ARPA offers an opportunity to eligible businesses, including tax-exempt organizations, to receive refundable tax credits.
The American Rescue Plan Act of 2021 (ARPA), which we wrote about in a previous Alert, modifies the employee retention credit (ERC) first created under the Coronavirus Aid, Relief and Economic Security (CARES) Act and creates a refund opportunity for some taxpayers. This highly popular employment tax credit is designed to encourage businesses to keep workers on their payroll and support small businesses and nonprofits throughout the coronavirus economic emergency. For many businesses, the support provided by the employee retention credit can even surpass what the Paycheck Protection Program provided. The credit is currently scheduled to expire at the end of 2021, though the Senate has recently passed legislation proposing an end to the credit on September 30 in order to generate funding for the pending infrastructure bill. As the House of Representatives is currently on recess until September 20, the credit is unlikely to end prior to September 30. Regardless of the credit’s status in the fourth quarter, time is running out―but there’s still time to act.
Eligible businesses who are private sector employers or tax-exempt organizations may qualify for this refundable credit in 2021 if the business:
- Was at least partly closed due to a government order or saw business gross receipts decline by 20 percent or more for any quarter in 2021 (50 percent in 2020) when compared to the corresponding quarter of 2019, and
- Maintained employees on its payroll.
If all the above applies, then you may be eligible for 2021 employee tax credits of up to $28,000 for each employee. For 2020, employee retention credits were capped at $5,000 per employee, based on a maximum of 50 percent of $10,000 of qualified wages paid, so the updated rules represent a substantial added benefit for employers.
The act allows eligible employers to claim the credit against employment taxes equal to a percentage of qualified wages paid to employees beginning in 2020. ARPA modifies the rules for the employee retention credit for calendar quarters beginning after June 30, 2021, as follows:
The act defines an eligible employer as:
- An employer whose trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to the coronavirus disease (COVID-19);
- An employer that experiences at minimum a 20 percent decline in gross receipts for the calendar quarter compared to the same quarter in 2019; or
- A recovery startup business started after February 15, 2020.
However, an “essential business” that is not shut down may not be considered fully or partially suspended if it is permitted to operate while other businesses must close.
Joe's Auto Parts Shop is considered an essential business and is open with no restriction to its hours of operation. However, the county government issued a stay-at-home order for January 2021 that limits community members from leaving home except for essential travel, such as going to the grocery store or a medical appointment. As a result, Joe’s business significantly declined during the month since people were not traveling and the demand for auto repair services diminished substantially. The shop is not considered to have a full or partial suspension of operations due to a government order. While an essential business generally does not qualify under the first prong of the test, if the business qualifies based on the reduction in gross receipts, or as a recovery startup business, they may still be considered an eligible employer.
However, if the shop was limited in the hours it could be open, limited in the scope of the work that could be performed and/or was significantly impacted by its suppliers’ inability to deliver necessary goods or materials due to the shutdown, the essential business may be considered partially shutdown.
RTD Beauty School is subject to the same stay-at-home order discussed above during January 2021. RTD is not an essential business, so it had to close its facility. Prior to the shutdown order, RTD provided all classes in-person at the facility. No employees teleworked. During the January shutdown, RTD is able to use an online format to hold some classes remotely. However, many classes cannot be held as they require in-person demonstrations, practice and hands-on learning. RTD's operations are considered to be partially suspended due to the government order, because access to beauty clients and hands-on practice are central to its operations, and its operations cannot fully continue because of the shutdown.
For employers that were not in existence at the beginning of the same calendar quarter in 2019, the employer may use the same calendar quarter in 2020 for the eligibility calculation. A “recovery startup business” means any employer that began carrying on any trade or business after February 15, 2020, with average annual gross receipts of $1 million or less, and is otherwise not considered an eligible employer.
Employers may also elect to use the immediately preceding calendar quarter compared to the corresponding calendar quarter in 2019 to determine eligibility.
Alice’s Restaurant was not subject to any government orders in the second quarter of 2021, but her business is still recovering from the pandemic as people are reluctant to return to indoor dining. Her gross receipts for the second quarter of 2021 are 65 percent of her gross receipts for the second quarter of 2019. She would qualify for the ERC on wages paid in the second quarter.
Suppose that in the third quarter the restaurant’s business recovered, and third quarter receipts for 2021 were 110 percent higher than the receipts in the third quarter of 2019. Alice can still qualify for the ERC by electing to use the immediately preceding quarter―the second quarter of 2021 as compared to the second quarter of 2019.
Qualified wages are based on the business’s average number of full-time employees in 2019 (or 2020, if a recovery startup business, as described above). In Notice 2021-49, released August 4, 2021, the IRS clarified that for purposes of determining whether the employer is a small or large employer, employers do not have to add “full-time equivalents” for purposes of this credit as established under the Affordable Care Act. Rather, full-time employees are those that average 30 hours of service per week or 130 hours in a month.
- Small employers, defined as those that had 500 or fewer employees, may receive the credit for wages paid to all employees whether or not they are providing services to the employer, and whether the employer is open for business or subject to a shutdown order.
- Large employers, defined as those that had more than 500 employees, may only receive the credit for wages paid to employees for time the employees are not providing services to the employer due to COVID-19-related issues.
- Severely financially distressed employers―those that are experiencing a minimum 90 percent decline in gross receipts for the calendar quarter compared to the same quarter in 2019―may receive the credit for wages paid to employees during any calendar quarter.
Further, Notice 2021-49 provided that the ERC can be claimed for part-time employees, as wages of part-time employees may be considered qualified wages if they meet all other criteria.
Finally, perhaps the largest inclusion in Notice 2021-49 is guidance on wages paid to related parties. While the statute for the ERC does not specifically address wages paid to business owners or relatives of the owners, the statute does provide a vague notion that rules “similar to the rules of [the work opportunity credit] shall apply.” The work opportunity credit does not consider wages paid to 50 percent or more owners, or certain relatives of such owners. In addition, the constructive attribution rules apply in determining majority ownership. Thus, it is likely that wages paid to related parties will not be considered as qualified wages. The qualified wage calculations, as well as the required credit assessment in its entirety, can be complex. We are happy to assist in maximizing your available credit.
Beginning with the first quarter of 2021, the amount of the credit is 70 percent (increased from 50 percent for 2020) of qualified wages paid to an employee, up to $10,000 per quarter. This means that, for 2021, the credit is worth up to $7,000 per quarter and up to $28,000 per year for each employee. Recovery startup businesses may claim a maximum credit of no more than $50,000 per quarter. Qualified wages may also include amounts paid to provide and maintain a group health plan that are excluded from employees’ gross income.
Employers must report their qualified wages on their federal employment tax returns, Form 941, Employer's Quarterly Federal Tax Return. They can reduce their required deposits of payroll taxes withheld from employees’ wages by the amount of the credit.
Small employers, those that had 500 or fewer employees, may elect for any calendar quarter to receive an advance payment of the credit not to exceed 70 percent of the average quarterly wages paid by the employer in calendar year 2019.
Sam’s Movie Theater qualifies for the ERC in the second quarter of 2021 due to an April 2021 stay-at-home order, and his third quarter 2021 gross receipts are 75 percent of his third quarter 2019 receipts. In the second quarter, he pays 10 employees $5,000 each, for a total of $50,000. His credit would be $35,000 ($50,000 x 0.7).
In the third quarter, Sam hires a new manager who he pays $12,000 in the quarter, in addition to the 10 employees making $50,000. Total qualified wages would be $60,000, as the manager’s qualifying wages are limited to $10,000. Thus, the total ERC for the third quarter would be $42,000.
Paycheck Protection Program Loans (PPP)/Shuttered Venue Operators Grants/Restaurant Revitalization Grants
ARPA made changes in the treatment of COVID-19-related programs and the availability of the employee retention credit. Businesses that received PPP loans, shuttered venue operator grants or restaurant revitalization grants in 2020 or 2021 may still claim the credit. While wages used to apply for PPP loan forgiveness cannot also be claimed for the credit, assuming forgiveness was granted, remaining wages may be eligible for the credit. However, payroll costs associated with unforgiven PPP loan proceeds will not fail to be deemed qualified wages.
There are limitations when considering an eligible employer's ability to claim the employee retention credit. A double tax benefit is not permitted. Other credits that impact the employee retention credit include, but are not limited to, the following:
- Wages that are paid for with forgiven PPP proceeds cannot qualify for the employee retention credit;
- Wages that are paid for with funds received from shuttered venue operator or restaurant revitalization grants also cannot qualify as wages for purposes of the employee retention credit for the third and fourth quarters of 2021;
- Qualifying wages for this credit cannot include wages for which the employer received a tax credit for paid sick and family leave; and
- Employees are not counted for this credit if the employer is allowed a work opportunity tax credit.
Wage Deduction Disallowance
A reduction in the amount of the deduction allowed for qualified wages, including qualified health plan expenses, caused by receipt of the employee retention credit may occur for the tax year in which the qualified wages were paid or incurred. When a taxpayer claims the employee retention credit or otherwise files an adjusted employment tax return to claim the employee retention credit, the taxpayer should file an amended federal income tax return or administrative adjustment request, if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken with respect to the wages reported on the originally filed tax return.
Employers that claim the ERC must maintain records and documentation that support the credit. This includes records for the relevant calendar quarters in 2019 and 2020 to document the significant decline in gross receipts or documentation of the government order that led to the full or partial suspension of operations.
Wage records for each employee for whom the credit was taken should be maintained. If the employer filed a Form 7200 requesting advance payment of the credit, records relating to the calculations on Form 7200 and a copy of the filed form also should be maintained. These records should be kept for at least four years after the later of (1) the due date of the Form 941 on which the credit is claimed, or (2) the date payroll taxes due with the Form 941 are paid. For credits taken on wages paid during the period of July-December 2021, these records should be kept for five years.
Finally, an eligible employer receiving a shuttered venue operator or restaurant revitalization grant must retain in its records support for the employee retention credit claimed, which must include any documentation supporting that the eligible employer did not claim the employee retention credit on amounts taken into account as payroll costs paid in the third and fourth quarters of 2021 in connection with the grant programs.
ARPA offers an opportunity to eligible businesses, including tax-exempt organizations, to receive refundable tax credits. In addition to potential credits for future years, and in consideration of changes to PPP loan and other pandemic-related program regulations, there may be a refund opportunity for 2020 or 2021 that will require the filing of amended payroll and possibly tax returns. The calculations and data analysis can be complex and cumbersome, as additional payroll and other data is required. Additionally, advance payments of the credit must be reconciled with actual wages paid during the quarter. It is much more efficient, with faster processing by the tax authorities, to file quarterly payroll tax returns with the employee retention credit data included. However, even if you have already filed quarterly payroll returns without the credit, you may be able to file amended returns to claim a refund. The key is: don’t delay! IRS processing times for amended returns is increasing as more taxpayers take advantage of these credits. Further, IRS guidance is continuing to evolve even as the credits expire shortly. If you cannot effectively determine eligibility or prepare the required tax filings, seek professional guidance so you do not miss this short-lived refund opportunity, which will sunset, likely forever, at the end of 2021, if not sooner.
For More Information
If you would like more information about this topic or your own unique situation, please contact John I. Frederick, Steven M. Packer or any of the practitioners in the Tax Accounting Group. For information about other pertinent tax topics, please visit our publications page.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.