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.

1. 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).
2. 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.
3. 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.
4. 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

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