You have most likely heard a lot about the Employee Retention Credit and may have been contacted by companies assuring you that you qualify and that you can get significant cash payments if you claim the credit. Unfortunately, these companies may be using very broad interpretations of the ERC qualifications that the IRS may not agree with if you are selected for audit. Many of these vendors charge a significant percentage of the ERC claimed. By the time the IRS audits your ERC claim, you may have to repay the ERC, plus penalties, and you may not be able to recover the fee paid to the vendor. The information below describes what the ERC is, how you qualify, how the credit is calculated, and how to account for it.
Overview – What is the ERC?
The Employee Retention Credit (ERC) is a refundable employment tax credit to help businesses with the cost of keeping staff employed. It was enacted as part of the CARES Act. The ERC covers wages paid from 3/13/2020 – 9/30/2021 for most employers (and for 10/1/21 – 12/31/21 for new businesses that started during the pandemic). The ERC is claimed on an employer’s quarterly Form 941 – Employer’s Quarterly Federal Tax Return. For employers that filed some/all 2020 and 2021 Form 941s without claiming the ERC, they are still able to submit the Form 941-X amended return to claim the ERC. The payment is up to $26,000 per employee ($5,000 in 2020, $21,000 in 2021) for employees that qualify for the full period. To qualify, the employer must have experienced EITHER a full or partial suspension of operations due to government orders due to COVID-19 OR a significant decline in gross receipts.
Qualifications – Who qualifies and how do you qualify?
The ERC was not applicable for government entities in 2020 but was for 2021 (through September 30, 2021). It was available for nonprofit entities for all of 2020 and through September 30, 2021. New entities formed in 2020 or 2021 could qualify for October 1, 2021 – December 31, 2021.
As noted above, to qualify, the employer must have experienced EITHER a full or partial suspension of operations due to government orders due to COVID-19 OR a significant decline in gross receipts.
- Full or partial suspension of operations – Must come from a government order (federal, state, or local), which is a documented order, proclamation, or decree, not just comments to the press. Must limit commerce, travel, or group meetings due to COVID-19. Must have a more than nominal effect – defined as a 10 percent reduction in gross receipts or in employee hours compared to the same quarter for 2019. Use https://www.huschblackwell.com/state-by-state-covid-19-guidance or state guidance on government orders or look on the individual state websites for public health orders related to the pandemic. No federal orders during 2020 or 2021 would qualify businesses for ERC, so only state and local orders will apply.
- Reduction in gross receipts – For 2020, for each quarter compared to the same quarter for 2019, if gross receipts are 50 percent or less in 2020, the employer is eligible for that quarter and will remain eligible until the quarter after gross receipts return to 80 percent or higher than 2019 gross receipts for the same quarter. For 2021, for each quarter, applicability may be measured using that quarter’s gross receipts or the preceding quarter’s gross receipts as compared to the same quarter from 2019 and using the 80 percent gross receipts threshold. Gross receipts would be box g on page 1 of the IRS Form 990 or similar for other businesses and includes almost all revenue. However, unrealized gains on investments are excluded, and for sales of investments, the amount included would be the gross receipts from the sales. PPP loan forgiveness is also excluded.
Calculation of Credit
The full credit is only available to small employers, which is defined as 100 employees or less for 2020 calculations and 500 employees or less for 2021 calculations. The employee count for both years is based on 2019 data. Only full- time employees are counted. To count full-time employees, count the number of employees each month that worked 130 hours or more. Then average the totals for all months. Large employers can only claim the ERC for wages paid to employees not to work, such us furlough pay.
For 2020, the credit is 50 percent of total wages and health insurance expense for each employee up to $10,000, for a total of $5,000 for the year.
For 2021, the credit is 70 percent of total wages and health insurance expense for each employee up to $10,000 per quarter, for a total of $7,000 per quarter, or
$21,000 for the first three quarters (exclude the fourth quarter except for new companies).
For allowable wages, exclude amounts claimed for the PPP loan forgiveness.
Timing
Employers have three years from the date the Form 941s are due to file the amended Form 941s. For all 941s for each year, the final due date is April 15th of the next year, so the 2020 final deadline is 4/15/2024. The 2021 final deadline is 4/15/2025. The IRS has 5 years from the date the 941s are filed to audit them. The IRS has been taking 4-12 months to process the payments.
Consolidated Entities
For purposes of calculating gross receipts, the more than nominal effect of a suspension of operations, and small vs. large employer, the consolidated entity should be considered as a whole, not by individual component units or departments.
Examples of COVID Effects and Applicability for ERC
Requirement to wear masks and gloves and to put up and work behind plexiglass windows – Not likely to be applicable as there is not a more than nominal effect on business operations.
Government order only in effect for partial quarter – only the wages paid during the period during which there was a partial or full suspension of services would qualify.
Government order suspending operations of a supplier – only applies if the supplies can’t be obtained from another supplier and the effect is more than nominal.
Government stay-at-home order causing patient volumes to decrease – does not apply since the government order is on the patients, not on the business.
Accounting
Because there is no requirement to claim the ERC, it is not recorded until you 1) determine that you qualify, and 2) decide to claim the credit. The actual filing of the 941 or 941-X does not need to be completed before recording the revenue and related receivable. As the calculation of the credit is fairly straight-forward, it should be considered to be reasonably estimable, which is required by the accounting standards to record the revenue. The ERC consultants helping you file the 941s can help with at least a preliminary calculation even before the 941s are filed.
If you file for the ERC and receive the payment but do not meet the qualifications, record a payable until additional guidance is released that indicates you do qualify or until the IRS period for audit has passed.
The fees paid to a consultant to help with the ERC calculations and filing should not be netted with the revenue but should be reported separately as an expense (and a related payable until it is paid).
Document your policies and procedures, including internal controls, for preparing, reviewing, and approving the ERC calculations, 941 preparation and filing, and accounting for the ERC.
Cost Report Effect
The ERC is NOT offset on A-8. It is reported on G-3 as a separate line 24.51. Any consultant fees used to apply for the ERC are also NOT offset on A-8.
Joe Lodge, Principal
