Employee retention credits (ERCs) were originally created under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 20201 and extended — with significant modifications — into the first three quarters of 2021 by §207 of the Consolidated Appropriations Act, 2021.2
According to §2301 of the CARES Act, the ERC is a fully refundable tax credit for employers equal to a set percentage — 50% for 20203 or 70% for 20214 — of qualified wages (including allocable qualified health plan expenses) that eligible employers pay their employees.
The ERC is claimed on an employer’s quarterly payroll tax return (Form 9415), either on the originally filed form or an amended form, if not claimed at the time of the original filing.6
The ERC has proven to be a very substantial benefit, especially for 2021 claims. This article covers a summary of the ERC program.
An employer is eligible for the ERC if they have fully or partially suspended operations due to a governmental order from an appropriate governmental authority,7 which is defined in §2301 of the CARES Act as an order that limits commerce, travel, or group meetings due to COVID-19 during specified quarters.
Based on Notice 2021-20, “Guidance on the Employee Retention Credit under Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act,”8 an acceptable order must come from the federal government or any state or local government. Statements from a governmental official, including in press conferences or interviews, do not rise to the level of a governmental order. Declarations of a state of emergency by a governmental authority also do not qualify as a governmental order if they do not limit commerce, travel, or group meetings or do not relate to the particular employer’s operations.
According to CARES Act §2301, an employer qualifies if their gross receipts — determined by their tax reporting accounting method — declined by more than 50% for 2020 calendar quarters or more than 20% for 2021 calendar quarters when compared to the same quarter in 2019.
For 2021, the employer may also elect to apply the gross receipts test by using gross receipts for the immediately preceding calendar quarter, compared to the corresponding calendar quarter in 2019 (e.g., qualification for the first quarter of 2021 could be determined by gross receipts comparison of the company’s 2020 fourth quarter to its 2019 fourth quarter).
Notice 2021-20 notes that gross receipts include other income items, such as capital gains, interest, dividends, or K-1 investment income.
Based on a comparison chart,9 for 2020, the credit equaled qualifying wages paid (up to $10,000 per employee paid after March 13, 2020, but before December 31, 2020) multiplied by 50%. But for 2021, the credit equals qualifying wages paid (up to $10,000 per employee per quarter for the first three quarters) multiplied by 70%.
Section 2301 of the CARES Act and §206 and §207 of the Taxpayer Certainty & Disaster Relief Act of 202010 notes that qualifying wages are dependent on whether the employer is considered a large or small employer (which is determined as a 2019 monthly average). For 2020, a large employer was more than 100 full-time employees; however, for 2021, a large employer is 500 full-time employees.
The CARES Act notes that large employer wages include wages paid to employees who were not currently providing a service to the employer, whereas small employer wages include wages paid to all employees, whether they were providing services to the employer or not.
Claims can be filed for as long as the related statutes of limitations are open, which is generally three years after the original payroll tax forms were filed.
Interaction With Other Federal Assistance
Under the CARES Act, recipients of Paycheck Protection Program (PPP) loans were not eligible to claim the ERC.11 However, the Consolidated Appropriations Act, 2021 retroactively eliminated that eligibility requirement, and wages that were not paid with PPP loan proceeds that were forgiven or expected to be forgiven may be eligible for the ERC.
In addition, as presented in Notice 2021-20, the calculation must consider any other credit or relief provisions utilized by the entity under the CARES Act, such as Families First Coronavirus Response Act (FFCRA) credits, Restaurant Revitalization Funds, and certain other applicable credits under the Internal Revenue Code (IRC).
Income Tax Implications
According to Notice 2021-20, the ERC benefit is not directly taxable for federal and many state tax purposes. However, unlike PPP loan forgiveness, no deduction is allowed for the portion of wages/salaries paid for with ERC (an employer must reduce its total payroll deductions by the amount of the ERC), resulting in possible tax liability.
Because the ERC strictly follows filings of Form 941, the taxability must be reported in the same fiscal year as the quarter under which the ERC is claimed.12 Given the IRS’ current backlog of processing the claims, this requirement can often result in stresses on cash flow as the payment of income taxes owed on wages and salaries reported on current or amended tax returns may likely precede the receipt of the related credits and refunds.
Accounting for the ERC
When and how should the ERC be recognized for financial statement reporting purposes for 2020 and 2021? Government assistance or loss recovery are two primary accounting approaches to consider when evaluating whether an entity may recognize the ERC as income during 2020, 2021, or another year.