The Employee Retention Credit, or ERC, is a tax credit enacted in 2020 under the CARES Act to help businesses keep employees on payroll during the COVID-19 pandemic.
For 2020, this provision allowed employers to receive a credit of 50% of qualified wages paid to employees, up to a maximum credit of $5,000 for the year. To be eligible for the credit, businesses had to have fully or partially suspended operations, or a reduction of at least 50% in gross receipts as compared to the same quarter in the previous year.
Qualified business owners were allowed to access this tax credit by reducing tax deposits they are normally required to make to the federal government. Since then, the ERC has been significantly expanded and, in the most recent relief bill signed by the president, the ERC has been extended for all of 2021.
However, many businesses have failed to take advantage of this tax credit, either because they do not understand the benefits, or they assume they are ineligible. The result has been that many businesses are still paying to the federal government a significant amount of cash that they could be retaining to help rebuild their businesses.
For 2021, the maximum amount of the ERC has been increased to 70% of qualified wages, up to a maximum credit of $7,000 for each quarter.
Thus, a business that has $10,000 in qualified wages per employee in the first two quarters of 2021, would be looking at a maximum ERC of $14,000 per employee. A 20-employee restaurant could reap a $240,000 ERC.
Here are some common misconceptions about the provision:
ERC versus PPP: Many people believe that businesses are not eligible for ERC credits if they have already received Paycheck Protection Program, or PPP, loans. In the Consolidated Appropriation Act (CAA) of 2021, Congress removed the prior limitation on claiming both benefits.
Although businesses are not permitted to “double dip” by using the same payroll dollars towards both 2021 ERC and PPP debt forgiveness, the PPP only accounts for 2.5 times the monthly payroll expenses spread out over six months, which leaves sufficient payroll for claiming the ERC credit.
The shut down myth. Another misconception revolves around eligibility. Many businesses assume they are not eligible for the ERC because their business did not “shut down” and they did not have a drop in gross receipts of 50% or more. To be eligible for the ERC, however, a business must show that its operations were fully or partially suspended or that it experienced a significant decline in gross receipts, not both.
Moreover, the legislation contains a very loose definition of operational shut down. Even a partial government-ordered suspension of operations will qualify a business for the ERC, so long as the business can demonstrate an inability to operate as before.
A partial shutdown (e.g. limited days), reduction in services offered (e.g. takeout only), having limited capacity (e.g. 25% seating), and reduction of hours to accommodate sanitation are all examples of situations that would likely qualify for the ERC.
A rebound won’t hurt. Finally, businesses can qualify for the ERC even if sales have rebounded in Q1 of 2021, as the CAA looks back at Q4 of 2020 to determine if gross receipts decreased by more than 20% compared to Q4 2019.
As such, a business can access ERC cash by reducing federal employment tax deposits in Q4 2021 even as the business grows, so long as it can show reduced gross receipts in the prior quarter. This prior calendar quarter test can create a significant inflow of cash today that businesses sorely need.
The new rules surrounding the ERC are hugely beneficial, but their complexity may cause businesses to delay or ignore the benefits. These benefits may, however, provide businesses with much needed cash flow at a time when PPP grants may have been spent, but businesses still need help to recover from the COVID economy. The ERC may well be a readily available benefit worth considering.
Arif Virji is the managing partner at the San Francisco and Sonoma, California offices of Kaufman, Dolowich & Voluck LLP, where he focuses on representing management in employment, labor and business litigation and advisory matters.