credit savings. Once filed, a PPP loan forgiveness application cannot be amended. A previously filed Form 941 however, that did not take any ERTC credits, can be amended. Finalize your strategy BEFORE you apply for PPP loan forgiveness. Caution: If a business applied for forgiveness prior to CAA, they are generally precluded from claiming the ERTC in 2020.
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The modifications to the Employee Retention Tax Credit translates into potential savings for New Mexico and Texas businesses, especially for those businesses who have not yet filed for forgiveness of their first round PPP loan. There will most likely be more published guidance about these changes, so it is critical to meet with your tax professional to figure out the possible savings for your company. If you want to know more about the modifications and guidelines described here or need help with accounting or tax problems, The Becerra Group can assist you. Call us at 505-462-9090 (NM) or 830-254-4708 (TX), or click here and complete our online contact form. We are here to serve all your tax, accounting and bookkeeping needs.