The Consolidated Appropriations Act, 2021, which became law on December 27, 2020, contains two provisions that extend and expand the employee retention credit for employers.
As originally enacted, Section 2301 of the CARES Act provided a 50% retention credit for “qualified wages” paid by an “eligible employer” between March 13 and December 31, 2020, up to a maximum credit of $5,000 per employee. Section 206 of the Consolidated Appropriations Act, 2021 (Act), includes retroactive changes that apply to the 2020 and 2021 versions of the employee retention credit (ERC). Section 207 of the Act creates an expanded version of the ERC for 2021, summarized below.
Retroactive Amendments Applicable to ERC on Qualified Wages Paid During 2020 and 2021
Section 206 amends the ERC retroactive to March 13, 2020, its original effective date. Accordingly, employers should consider whether any of the following amendments allow for additional credits on wages paid to employees since the ERC became effective:
- PPP Loan Recipients Now Eligible to Claim ERC. Prior to amendment by Section 206, an employer that received a Paycheck Protection Program (PPP) loan could not claim the ERC on any wages, even for wages that were not funded with PPP loan proceeds. This proved troublesome for aggregated employers and employers engaged in mergers and acquisitions (M&A) transactions. Now, employers that received PPP loans may also claim the ERC on qualified wages, subject to one additional limitation. An employer may not double benefit by claiming the ERC on wages that the employer paid with PPP loan proceeds that the Small Business Administration (SBA) has forgiven. An eligible employer may, however, claim the ERC on qualified wages that were funded through other means, including with PPP loan proceeds that are not forgiven. Given that a fully forgiven PPP loan provides a more favorable economic benefit than a 50% ERC, we expect that many eligible employers will pursue PPP loan forgiveness to the maximum extent possible, but may claim the ERC for wages that are not covered by a forgiven PPP loan.
- ERC Available for “Qualified Health Plan Expenses” an Employer Pays on Behalf of Furloughed Employees. Section 206 clarifies that “qualified health plan expenses” paid by an employer are eligible for the ERC even if such health plan costs are attributable to furloughed employees who are not receiving any other wages from their employer. This clarification aligns with the current Internal Revenue Service (IRS) interpretation of the original CARES Act, after congressional pressure led the IRS to change its original position that health plan expenses were only eligible for the ERC when paid on behalf of employees receiving other wages as well.
- Clarification That Tax-Exempt Organization “Gross Receipts” Test Applies to All Gross Receipts (and Not Only to Unrelated Trade or Business Gross Receipts). Section 206 clarifies that tax-exempt organizations determining eligibility for the ERC under the “gross receipts” test must account for all gross receipts within the meaning of Internal Revenue Code (IRC) Section 6033, and not only gross receipts from unrelated trade or business activities. This also is consistent with current IRS guidance.
- Reporting Options for Claiming Previously Unavailable ERC on Qualified Wages Paid during 2020. Employers may “catch up” on previously unclaimed ERC (i.e., on qualified wages paid between March 13 and December 31, 2020) by claiming the ERC on the fourth-quarter Form 941 that most employers are required to file with the IRS by January 31, 2021. We do not yet know how the mechanics of catching up will operate, but we expect the IRS to issue clarifying guidance and updated Forms 941 and instructions early in January. Eligible employers also may claim the ERC retroactively by filing amended quarterly employment tax returns (i.e., Form 941-X) for affected calendar quarters of 2020.
Prospective Amendments Applicable to ERC on Qualified Wages Paid During First Two Quarters of 2021
Section 207 extends and expands the ERC prospectively for qualifying wages paid between January 1, 2021 and June 30, 2021, in the following ways:
- Increases ERC from 50% to 70% of Qualified Wages. The Act increases the ERC from 50% of qualified wages paid during 2020 to 70% of qualified wages paid during each of the first two quarters of 2021.
- Changes the $10,000 Cap on Qualified Wages from “All” Quarters to “Any” Quarter. In 2020, employers can claim the ERC on up to $10,000 of qualified wages per employee. For 2021, the $10,000 annual cap becomes a quarterly cap. Therefore, the maximum ERC for the first two quarters of 2021 equals $14,000 per employee (i.e., 70% of up to $10,000 of qualified wages paid during the first quarter of 2021, plus 70% of up to $10,000 of qualified wages paid during the second quarter of 2021).
- Lowers the Gross Receipts Eligibility Threshold from 50% Decline to 20% Decline. For 2020, an employer satisfied the gross receipts test only if quarterly gross receipts declined by more than 50% compared to the same calendar quarter in 2019. For 2021, an employer will satisfy the gross receipts test if quarterly gross receipts decline by more than 20% compared to the same calendar quarter in 2019. Using 2019 as the baseline period will be more favorable for employers whose gross receipts declined during 2020. For an employer that was not in business as of the beginning of the same calendar quarter in 2019, the baseline period is the corresponding calendar quarter in 2020.
Alternatively, an employer may elect to apply the gross receipts test for 2021 using gross receipts for the prior calendar quarter, compared to the corresponding calendar quarter in 2019. For example, an employer can satisfy the gross receipts test for the first quarter of 2021 in the following two ways: (a) first-quarter 2021 gross receipts fall by more than 20% compared to first-quarter 2019 gross receipts, or (b) fourth-quarter 2020 gross receipts fell by more than 20% compared to fourth-quarter 2019 gross receipts. It is not clear whether an employer can use this rule to qualify for the ERC in the first two quarters of 2021 based solely on a decline in gross receipts during the first quarter of 2021. We expect IRS guidance will address this question.
- Permits Employers with up to 500 Employees (Previously 100 Employees) to Claim ERC on All Wages Paid During an Eligible Period. For 2020, employers with 100 or fewer full-time equivalent (FTE) employees during 2019 can claim the ERC on all wages paid to employees during a period in which the employer satisfied the shutdown test or the gross receipts test. Employers with more than 100 FTE employees during 2019 can claim the ERC only on wages paid for nonworking periods triggered by a government shutdown order or a decline in gross receipts. For 2021, the Act increases the small employer threshold from 100 to 500 FTE employees, meaning employers with up to 500 FTE employees in 2019 may claim the ERC for 2021 on wages paid for working or nonworking periods.
- Removes Cap on Qualified Wages for Increased Pay. For 2020, eligible employers with more than 100 FTE employees during 2019 could not claim the ERC on wages in excess of the amount an employee would have received for working an equivalent duration during the 30 days immediately preceding the shutdown or the decline in gross receipts. The Act removes this cap for 2021 wages, which means increases in employee pay (e.g., bonuses) may qualify for the ERC.
- No Advance Payment of ERC for Employers with More Than 500 Employees. For 2020, an eligible employer can claim the ERC by reducing federal employment tax deposits, filing IRS Form 7200 requesting advance payment, and/or claiming a refund on IRS Form 941. For 2021, the Act appears to eliminate the Form 7200 advance payment option for employers with more than 500 employees. It is not clear whether such employers may continue to claim the ERC by reducing federal employment tax deposits, or whether the credit may only be claimed on IRS Form 941.
- Expands Advance Payment of ERC for Employers with 500 or Fewer Employees. For 2021, an eligible employer may elect to receive an advance payment of up to 70% of the average quarterly wages paid by such employer during 2019. For seasonal workers, an eligible employer may elect to calculate the advance payments based on actual wages paid for the corresponding calendar quarter in 2019. Interestingly, the statute does not limit the advance payment to $10,000 per employee per month, which may enable employers to obtain advance payments that far exceed the projected ERC for the quarter.
- Procedures for Repaying Excess ERC Advance Payments. If an employer receives an advance payment that exceeds the allowable ERC for the quarter, the employer must account for the excess on the affected quarterly Form 941 as a mathematical error. This allows the IRS to immediately assess and begin collection activities to recoup excess advance payments, thus depriving affected employers of any right to first challenge IRS assessment and collection activities in the US Tax Court through the IRC Section 6213(a) deficiency procedures.
- ERC Eligibility for Certain Governmental Employers. For 2020, the ERC was not available to federal, state, and local governments and their political subdivisions, agencies, and instrumentalities. For 2021, the following public entities are eligible for the ERC if they otherwise qualify: (a) colleges and universities; (b) entities whose principal purpose or function is providing medical or hospital care; and (c) certain tax-exempt corporations organized under act of Congress as an instrumentality of the United States (e.g., the Central Liquidity Facility, Resolution Trust Corporation, Resolution Funding Corporation, and Patient-Centered Outcomes Research Institute).
- Expands Denial of Double Tax Benefits. For 2020, the ERC is not available for wages that an eligible employer takes into account under IRC Section 45S (employer credit for paid family and medical leave). For 2021, ERC is not available for wages taken into account under the following additional Internal Revenue Code provisions: (a) Section 41 (credit for increasing research activities); (b) Section 45A (Indian employment credit); (c) Section 45P (employer wage credit for employees who are active duty members of the uniformed services); (d) Section 51 (work opportunity credit); and (e) Section 1396 (empowerment zone employment credit). These changes apply only to 2021, which suggests that the ERC can be claimed on qualified wages paid during 2020 that an employer also took into account for purposes of these sections.
- IRS/SBA Public Awareness Campaign. The Act requires the IRS, in coordination with the SBA, to provide information regarding the availability of the ERC, with particular focus on employers that reported employing 500 or fewer employees on the most recently filed quarterly employment tax return.