Note: The Paycheck Protection Program Flexibility Act (“PPP Flex Act”) was signed into law on June 5, 2020. The PPP Flex Act extends the availability of loans under the Paycheck Protection Program (PPP) and adjusts certain rules applicable to PPP loans. The information reflected here may therefore be outdated. We are working to update our resources to reflect these updates to the PPP, so be sure to check back soon. Please refer to the latest guidance from the SBA and Treasury to confirm current program rules and how they apply to your particular situation.
As the coronavirus continues to slow consumer spending and suspend regular business operations, small business owners are turning to emergency loans and grants. Among them are the Paycheck Protection Program (PPP), a loan intended to maintain employee payroll, and the Economic Injury Disaster Loan (EIDL).
But for some business owners, the Employee Retention Credit might be what they need. If you’re not quite sure what this credit is or how it works, you’re not alone. Read on to learn more.
What is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a refundable tax credit intended to encourage business owners to keep their employees on the payroll and minimize the number of workers filing for unemployment benefits.
Although the ERC is technically a credit against the employer’s liability for Social Security taxes on payroll, an employer need not wait until its quarterly tax filing to receive the benefit of the credit. As described below, eligible employers can receive a current cash benefit either by reducing the employment tax deposits they are otherwise required to make or by filing a claim for “advance refund” of the credit that is anticipated for a given quarter.
How is the credit amount determined?
The tax credit is equal to 50% of qualified wages that eligible employers pay their employees in a calendar quarter. The credit applies to wages paid after March 13, 2020, and before January 1, 2021. Eligible wages per employee max out at $10,000, so the maximum credit for eligible wages paid to any employee during the qualifying period is $5,000.
Let’s say you pay an employee $8,000 between April and June 2020 and $8,000 between July and September 2020. The maximum credit with respect to those wages would be $4,000 in Q2 and $1,000 in Q3, for a total of $5,000.
Who is eligible for the Employee Retention Credit?
An eligible employer must “carry on a trade or business during calendar year 2020 and must meet one of two requirements:
- The operation of the employer’s business is suspended fully or partially due to orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19; or
- The employer’s business experiences a decline of more than 50% in gross receipts for a calendar quarter of 2020, compared to the same calendar quarter in 2019.
For example, if your gross receipts were $210,000 in Q1 of 2019 but $100,000 in Q1 of 2020, you would meet the gross receipts test because your Q1 2020 gross receipts are equal to 48% of the comparable quarter in 2019. The test for full or partial suspension due to government order applies, regardless of the revenue impact.
Who is not eligible for the ERC?
Government employers are not eligible for the Employee Retention Credit. Self-employed workers are also not eligible for the ERC for their self-employment earnings.
What are qualified wages?
The Internal Revenue Code defines wages in section 3121(a). In general, “wages” refers to payment for employment, including taxable benefits. The ERC also includes wages the portion of group health plan expense (including both employer contributions and pre-tax employee contributions) that is allocable to otherwise qualifying wages. The determination of which wages are qualified wages depends on the average number of full-time employees employed by the eligible employer in 2019.
Qualified wages for larger employers
For employers that had an average of more than 100 full-time employees in 2019, qualified wages are those paid to an employee for the time they aren’t providing services due to the suspension of operations or decline in gross receipts that qualifies the employer for the credit. The wages the ERC takes into account may not exceed what the employee would have been paid for, working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
Qualified wages for smaller employers
For employers that had an average of fewer than 100 full-time employees in 2019, qualified wages are those paid to any employee during the period that its operations are fully or partially suspended due to a government order or the period of a decline in its gross receipts. The period of decline in gross receipts begins with the first quarter of 2020 in which there is a more than 50% decline in gross receipts (compared to the same quarter of 2019) and ends on the last day of the first subsequent quarter in which the employer’s gross receipts are more than 80% of those for the corresponding quarter of 2019. Many small businesses have employees who “wear many hats,” and the ERC rules give businesses with fewer than 100 employees more leeway in eligibility requirements. These businesses can claim the credit for wages paid to all employees, rather than just the employees who are not working due to a closure.
What wages do not qualify for the ERC?
Qualified sick and family leave pay for which the employer is eligible for tax credits under the Families First Coronavirus Response Act are not eligible for the ERC. Wages paid to an employee with respect to whom the employer is eligible for the work opportunity tax credit for a given period also cannot be included in computing the ERC.
How can eligible employers receive the Employee Retention Credit?
If you are eligible, you can receive an Employee Retention Credit in any of three ways.
- You can claim credits on your quarterly employment tax return (Form 941), beginning with the second quarter of 2020, by reporting your total qualified wages for the quarter (the Q2 return can also include qualified wages from Q1).
- You can reduce the amount of employment taxes you are required to deposit with the IRS for each payroll cycle by the amount of the ERC to which you are entitled, without penalty.
- You can submit Form 7200 to receive an advance refund of the ERC from the IRS. You can file Form 7200 any time during a quarter and request a refund of the ERC anticipated for that quarter (less any amounts received through reduction of payroll deposits). You can file multiple times for a quarter if the amount of ERC you anticipate increases. The last date to file Form 7200 for a given quarter is the end of the month following the quarter.
Does the Employee Retention Credit work with the Paycheck Protection Program?
No, an employer is not eligible for the Employee Retention Credit if they receive a loan under the Paycheck Protection Program.
Which is better for my business, the ERC or PPP?
Both the Employee Retention Credit and Paycheck Protection Program are intended to keep employees on payroll and out of the unemployment office. However, receiving a PPP loan renders your business ineligible for the ERC. So it’s important to weigh the pros and cons of each and make an educated decision.
Pros and cons of the Paycheck Protection Program
The Paycheck Protection Program offers small business owners loans up to $10 million to cover payroll costs and other qualifying business expenses. In certain circumstances, PPP loans may be forgivable. Paycheck Protection Program loans may be a good solution for small to midsize businesses. The PPP can provide these businesses with critical cash that allows them to keep their doors open and pay their employees.
|Cons of the Paycheck Protection Program|
|A PPP loan may put money in your pocket, up to $10 million. The loan amount is calculated based on your average monthly payroll costs.||Employers with 500 or more employees are not eligible for PPP loans unless they’re considered “small” under the SBA’s size standards.|
|The portion of a PPP loan spent on payroll and certain other qualifying costs in the eight weeks after the loan is funded is eligible for forgiveness, but forgiveness is reduced in the case of certain headcount or salary reductions.||The window to apply for and receive a PPP loan is narrow. There is a cap on the total dollar amount of loans available.|
|PPP loans have low interest rate of 1%.||75% of the loan proceeds must be used for payroll costs, and any amount that does not qualify for forgiveness must be repaid.|
Pros and cons of the Employee Retention Credit
The Employee Retention Credit allows business owners quick access to cash via a reduction in payroll tax deposits or an advance refund procedure. The Employee Retention Credit isn’t a loan, so it does not need to be repaid.
Because the ERC is not a loan, recipients don’t need to repay funds.The window to apply for and receive a PPP loan is narrow. There is a cap on the total dollar amount of loans available.
|Pros of the Employee Retention Credit||Cons of the Paycheck Protection Program|
|The ERC is available through December 31, 2020, and there’s no cap on the total amount available (although each employer can only claim $5,000 per employee).||Because the ERC covers only 50% of wages, employers that qualify for a PPP loan will often receive a larger amount up front than they would via the ERC.|
|Because the ERC is not a loan, recipients don’t need to repay funds.||The ERC requires a qualifying closure (full or partial suspension of the business or significant decline in gross receipts), and larger businesses only get credit for wages paid while employees are not working because of the closure.|
|Businesses of all sizes are eligible to receive the ERC.|
|There is no application process, and the government generally will not disclose the fact that an employer receives the ERC.|
Comparing ERC and PPP loans
Generally, businesses with more than 500 employees or businesses with primarily low-wage workers may find greater benefit through the ERC than the PPP. Lenders calculate PPP loans using your average monthly payroll costs, while the ERC is driven more by employee headcount. Let’s take a look at some simplified examples.
Let’s say Employer A has 3,000 employees not working due to a shelter-in-place order. Those employees are paid $30,000 per year, or $2,500 per month, in income. Total employer and employee payroll taxes at the rate of 15.3% are $382.50 per employee, per month, for a total of $1,147,500 per month. Under the ERC, beginning with the first eligible quarter, Employer A would keep the full $1,147,500 per month, plus any income tax withholdings (which vary based on the employees’ filing status, but might run around $500,000 to $600,000 per month for this payroll) rather than paying over those deposits to the Treasury. Employer A could also receive additional amounts through the advance refund procedure at a rate of approximately $2 million per month (which could be advanced for the full quarter as soon as Employer A became eligible). This would continue until the end of the qualifying closure or until the Employer A received a total benefit of $15 million. That’s 3,000 employees at a maximum benefit of $5,000 per employee through the end of 2020, the equivalent of two full months’ wages for all 3,000 employees.
Because Employer A has more than 500 employees, it would not qualify for a PPP loan. Even if it did, the maximum PPP loan amount of $10 million would not be enough to cover payroll for two months. In this case, the Employee Retention Credit is more beneficial.
Employer B is a small business with 40 employees. Its employees’ average income is $50,000 per year (with none making more than $100,000). Under the Paycheck Protection Program, Employer B could receive a loan of approximately $417,000—calculated as 250% of its monthly payroll cost. Employer B may not have to repay loan proceeds that are spent on eligible payroll costs and (up to 25%) on other eligible costs during the eight weeks after loan funding. The maximum benefit Employer B could receive through the ERC is $200,000 (40 employees, $5,000 per employee). That’s less than half the amount it could receive under the Paycheck Protection Program. In this case, the PPP may be the better choice for Employer B.
These are simplified examples that do not take into account items such as benefits costs, which affect the PPP and ERC differently. In the real world, there may not be an obvious choice for your business. When in doubt, consult your accountant or financial adviser.
“It’s not a one-size-fits-all kind of answer,” said Andrew Poulos, of Poulos Accounting and Consulting, Inc. “It’s a case-by-case basis to see what is best for each business owner and whether the business has the ability to pay their employees at the moment or if the PPP loan is the best solution.”
“It depends on the organization,” agrees Dan Luthi, COO of Ignite Spot. “If you are much larger and don’t need a short-term grant to keep you afloat, the credit may be better, and it has a longer runway. It also carries less risk on the forgiveness side and allows for a managed cash discount. For clients who need cash today just to keep the doors open, the ERC may not be enough to save them over the next few months. In that case, the PPP is probably the way to go.”
The resources described above are made available to businesses within the United States of America.
COVID-19 relief programs are evolving regularly. Please visit SBA.gov for the most up to date information.
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