The Employee Retention Credit program was enacted as part of the CARES Act on March 27, 2020, to provide reimbursement of wages for businesses affected by the COVID-19 virus and incentivize employers to maintain a pre-pandemic level workforce.
The 2020 Employee Retention Credit was not available for PPP borrowers and required a loss in revenue that amounted to 50% more for each calendar quarter of 2020 when compared to the respective revenue for the corresponding quarter in 2019 to qualify. These restrictive requirements prevented most businesses from being eligible to claim the credit.
The Economic Aid Act, passed on December 27, 2020, made the Employee Retention Credit much more available by allowing PPP borrowers to apply for and receive the credit for 2020 if they satisfied the 50% of receipts reduction.
More importantly, the December CARES Act amendment dropped the threshold from 50% to 20% to qualify for the credit in the first and second quarters of 2021. Further, the amendment provided that 2021 wages can be reimbursed for up to 70% of the first $10,000 paid to each employee for each calendar quarter, amounting to a maximum of $7,000 per employee each quarter.
In addition, the credit can be received for the first quarter of 2021 if the employer satisfies either of the following:
A. If the gross receipts of the business for the fourth quarter of 2020 were 80% or less of the gross receipts of the fourth quarter of 2019;
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B. If the gross receipts for the first quarter of 2021 are 80% or less of the gross receipts of the first quarter of 2019.
If the business has met the test for the first quarter of 2021, it can file an application known as a Form 7200 to get an advance on the credit based upon the anticipated filing of a Form 941 to claim the Employee Retention Credit.
Unlike the PPP program, there is no requirement that the business be in need of monies or that there be any “necessity” to borrow money to claim the Employee Retention Credit. The wage credit received is not taxable, but the wages that were paid that qualified for the credit will not be tax-deductible.
For example, if $5,000 was received in 2021 as credit for $12,000 paid to an employee in the third quarter of 2020, then the $5,000 received in 2021 may not be taxable, but $5,000 of the $12,000 paid in 2020 will not be tax-deductible on the 2020 income tax return.
This will cause difficulty for accountants (don’t they already have it bad enough?) as S-corporation and partnership tax returns are due on March 15 and C-corporation tax returns are due on April 15. These then must be amended unless this rule is changed to allow the deduction to be reduced in 2021 when the credit is paid.
Here are three planning techniques that can help assure qualification for the Employee Retention Credit or increase the amount the employer would receive.
1. If the business does not qualify when the fourth quarter of 2020 is compared to the fourth quarter of 2019, under the first test above, then steps can be taken to help assure that gross receipts for the first quarter and second quarter of 2021 are less than the corresponding gross receipts for the first and second quarter of 2019, in order to fulfill the second test.
Here are some ways that this might be accomplished:
- Postpone sending invoices and reminder notices to customers who can be expected to pay for its products services at a later time if the business is on the cash method of accounting for income tax reporting purposes.
- If any customers or third parties are owed refunds that would cause a reduction in gross receipts, make sure that the refunds are given.
- Some businesses may even consider closing down nominally profitable or loss operations if this will reduce gross receipts in an amount sufficient to allow for qualification for the credit.
2. If the primary revenue generator is a service provider or salesperson, consider taking a long-deserved vacation during a quarter that may otherwise not qualify for the credit.
3. Certain businesses must include costs and advances that they pay for customers in gross receipts.
These businesses can request that the customers purchase these items on their own so that they will not be included in gross receipts for purposes of the credit calculation.
For example, construction firms that buy appliances and major components of a building concerning a renovation may request that customers purchase these items directly so that the amount included thereof will not be included in gross receipts.
Law firms may request that clients pay directly for deposition services, title insurance, and related items.
4. The wages of children, siblings, and certain other relatives of business owners are not eligible for the wage credit. Wages paid to an owner holding at least 10% ownership who is related to another owner will qualify.
The statute does not indicate when the ownership should or should not exist to qualify.
Therefore, it may be appropriate to transfer 10% or more in ownership to each working relative of the owner that falls under this rule before an application is filed, or at least on or before the first day of a calendar quarter where the wages may qualify.
5. Employers may also pay wages or past earned compensation when deserved. While the rules for the 2020 Employee Retention Credit provided that wages exceeding historical compensation for an employee will not be counted as eligible for the credit, the 2021 rules do away with this limitation.
Given that 70% of the first $10,000 paid to each employee for a qualifying quarter will be reimbursed, it would make sense to grant the employee a bonus as compensation for prior services rendered, or a pay raise as deserved since these payments will be subsidized by the government.
It is vital to note that there should not be any “under the table” understandings that the money paid will be considered as a prepayment for future services.
How aggressive can the above planning be? Judge Learned Hand stated in the famous Tax Court case of Helvering v. Gregory that any person “may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury.” The same standards of conduct and practice have historically applied for tax litigation and IRS controversy work with respect to tax credits. Nevertheless, given the extreme budgetary issues that our country is facing and that this program is intended to benefit employers impacted by COVID-19, this may not be the best time to be as aggressive as some taxpayers and tax advisors may want to be in normal income tax planning.
In particular, it is not acceptable to take checks that have been received in the mail in March and simply deposit them in April due to the doctrine of constructive receipts or to return money to a customer any amount they have recently paid, and ask them to pay it again later.
My book entitled, The Employee Retention Credit Guide: Everything You Need to Know, and More to Claim and Receive the Employee Retention Credit was recently updated to reflect the newest changes to be ERC program, which most notably include an ability to receive a credit for the third and fourth quarters of 2021 if certain requirements are met.