With Randy Crabtree
The Employee Retention Credit, or ERC, saw significant expansion for 2021. Randy Crabtree talks about various ways for your clients to qualify for the credit, how much benefit they can receive, and how the credit interplays with other credits available, with a particular focus on the Paycheck Protection Program, or PPP.
Today, we’re gonna do things a little bit different than we normally do. Instead of having a guest on with me, we’re going to go through an area of the tax code that’s been on everybody’s mind lately, which is the Employee Retention Credit.
I’ve done a lot of work with the Employee Retention Credit over the last six, seven months. I’ve had a lot of people asking me questions about the credit. I thought we could address it here on the podcast and give you some basic information that hopefully will be useful for you when you go to look at the credit, to see if you have clients that you can help with this.
So the Employee Retention Credit, let’s give you a little legislative history, just to see where we were and where we are today. The credit originally was defined in the CARES Act. The problem with the CARES Act definition was that if you took a PPP loan, you could not take advantage of the Employee Retention Credit. And so most taxpayers took the PPP loan, and we ignored the Employee Retention Credit. In the CARES Act, the Employee Retention Credit was scheduled to expire at the end of 2020.
The Consolidated Appropriation Act that came out at the end of December of 2020, removed that exclusion between PPP and ERC—and removed it retroactively. So now, we could go back all the way till March 13th of 2020, to look at a client’s operations to see if they qualified for the Employee Retention Credit. The CAA also extended the credit till the end of June of ‘21, and then the ARP, the American Rescue Plan extended it even further to the end of December of ‘21.
So we currently have an Employee Retention Credit that is available to be looked at for taxpayers from March 13th of 2020, through December 31st, of ‘21. So that’s a pretty long period to look at, and see if a client could qualify.
A couple other things I want to point out is the ARP changed the definition a little bit of how somebody can qualify for the last two quarters of ‘21. We’ll talk about that at the end. But they did another very important thing—they extended the audit period on any 941—because this is credit as claimed on the 941, or the 941x. They extended the audit period from three years to five years. So they will be looking at these closely, which shouldn’t deter anybody from taking advantage of the benefit they have potentially earned or deserved. It just means be prepared. With everything you do, be prepared. Fully documented—make sure you can support any credit that you’re taking, and don’t be afraid of the audit, be prepared for the audit.
So those are the three major areas of legislation that has affected the ERC, but what is the ERC? That’s the most important thing. Why are we talking about it, why is everybody talking about it right now? Well, because it’s a significant benefit, that could go back into taxpayers’ banks and help them through this time where they’ve been hit by the pandemic.
And so there’s two ways you can qualify for this credit, and this is very important, because there’s a lot of confusion around this—these are mutually exclusive. It’s an “or.” It’s an “either.” It’s not both. But the first way is if you had a significant decline in grocery seats, you can qualify—Safe Harbor rules. And we’ll expand on that, because each year, ‘20 and ‘21, is a little bit different on the definition of what a decline in gross receipts is, but Safe Harbor rule says, you qualify if you had a significant decline in gross receipts during any quarter. So we look at this quarterly.
But if you don’t make that, it does not mean you don’t qualify. If you don’t make that requirement, if you don’t meet the Safe Harbor—and I’ll probably keep stressing Safe Harbor, because that’s what it is—you don’t have to have a decline of gross receipts. A lot of people will look at this and say, well, we didn’t have a decline of gross receipts and we don’t qualify. That’s not true. I’ll probably give you an example as we go on that.
But if you don’t meet the decline in gross receipts, how else can you qualify? Well, I like to say it as, “Was your business restricted by a government order? Did some government entity put some restriction out there that you had to follow, that hindered your ability to conduct your business?” The code of the legislation actually says, “Was your business fully or partially suspended due to orders from the federal state or local government that limited commerce, travel, or group meetings due to COVID-19?” So I think it’s easier just to say, “Was there a restriction placed on your business by a government entity? If so, we need to look further, and see the effect of that, and does that allow you to qualify for the Employee Retention Credit?”
That’s the two qualifying factors. That’s one of those—meet one of those—you qualify. If you do qualify, then, what’s the value? What’s the benefit? What are we getting all excited about here? Well, for 2020, it’s a 50% credit of the first $10,000 of eligible wages per employee—eligible wages will be important—but eligible wages per employee, 50% of the first 10,000. So up to $5,000 of credit per employee in the year 2020, wherever we qualify. As early as March 13, all the way to potentially the end of the year.
‘21, everything got more beneficial, became enhanced, and instead of an annual credit, it’s now a quarterly credit. We look at each quarter individually, and we can get a 70% credit of the first $10,000 of eligible wages per employee per quarter. And so each employee, if we qualify, can be worth up to 7,000 per quarter, or if we qualify all four quarters in ‘21, $28,000 for the year. So if we as a business qualified for the entire period from March 13, till the end of ‘21, one employee could have a value of $33,000 of credit.
Put it into business terms—we have a small business with 10 employees, they all qualify, they all met the max eligibility for each quarter for the entire period—that’s a $330,000 credit. And the interesting part is, it’s a refundable credit. We don’t have to wait and see what kind of income taxes we have to offset, or what kind of payroll taxes we have to offset—it is a 941 credit. And bottom line is, the amount of the credit is a refund.If we have a small business with 10 employees, they all qualify, they all met the max eligibility for each quarter for the entire period—that's a $330,000 Employee Retention Credit. Click To Tweet
If you read the legislation or IRS FAQs, it might look a little confusing, because it talks about, you know, offsetting a portion of the 941 tax, and then there’s a refundable portion, and a nonrefundable portion. Bottom line is, it all ends up being a refund. So in that example we just said, that company if they qualified for that entire period with those ten employees over a seven quarter 941 filing—941x for most of those quarters now—would receive $330,000 in refunds. So that’s the important part. That’s why this is really important to talk to clients about because of the potential benefit that is out there.
Alright, let’s define the “decline in gross receipts” a little bit further, and let’s see how that affects our ability to qualify for the credit. So in 2020, the rules say I have to show at least a 50% decline in gross receipts in a quarter, when I compare it to that same quarter of 2019. If I show a 50% or more drop in gross receipts, I meet the Safe Harbor rule—I qualify, now let’s start to do the quantification of the credit. And that’s, more complications come in with that. But at least I know I’m at the Safe Harbor rule. That’s 2020. 2020 also has a rule that says if I qualify for a quarter, let’s assume it’s the second quarter, the rules, the legislation, say I automatically qualify for the next quarter—so if I qualify for the second quarter, I automatically qualify for the third quarter—and I continue to qualify until the quarter after the quarter that my gross receipts exceed 80% of 2019’s quarterly gross receipts. So that’s the 2020 rule overall.
‘21, as we kind of mentioned, got more enhanced, got easier to qualify. In ‘21, I can qualify if I show a 20% reduction in gross receipts in the quarter I’m in, compared to that same quarter in 2019. So 2019 is our base period again. That’s what we compare back to. So 20% decline in a quarter in ‘21, that quarter qualifies. Now in ‘21, the subsequent quarter qualification definition’s a little bit different, but if I qualify the first quarter based on the first quarter, it actually pre-qualifies the second quarter as well.
I can actually also qualify the first quarter in ‘21 by showing a 20% drop in gross receipts in the fourth quarter of ‘20, But if I qualify the first quarter of ‘21 based on the fourth quarter, that won’t automatically qualify the second quarter. Second quarter only qualifies based on its own drop, or if the first quarter of ‘21 also had a 20% drop that pre-qualifies the second quarter. A little confusing, but bottom line is, you know we can qualify more than one quarter with this drop.
So that’s the Safe Harbor rule. That’s the easiest way. That’s math. If we meet the math, we qualify now we just have to do the more complicated math of figuring out what the credit is.
But if we don’t meet the Safe Harbor Rule, then, what’s my other option? My other option is to show that I had restrictions placed on me and my business by a government entity. And those restrictions could have been as broad as “Close the doors, everybody stay at home”—which happened in places for a week, two weeks, three weeks, four weeks. And obviously, every rule is different around the country, and you know, the state rules, the county rules, the city rules—we just have to see what those rules are out there.
But, “Was my business restricted?” And it says “a more than nominal portion of my business affected”—and we’ll define what more than nominal means in a minute. But “if more than a nominal portion of my business was affected by a government restriction, then I can also qualify.” So this “more than nominal impact” has to affect some portion of my business.I want to somehow be able to quantify that effect—a drop in revenue is obviously a good way to quantify the effect—but I think an increase in expenses is also a way to show that there's been an effect. Click To Tweet
The IRS came out with some clarification that says “more than nominal” means, “Okay, if we have a 10% portion of our 2019 business—2019 revenue, let’s say, or 2019 hours worked in the segment of a business—if we can prove that there’s that portion segment of our business that was affected by a government order, then,”—I really look at this as a secondary Safe Harbor Rule—”if we can show that there’s more than 10% of our business was affected based on our 2019 gross receipts or hours work by our employees, now, I have shown that I’ve been affected and I qualify.”
Now, nowhere in there does that say that this 10% has to show a drop in revenue. It says there has to be an effect. I want to somehow be able to quantify that effect—a drop in revenue is obviously a good way to quantify the effect—but I think an increase in expenses is also a way to show that there’s been an effect.
And as an example, let’s assume we have a business where customers came into our location, and they packaged up food, that then they would take home and cook at home. We were restricted, let’s say, from capacity restriction—so their customers couldn’t come in anymore. We still wanted to be able to provide them with this product. The only way we could provide him with this product is to start to pack it up ourselves. To be able to pack it up ourselves, we had to hire more people. So that packing up portion of our business, if we can show that that was more than 10% of our revenue in 2019, even if that revenue doesn’t go down, my expenses went up, because to be able to continue that portion of the business I had to change. I was under restriction, I had to change my operation. So I think that that’s a way that we can qualify under the suspension rules as well.
And the suspension rules in general, were not static—they evolved over time. And especially, let’s say in the restaurant business, restaurants went through a time where there was no indoor dining, but there was curbside pickup and delivery. Maybe then outdoor dining got added, but the indoor was still closed. Maybe indoor got 25% capacity after a point in time. Maybe it got to 50% capacity after a point in time. Maybe it got to 100% capacity, but six feet of spacing between tables requirement, which then reduced their capacity, potentially. Under all those scenarios, those evolving government orders, that restaurant was affected.
So restaurants in general have been affected for a significant portion of the year. But there’s been a lot of industries. We’ve done, we’ve seen a lot in the medical field as well. We’ve seen it in just about every business. So I always say, if you’re looking at clients, I don’t think you can disqualify them just on the surface. You need to have a conversation. I think it’s your responsibility to have a conversation with every client to discuss what effect a government suspension had on them: How was their business affected? Because it doesn’t even have to be a direct effect. If—and this is straight from IRS FAQs—if their supply chain was affected, and let’s say that somebody’s supplying the materials that they can’t continue to do their business without this material, and that supply chain—that provider of those services or products—was suspended by their local government entity? Well, now that’s trickled down to us, and we’ve been affected. So you need to really dig into each individual client’s circumstance and see how they’ve been affected.
Really, what you need to do is just for the suspension rules, you can look at the term of the suspension, like we just said—it evolves. You need to see if you can quantify how a suspension affected them, so you’re going to analyze financial statements you’re going to look at, you know, revenue by segments of the business, you’re going to look at expenses, you’re going to see, was there a change in any revenue line item or expense line item? If so, why? Dig deeper into that? You know, you could look at specific industries and look at ticket count maybe in restaurants, look at patient counts for medical, look at production reports for manufacturing. Dig deeper than just the surface of a financial statement, and see where there’s effect. Review POS systems. Determine if somebody put new products or services in. Maybe their revenue looked flat or even up a little because they added PPE equipment, but they had another portion of their business that was significantly affected. You have to look deeper into this. And I think it again, like I said, I think it’s our responsibility as tax advisors to do this.
Alright, so that’s just the whole, either, the drop in revenue or the suspension rules. Let’s get in quickly, just into wages in general. Wages in general is what you expect: You paid somebody, it’s their wage. You don’t subtract contributions to a retirement plan. You don’t, unfortunately, get wages as a self-employed individual. If you employ people you do, but not that Schedule C income, not LLC or partnership income that’s passed through subject to self employment income. It has to be W-2 income that’s included. Severance pay doesn’t get included in the ERC. But overall, it’s just, it’s wages, it’s “what did we pay individuals?”
One very important thing to determine how we as a company are going to quantify the credit is there’s a designation out there to determine if you’re a small employer or a large employer. And a small employer, if they qualify, gets to take every individual into the calculation of the credit—all part time, all full time, new hires, people that aren’t there any longer—everybody goes into the calculation of the credit. If you’re considered a large employer, then you only get to take individuals into the calculation of the credit that were being paid, but not providing services. They weren’t working.
And so the small employer designation is obviously going to be more beneficial if you qualify. So to be considered a small employer, you have to look at ‘19’s headcount—again, ‘19 is our base period—look at 2019 headcount for our employees, and see how many full time employees we had in 2019, on average. And if that average full time employee is 100 or less, we’re considered a small employer. In ‘21, that goes up to 500. So again, everything in ‘21 got enhanced. So if in 2019, our full time headcount—full time only, not full time equivalent, we’re looking at individuals that were full time employees—if that full time employee headcount is 500 or less, we’re a small employer in 2021. And so if that’s the case, then every single employee that we pay can be used in the calculation of the credit. So it’s a very important designation that we need to determine to see how we quantify the credit for that taxpayer.
One last thing I just want to touch on—I’m not going to get into everything today—we don’t want to make this an hour long. But just be aware, too, there’s aggregation rules. If we have a parent subsidiary relationship between businesses, or we have a brother-sister relationship between businesses, we have to look at those businesses as if they’re one when we’re doing all of our work for the Employee Retention Credit.
We look at it based on the suspension rules. If we had five businesses that were related, and one was affected, and that one was more than 10% of our 2019 overall group revenue—if that one was affected, it actually brings all five entities into the calculation of the credit, because we meet that “more than nominal” effect. So the aggregation rules can have a positive effect, so if we wanted to try to qualify on a decline in gross receipts, we have to look at those gross receipts in totality, and therefore it could, if we had five operations and four did well and one didn’t? Well, we probably won’t meet that gross receipts test. It comes into play with that 2019 full time headcount, so you know, it could put us into that “large employer” effect.
Just be aware, the aggregation rules exist, and we don’t look at each individual business on its own if we have these relationships—aggregated rule relationships, control group relationships—we have to look at that entity as one, and then we break the credit back out to its individual entities within the control group.
So that’s just a basic overview. It is a very interesting area to work on. There’s a lot of benefit for taxpayers. As you can probably see, just in this quick overview, it’s a lot more complex than it sounds on the surface. I didn’t get into this too much, but let’s just, real quick—there’s a lot of interaction with other credits and incentives, and you can’t double dip. One of the biggest ones is PPP. You can use the same employees that used forgiveness that you use for ERC, you just can’t use the same dollars. It’s really important, if at all possible, to make sure that the client uses the 24 week period for forgiveness.
Now, first PPP forgiveness has happened for a lot of individuals, and whatever they used for forgiveness is what we have to stick with. PPP 2, if a client has it, we really want them to extend that forgiveness period out for 24 weeks, and we want them to show every single dollar of available expense for forgiveness.
So as an example, we had a $300,000 loan, and during the 24 weeks, we had 1.5 million in wages, and 300,000 in other expenses that qualify? Show them all those dollars during the forgiveness application. Don’t limit it to the $300,000 loan, show them everything, because if we do that, it gives us more flexibility to try to maximize each employee’s credit, based on $10,000 of wages per quarter.
Big mistake is to try the front end load the ERC, or try the front end load the PPP—meaning use the first dollars for PPP forgiveness—because you’re going to lose a lot of potential Employee Retention Credit. So you have to be very analytical at looking at this 24 week period, you have to be very analytical at the interaction between about 12 other credits and incentives. But if you do it correctly, there can be a significant benefit there for the taxpayer.
This is something we’re doing all the time at Tri-Merit. If you have any questions on any of this, you can reach out to us at our website, Tri-Merit.com. Under services, there’s an ERC, an Employee Retention Credit tab. You can get more information there, there’s actually a spot where you can fill out some information to see if you have a client that qualifies. You can also go to the About Us page—there’s a meet the team section there—you can get pretty much everybody’s contact information. My contact information’s there, everybody on our team’s contact information is there as well, and reach out to us with any questions: email, call. It’s an area that I don’t get tired of talking about, so I’ll field any questions I possibly can.
And thank you for joining us today. And you can find all the links and show notes for today’s episode as well as more about Tri-Merit at TheUniqueCPA.com. Remember to subscribe and join us for our next episode where we’ll be going beyond compliance into forging new pathways of delivering value to clients, diversifying your revenue streams, and leading edge management techniques and styles.
About the Guest
Meet the Host
Randy Crabtree, CPA
Randy Crabtree, co-founder and partner of Tri-Merit Specialty Tax Professionals, is a widely followed author, lecturer and podcast host for the accounting profession.
Since 2019, he has hosted the bi-weekly “The Unique CPA,” podcast, which ranks among the world’s 5% most popular programs (Source: Listen Score). You can find articles from Randy in Accounting Today’s Voices column, the AICPA Tax Adviser (Tax-saving opportunities for the housing and construction industries) and he is a regular presenter at conferences and virtual training events hosted by CPAmerica, Prime Global, Leading Edge Alliance (LEA), Allinial Global and several state CPA societies. Crabtree also provides continuing professional education to top 100 CPA firms across the country.
Schaumberg, Illinois-based Tri-Merit is a niche professional services firm that specializes in helping CPAs and their clients benefit from R&D tax credits, cost segregation, the energy efficient commercial buildings deduction (179D), the energy efficient home credit (45L) and the employee retention credit (ERC).
Prior to joining Tri-Merit, Crabtree was managing partner of a CPA firm in the greater Chicago area. He has more than 30 years of public accounting and tax consulting experience in a wide variety of industries, and has worked closely with top executives to help them optimize their tax planning strategies.