Clarifying Misconceptions Surrounding the Employee Retention Credit
The Employee Retention Tax Credit (“ERC”) has been a hot topic in tax circles lately. Enacted alongside the Paycheck Protection Program in 2020, the ERC was widely overlooked until recently. As the ERC has become more widely discussed, several misconceptions about the ERC have popped up, leading many to believe—incorrectly—that their business does not qualify when it might. This blog is intended to address a few of the most-frequently heard misconceptions about the ERC.
Two Tests to Qualify for the ERC. The most common misconception with the ERC is that an employer must have a decline in revenue/gross receipts during 2020 and 2021 compared to 2019 to qualify for the ERC. While this is one test, there are actually two tests under which an employer may qualify for the ERC.
Gross Receipts Test: Under the gross receipts test, an eligible employer may qualify for the ERC if they have a 50% or 20% decline in gross receipts (not profit, not revenue) on a quarterly basis for 2020 and 2021, respectively, compared to the corresponding quarter in 2019.
There are many areas of confusion with the gross receipts test, including:
- Many eligible employers believe that since a decline in revenue may qualify them, an increase in revenues will disqualify them. That is not the case. The statute makes no mention of increases in gross revenue at all. So, while a decrease may qualify an eligible employer, an increase only disqualifies them for that test (remember, there are two) for that quarter.
- The gross receipts test is analyzed on a quarterly basis, so failure to meet the gross receipts test in one quarter does not preclude qualification in another quarter. For example, an eligible employer may not qualify under the gross receipts test for Q4 2020, but may qualify for Q1 2021.
- There is more than one method to apply the gross receipts test, such as the primary method and the alternative quarter election.
- PPP loan proceeds are not included in gross receipts for purposes of the ERC. Initially, guidance required eligible employers to include PPP loan proceeds in gross receipts; however, subsequent guidance changed this so that such proceeds are excluded. Given the large dollar amounts of PPP loans, exclusion could make the difference in qualifying for the gross receipts test.
Full or Partial Suspension Test: The second test, which is often overlooked, is the full or partials suspension of operations due to a governmental order test. as with the gross receipts test, there are many misconceptions with this test, including:
- Many eligible employers believe they don’t qualify under this test because their revenues or gross receipts increased during 2020 and 2021. As should be apparent by now, the gross receipts test is only one of two tests under which an eligible employer may qualify for the ERC. To be clear, a company may have had record gross receipts in Q1 2021 and still qualify for the ERC if the eligible employer was subject to government orders related to COVID that placed restrictions on their business.
- Due to the use of the term “suspension,” many believe they do not qualify because their business did not “shut down.” This is not the test. The statute requires a suspension of operations, not closure of a business. Suspensions may result in numerous ways, and the order need not necessarily directly impact the business looking to qualify. Orders which caused supply chain issues, for example, may qualify if other criteria are met. Additionally, government orders that required social distancing in your business may also qualify as a partial suspension.
Credit Amount. For employers who qualify, and are able to receive the maximum credit, they can receive $5,000 per employee for 2020 and $7,000 per employee, per quarter for the first 3 quarters of 2021. A company may qualify in Q4 of 2021 as well, but that is only for small companies that started operations during COVID (called Recovery Startup Businesses). Thus, the total benefit to non-Recovery Startup Businesses could be as much as $26,000 per employee, plus interest. This is a refundable credit, so will result in a refund to the eligible employer that qualifies.
PPP Loans Do Not Disqualify. Another misconception is that a business that received a PPP loan is disqualified from claiming the ERC. This was true when the credit was first established, but subsequent legislation retroactively eliminated that restriction. After the retroactive change, an employer that received a PPP loan may also qualify for the ERC (however, there is no double dipping wages).
Does Your Business Qualify? Small eligible employers that have not taken advantage of the ERC should consider whether they qualify for the consequential and substantial ERC. Based on our experience, non-profit entities, restaurants, breweries, doctor and dental offices, and car dealership, to name a few, have mistakenly believed they did not qualify for the ERC, when they, in fact, did.
Word of Caution. We must conclude with a word of caution. Due to the potentially substantial dollar amount of the ERC, many fly-by-night operations have popped up to help clients obtain the ERC. While some of these operations are qualified to analyze and apply the law, many are not. If you choose to file for the ERC and engage a third-party to help, please ensure you are choosing an accountant or attorney who is qualified and will be there to represent you if the IRS questions your claim for the ERC.
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