I recently wrote about reasons to hold off on Paycheck Protection Program (PPP) forgiveness applications for the time being. Among them is the complex interaction between PPP and the Employee Retention Credit (ERC), which previously was not permitted as an option for financial relief for those that had received PPP funding.
Because ERC is now available for small businesses who have accepted PPP funds — but not for the same payroll dollars (no double-dipping) — there are some pretty complicated calculations that, if done right, could generate a great deal of financial relief to a lot of independent business-owners in need.
The IRS came out with guidance on March 1. The Journal of Accountancy summarizes:
The notice explains (1) who are eligible employers; (2) what constitutes full or partial suspension of trade or business operations; (3) what is a significant decline in gross receipts; (4) what is the maximum amount of an eligible employer’s employee retention credit; (5) qualified wages; (6) how an eligible employer claims the employee retention credit; and (7) how an eligible employer substantiates the claim for the credit.
Summary of the 2020 Employee Retention Credit
As a reminder, the 2020 ERC is a payroll tax credit available to business owners whose operations have been fully or partially suspended by government order, or who have seen a drop in income of more than 50% compared to the same quarter in the previous year. (Note: in the new IRS guidance it also states that if “the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order”, your business may be eligible for ERC — even though there was no governmental order in your area.)
The credit comprises 50% of up to $10,000 in wages to each employee. The credit cannot be taken on wages that were paid for by PPP funds — but as long as there is no double-dipping, PPP recipients can claim other wages for the purpose of ERC.
The ERC is claimed as a reduction of payroll taxes on quarterly Form 941 (or a prepaid refund on Form 7200). The IRS updated the form on July 1, and a handy breakdown of the new lines can be found here. There are different rules for eligible businesses to be able to claim the 2021 ERC moving forward — a topic for another day — but this post concerns the opportunity to “scoop up” payroll dollars from 2020 that would have been eligible for ERC had it not been for the PPP Loan. These can be claimed by filing an amended Form 941 for each relevant quarter.
Keep in mind that the ERC is complex, and this blog post will not walk you through the specifics — I’ve included a list of some of my favorite resources below. The goal here is to share the steps in our firm’s approach toward these calculations for our clients.
So let’s start with a couple of things to be aware of before we go through the steps that my firm plans to walk through come May/June.
- First, the ERC is not generally as valuable as the PPP. It is a payroll tax credit, rather than actual cash funding (though you can file for an advance on it).
- And the ERC did not get the benefit of having Congress declare its related expenses deductible, like the special treatment that PPP costs received. So you will lose all the deductions for the payroll tax dollars on which you receive the credit. Deductions aren’t worth as much as credits, so you still come out ahead. But if you’re choosing PPP or ERC for a given payroll dollar, you want to pick the PPP first — up to the minimum 60% requirement for that loan to be forgiven.
- However, once you’ve reached that 60% requirement, if you can use non-payroll costs for the remaining 40%, then you “free up” the rest of the payroll dollars to be used for ERC. So you’ll want to work on PPP1 forgiveness applications at the same time as 2020 ERC calculations — they are related to each other, and changing one will potentially affect the other.
- But what does this mean for companies filing income tax returns for 2020? Businesses that later decide to retroactively claim the ERC will need to file amended income tax returns — or preferably, put their income tax returns on extension until they have claimed the ERC for 2020. We had previously thought that cash-basis filers could potentially claim the income for the credit and the associated reduction in payroll costs on the 2021 income tax return, but that was ruled out with the most recent IRS guidance.
Steps to Evaluate Payroll for PPP vs ERC
The hope is that in most cases you’ll be able to do Steps One and Two and skip the rest. But just in case, Steps Three and Four will take you the rest of the way there.
Step One
When figuring out how to combine ERC and PPP, literally make a calendar for each client and work from that.
a) Determine dates for which you qualify for ERC, based on either:
– the full or partial shut-down period, or
– a gross receipts decline of 50% over the same quarter in 2019
(the latter qualifies you from the beginning of that quarter to the end of the quarter where receipts go back up to 80%)
Keep in mind that both scenarios may apply, but for different periods — for example, the business was shut down on 3/18/20, and then later fully reopened… and then the 50% revenue drop started in the following quarter.
Note: you may want to find out the exact dates that your client’s city/county/state decreed full-capacity indoor dining was illegal — for those dates, restaurants qualify for ERC based on “full/partial shut-down” rules. If your client is a gym, bar, or other type of non-essential business that had hours limited, find out the exact full-or-partial shut-down dates decreed for that industry in that specific area.
b) Determine PPP covered period. For most folks, this will be the 24 weeks starting on the date of loan fund disbursement.
c) Determine the “bookend” periods — the time both before and after the PPP covered period; for the timeframe when the client qualified for ERC but was not in the PPP realm.
Step Two
You may be able to skip the rest of the steps by eyeballing whether you’re able to claim the entire 2020 ERC of $5k per employee (on the first 10k paid to each) all in one quarter — for most businesses this would usually be the final quarter of the year. Then, not only will you not have to worry about overlapping PPP and ERC payroll dollars, but you also will be able to claim this through most payroll companies and not have to manually amend the 4Q 2020 Form 941. Double-bonus!
If not, then see if you can get the full $5k per employee ERC (again, on the first 10k paid to each) using only the periods before and after the PPP1 covered period. You at least eliminate the need to juggle the PPP payroll dollars along with the ERC payroll dollars during the covered period.
Step Three
If that’s not an option — if you can’t get to the full 10k within the bookend periods — then:
Before you work on PPP1 forgiveness, subtract whatever the 2020 unallocated ERC balance is after Step 2 (not to exceed 10k of wages per employee) from the payroll amounts during the PPP covered period — before putting numbers in the forgiveness application, just to make sure you can still get full forgiveness at this rate. This is just a “gut check” to see if you can eliminate the need to run the actual ERC calculations for the PPP covered period.
If so, then go ahead and take ERC on the difference, even if you haven’t figured out the specifics of your PPP1 forgiveness yet.
Step 4
If you can’t get full forgiveness on PPP1 at this rate, then go ahead and fill out the PPP1 application in full, using only 60% of the PPP funds to allocate payroll.
Then see how many payroll dollars are “left over” to be used for ERC.
And remember that you can use payroll from employees who made over $100k annually for ERC during the PPP period — because those dollars are not eligible for PPP (due to rules and limitations specific to that program), but they are eligible for ERC.
You can also count — for ERC purposes — dollars that were above 60% of the PPP loan, and therefore are not needed for forgiveness (presuming the business has sufficient eligible costs to make up the 40% “non-payroll” portion of PPP forgiveness).
Think of it this way: you are effectively reducing the ERC subtraction amount per-employee from PPP forgiveness until you get to full PPP forgiveness… and taking 2020 ERC on the balance (since as I mentioned before, the PPP payroll dollars are more tax-advantaged than the ERC dollars).
Does this four-step process sound easy? No! It’s not. It may not in fact be worth it for most small business clients to pay a professional to scoop up the remaining piddly amounts in the PPP covered period — in which case, consider just using Steps One and Two: the amounts in the bookend periods, or even better, just the amount from the final quarter (because that way they don’t have to pay you to manually prepare a 4Q Form 941, either).
But reviewing this approach before going in and working on all the client ERC and PPP calculations should help a great deal in identifying where the bulk of the payroll dollars are that will qualify for the ERC program, and will allow you to make intelligent decisions about which periods to mine for this type of financial relief for your small business clients.
Resources
For a wonderful in-depth explanation of the Employee Retention Tax Credit, please see Tony Nitti’s two-part Forbes article:
– Breaking Down Changes To The Employee Retention Tax Credit In The New Covid Relief Bill, Part 1
– Breaking Down The Changes To The Employee Retention Credit In The New COVID Relief Bill, Part 2
– Part 2 also links to an earlier article of his that goes through the details of calculating the ERC according to the 2020 rules.
KBKG is offering a free one-hour webinar on March 17:
– Employee Retention Tax Credits: Qualifications, Benefits & Refunds (kbkg.com)
–This is the same firm that offers the free 2021 ERC estimator calculator.
The three paid courses I’ve taken so far that were the most valuable were:
– Tom Gorczynski‘s Employee Retention Credit Update, which included an Excel Calculation Template.
– AICPA – The NEW Employee Retention Credit: More for Eligible Employers
– NATP (natptax.com) – Calculating the Earned Income Credit
If this or any other posts on the website were useful to you, and your financial situation permits it, please consider contributing to my tip jar. Ths allows me to continue to provide free accounting resources to small businesses who do not have the funds available to hire a CPA.
It’s now May 19, 2021
Thank you for the very good and concise explanation. 2 things:
1) does this still apply in this ever changing world of Covid. If not, do you have an update?
2) For the more detailed analysis of allocating payroll, step 4, to ERC vs PPP are there rules regarding how to allocate or can we allocate payroll any way we want as long as an employees wages are not used for both.
Excellent questions — things change so quickly in this crazy Covid-19 world. However:
1)These steps remain my best recommendation, and it’s exactly the process we are using in my firm.
2) Thankfully there are no specific rules about how to allocate payroll as long as you are following the already-existing PPP rules regarding owner compensation, FTE reductions, wage/salary reductions, and pay for >$100k annualized. What I’ve been doing is calculating a “target” PPP amount based on these rules and then allocating ERC wages in the way that meets the target for PPP and maximizes the ERC accordingly.
Finally, wanted to mention that KBKG is doing another free session on the ERC on May 26th:
https://www.kbkg.com/webinars/employee-retention-tax-credits-qualifications-benefits-refunds
Best of luck to you!
Great article. Does this apply only to those who have not yet applied for PPP forgiveness and are trying to maximize the benefits between ERC and PPP forgiveness?
Am I correct that if an employer has already applied for and received PPP forgiveness then the amount of wages used in the forgiveness application up to the forgiveness are deemed to have been elected out for ERC consideration and therefore any opportunity to allocate to your advantage as shown in this article has passed? Ex. $200k eligible ERC wages, but $100k of wages were used in the forgiveness of $100k PPP loan. Would this leave only $100k of wages eligible for ERC?
Yes, you are exactly right in your understanding. The IRS has ruled that any amounts noted for payroll on the PPP Forgiveness application are deemed to have been elected out for ERC, and as you know, there’s no double-dipping. We were hoping that payroll amounts that were unnecessarily used for PPP Forgiveness would be allowed to qualify for ERC, but that’s not the case, unfortunately. I feel extremely fortunate that the AICPA promoted holding off on applying for forgiveness until we had more guidance, for exactly this reason.
For what it’s worth, if the employer applied for PPP Forgiveness and did not receive full forgiveness, the IRS has said that those wages are allowable. They go through a few excellent examples of how to deal with PPP Forgiveness and ERC in the IRS Revenue Ruling — https://www.irs.gov/newsroom/irs-provides-guidance-for-employers-claiming-the-employee-retention-credit-for-2020-including-eligibility-rules-for-ppp-borrowers
Hi there, thank you for the detailed information. I am trying to determine our 2020 ERC qualified wages as they relate to the PPP. Our PPP amount was $379,000. I already applied for and received forgiveness. For the forgiveness application, I reported $318,602.72 in payroll costs and $99009.02 in non payroll costs – which is obviously more than $379k. Do I have to subtract off the full $318k to avoid “double dipping” for the ERC, or can I only subtract off $279991?
The article I’ve pasted below seems to indicate that I can use the lower number, but your messages make me think I can’t… please confirm. Thanks!
https://gmco.com/irs-guidance-on-the-relationship-between-ppp-loan-forgiveness-and-the-employee-retention-credit/
This is a great question. Luckily, the IRS provided guidance for this exact situation in Notice 2021-20, Question 49, Examples 3-5.
https://www.irs.gov/newsroom/irs-provides-guidance-for-employers-claiming-the-employee-retention-credit-for-2020-including-eligibility-rules-for-ppp-borrowers
As long as you reported the $99,009.02 as qualified non-payroll costs, and that leaves you with more than 60% of the loan substantiated with qualified payroll costs, then you only have to subtract the smaller amount of wages to avoid double-dipping. The problem is that many folks incurred qualified non-payroll costs but did not report them on the PPP forgiveness application — in those cases, they unfortunately lost out. This is why we recommended our clients wait until the IRS came out with clear guidance for what qualifies as PPP as well as ERC before filing forgiveness applications.
I suggest clicking on the IRS link and notice and going to page 73 to read through Examples 3-5. They really are clearly written and easy-to-follow and you can compare your situation to them, apples-to-apples, to make sure you understand the nuances.
Hello,
Can you help me with the following example:
Employer A’s gross receipts were $38,000, $13,000, and $60,000 in the first, second, and third calendar quarters of 2020, respectively. Its gross receipts were $18,000, $45,000, and $54,000 in the first, second, and third calendar quarters of 2019, respectively. Thus, Employer I’s 2020 first, second, and third quarter gross receipts were approximately 211 percent, 29 percent, and 111 percent of its 2019 first, second, and third quarter gross receipts, respectively. Accordingly, Employer I had a significant decline in gross receipts commencing on the first day of the second calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50 percent of the same quarter in 2019) and ending on the first day of the third calendar quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80 percent of the same quarter in 2019). Thus, Employer I is entitled to a retention credit with respect to Q2 and Q3.
Am I correct?,
Or the employer is entitled to ERC in Q2, Q3 and Q4 of 2020
Thank you
Based on this data, the employer qualifies for 2Q and 3Q of 2020 only — the period in which they first qualify, through the end of the period in which they return to 80% of the same quarter of 2019. However, in Illinois, our governmental orders required restaurants and retail to have capacity restrictions all the way until early June 2021, so many of them qualify based on the “partial or total closure” rule for much longer than they qualify under the gross receipts rule. Just wanted to make sure you’re not forgetting that there are two different tests.
Thank you very much for the clarification and the note on gov orders. I still have a question to ask.
For employers who run paychecks for themselves together with other employees, can their paychecks be considered as “qualified wages” for ERC, or just other employees’ paychecks can be qualified for ERC?
Thank you
If they are employees of their own corporation, they may or may not qualify — I’ve written quite a few blog posts on the lack of guidance in this area. Here’s one of the most recent:
https://www.thedancingaccountant.com/?p=3149
thank you for your answer.
1. Do we have to call IRS to verify the eligibility of each employee for ERC?
2. Is “qualified wage” = “the total cost” (total pay + employer’s tax) or the “net amount” ( total pay – taxes withheld).
I’m thinking the “total cost” would be correct, but still not sure which amount to use for ERC.
3. Example: Employee A receives his paycheck bi-weekly, and the total hours on each of his check must be 80 hours to be considered full-time. However, under the covered period of ERC, there were some weeks in which his total working hours was below 80. Are the paychecks for the weeks that have below 80 working hours considered “eligible wages” for ERC?
Thank you very much
1. I’m not sure why you would call the IRS — they have no way of knowing if your employees are eligible or not.
2. Qualified wages are neither the total cost nor the net pay. You want “Gross Wages” plus the employer portion of health insurance.
3. This has nothing to do with full-time vs part-time. I’m not sure where you got that?
Your questions lead me to believe that you don’t have a sufficient grasp on ERC to be doing these calculations yourself. I strongly recommend you take one of the many free webinars that are out there, such as the one I have recommended numerous times by KBKG.
Thank you very much for your responses, Nancy.
I was told by a representative from Intuit, my company payroll agent, to call the IRS to verify the eligibility of each employee. I was confused hearing that too.
I’ll check the webinars you recommended. Thank you again!
You are so welcome! I think Intuit Payroll is the absolute worst payroll company out there and I do not allow my clients to use it. I strongly recommend you use Gusto instead — here is a referral link:
https://gusto.com/r/nancy11
When you sign up and run your first paid payroll, you’ll receive a $100 Visa gift card! They have a solid integration with QuickBooks Online that works seamlessly, and they will convert you from Intuit Payroll to Gusto at no charge! Their customer service is top-notch… and they won’t give you mistaken info about ERC, either. :) Good luck!
Thank you for all the help :p
You’re so welcome! Please let us know how it goes.
Hi Nancy,
I have a question and wondered if you had come across this scenario. It’s related to a 2nd draw PPP loan in 2021 and the ERC credit for quarters 1-3 for the same year.
Company got a 2nd draw PPP loan of $67,500.
During the 24 month period, company paid the owner and daughter more than $67,500 with neither going over the $46k limit per employee.
Other wages during the first 3 quarters of the year came to $45k.
Revenue drop for all 3 quarters qualifies for the ERC.
Can we choose to allocate the owners wages to the PPP, freeing up the other staff wages for the ERC?
I’ve looked through all the guidance and can’t see anything that prohibits it but it’s a lot of money! Legal loophole?
I want to be very careful in responding, because the details are everything in a scenario like this, and I don’t know your specific details.
But the short answer is that not only is there nothing prohibiting PPP from being allocated to owners (thereby freeing up ERC for eligible W-2 staff), but in fact the SBA has clarified that this is absolutely fine. The trick is that when you say “neither going over the $46k limit”… how was that limit calculated? The limits for owners are 2.5 months of the prior-year’s pay (defined as W-2 earnings for S/H-EEs or self-employment earnings for sole props and partners), or the amount actually paid during the covered period — whichever is less.
We are handling this internally by calculating a “PPP Target” for the entire company (total ‘payroll’ allocated to PPP) and per owner (subject to the owner limitations on PPP-eligible pay). Then we allocate ERC accordingly.
I hope this answers your question — yes, you can allocate PPP forgiveness to owner pay, but be extremely careful with your calculations.
Hi Nancy,
Very good article. My question is regarding allocating sole proprietor’s $20,833 max compensation to the PPP to maximize the ERC. If just the wages were listed on the 3508 form and no mention was made of the sole proprietor’s $20,833 on the 3508 form can we use the $20,833 as part of the PPP forgiveness calculation to minimize the wages going to the PPP and maximize the wages going to ERC.
It appears the 3508S form did not require any documentation but the 3508 & the 3508EZ may have.
Thanks for you help and I will be happy to contribute to the Tip Jar.
Yes, this is an excellent strategy for maximizing ERC. Although it is not required on most of the 3508 series of forms, we do create a person-by-person allocation of every single PPP and ERC dollar, in order to get the most non-ERC-qualifying dollars (like sole proprietor and partner pay, or SUTA, or retirement) allocated to PPP, leaving more qualifying dollars available to be used for ERC. It doesn’t get reported on the form, but it’s in our workpapers in case of audit.