The IRS has been busy. On March 1, 2021, they released a 102-page document that answers taxpayer questions about both the Employee Retention Credit (ERC) and the Paycheck Protection Program (PPP). Notice 2021-20 more clearly defines ERC eligibility – something that was sorely needed – but it is noteworthy for another reason: it explains how the ERC and the PPP work in tandem.
Why the Notice Is So Helpful
Both the ERC and the PPP were created in March of 2020 when President Trump passed the very first COVID-19 relief bill. The Coronavirus Aid, Relief, and Economic Security (CARES) Act created two distinct programs to incentivize businesses to keep workers on the payroll. The ERC provided a refundable employment tax credit for businesses that kept workers employed even when they suffered economic losses, and the PPP granted short-term loans to businesses that could be forgiven if loan proceeds were used on payroll and other approved expenses. Businesses wanted to accept both incentives but found themselves at an impasse; the CARES Act did not permit businesses to accept the ERC and have their PPP loans forgiven.
Congress reversed this ruling when it passed its second coronavirus relief bill in December 2020, the Consolidated Appropriations Act, 2021 (CAA). The IRS guidance in Notice 2021-20 interprets what was written in the CAA so that businesses understand how they can receive the ERC and get their PPP loans forgiven.
How ERC and PPP Work Together
The CAA states that while businesses can apply for both incentive programs, expenses that qualified them for PPP loan forgiveness cannot also be used to qualify them for the ERC. This statement is simple on its face, but in execution it can get tricky. How businesses report their payroll expenses matters. Consider the following example:
Employer A received a PPP loan of $100,000. To qualify for forgiveness, they must report $100,000 of eligible costs, $60,000 of which must be payroll costs. Over the PPP covered period, they had $110,000 of payroll costs and an additional $50,000 of non-payroll costs that were qualifying expenses.
Employer A applied for PPP loan forgiveness and listed only its payroll costs of $110,000 on its loan forgiveness paperwork. In doing so, the business elected for $100,000 of these payroll costs to count toward PPP loan forgiveness. Only the remaining payroll costs of $10,000 can be treated as qualified wages for the ERC.
Employer A applied for PPP loan forgiveness and listed $60,000 of payroll expenses and $40,000 of non-payroll expenses on its loan forgiveness paperwork. The remaining payroll costs of $50,000 can be treated as qualified wages for the ERC.
The covered period for most PPP loans is a 24-week period ending sometime in 2020 or early 2021, which often overlaps with the payroll periods for which businesses hope to also claim the ERC. It is important that you understand how the PPP and the ERC work together. You want to maximize your PPP forgiveness while also leaving room to claim the ERC. CRI can help you apply payroll expenses in a manner that will optimize your usage of both programs.
The IRS notice provides many examples of how the ERC and the PPP interact, but the notice also addresses ERC-specific concerns.
Other Items in the Notice
The IRS’s job is to provide clarification when the tax laws are unclear. The following are just a few questions about the ERC that the notice was able to answer.
When will the IRS consider operations to be fully or partially suspended?
To be eligible for the ERC, businesses must either report a significant decline in gross receipts or have operations be fully or partially suspended due to a government order. Partial suspension of operations must have “more than a nominal effect” on business operations to meet IRS tests, which would be met in any of the following scenarios:
- The gross receipts from the partially suspended operations is at least 10% of the business’s total gross receipts.
- The service hours attributed to the partially suspended operations is at least 10% of the business’s total service hours.
- The business’s ability to provide goods or services has reduced by no less than 10%.
The notice also clarifies that the government order must have affected the business directly. If the government order causes customers to stay home or otherwise reduces demand, that reduction in business cannot be considered when determining if operations have been partially suspended.
If employers can continue operations that are comparable to operations prior to the government order, their operations are also not considered partially suspended. The notice specifically lists teleworking as an example. If employees can perform their duties remotely and the employer’s IT infrastructure can support telework, their operations cannot be considered partially suspended.
How is ERC eligibility determined in an aggregated group?
The CARES Act states that all businesses treated as a single employer by Section 52(a) or (b) of the tax code will be treated as a single aggregated group for purposes of the ERC. The IRS notice clarifies that ERC eligibility will be based upon the group as a whole. For example, when testing if there has been a significant decline in gross receipts, the IRS will look to the group as if its operations were one company. The credit will then get distributed among members of the group based on how their payroll costs attributed to the credit.
Are ERC-eligible wages deductible?
No. The IRS notice reveals that the business’s payroll or wage deduction should be reduced by wages that were used to qualify for the credit.
The notice also answers the following questions:
- What types of government orders are considered when determining if operations have been suspended due to COVID-19?
- What records should employers gather, and how long should they retain proof of ERC eligibility?
- How can businesses that use third-party payers qualify for the credit?
- Does the ERC affect employees’ reportable wages?
- How does the ERC affect other tax credits (like the Work Opportunity Tax Credit)?
- How can tribal governments and nonprofits qualify for the ERC?
Although the IRS notice is lengthy, it can be a helpful resource for taxpayers. The FAQ format is simple to follow, and the IRS provides numerous examples to help illustrate complex issues. If you have questions about your ERC eligibility or want to ensure your PPP forgiveness application has little impact on your ERC, please reach out to your CRI advisors today.