On March 1, the IRS issued guidance for employers claiming the employee retention credit (ERC) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as modified in December 2020 by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act). The ERC is designed to help eligible businesses keep employees on their payroll by offering a credit against employment taxes when qualified wages and healthcare expenses are paid during the COVID-19 pandemic. The guidance under Notice 2021-20 clarifies and describes retroactive changes to the ERC under the new law for employers seeking to claim the credit for 2020 in the form of frequently asked questions. The IRS has stated that it will address calendar quarters in 2021 in later guidance.
Under the 2020 ERC rules, 50% of qualified wages and healthcare expenses (up to $10,000 of wages per employee in 2020) are fully refundable if paid by businesses that experienced a full or partial suspension of their operations or a significant decline in gross receipts. Prior to the Relief Act, employers that had received Paycheck Protection Program (PPP) loans were not eligible to claim the ERC. Now, employers with PPP loans can retroactively claim the ERC, however, the same wages cannot be used for both benefits. Q&A 49 of the notice outlines the IRS’ position on the interaction of the ERC with PPP loans for 2020.
Unfortunately, borrowers who have already received PPP loan forgiveness do not have the same planning opportunities that are available to borrowers who have not yet filed the SBA application, Form 3508 series, for forgiveness.
An eligible employer can elect which wages are used to calculate the ERC and which wages are used for PPP loan forgiveness. Generally, the election is made by not claiming the ERC on the federal employment tax return for the quarter. If the IRS adhered to this general rule, it would nullify the retroactive effective date of the credit. Therefore, in lieu of the general rule on how an employer would elect the wages used for ERC (i.e., by not claiming the ERC on the federal employment tax return for the quarter), the notice provides for a deemed election for any qualified wages that are included in the amount reported as payroll costs on the PPP Loan Forgiveness Application, unless the included payroll costs exceed the amount needed for full forgiveness when considering only the entries on the application.
For example, a business that borrows $100,000 of PPP loans and has both payroll and nonpayroll costs that far exceed the borrowed amount but reported payroll costs of $100,000 on their application to simplify the forgiveness process, cannot use any of the $100,000 of payroll cost to claim the ERC. This is notwithstanding the fact that 100% forgiveness may have been achieved by reporting only $60,000 of payroll costs and the remaining $40,000 from nonpayroll costs.
While the text of Q&A 49 appears to treat the minimum amount of payroll costs required for PPP loan forgiveness (i.e., 60%) as being the deemed election, the examples make it clear that the entire $100,000 in payroll costs reported on the PPP application cannot be included in ERC calculations. The IRS’ examples do not address the documented nonpayroll expenses that were excluded from the PPP application but were retained in the borrower’s files in accordance with the SBA’s instructions.
The notice also formalizes and expands on prior IRS responses to frequently asked questions and addresses changes made since the enactment of the Relief Act. It contains 71 frequently asked questions regarding the following topics:
- Eligible employers
- Aggregation rules
- Governmental orders
- Full or partial suspension of trade or business operations
- Significant decline in gross receipts
- Maximum amount of employer’s ERC
- Qualified wages
- Allocable qualified health plan expenses
- Interaction with PPP loans
- Claiming the ERC
- Special issues for employees regarding income and deduction
- Special issues for employers regarding income and deduction
- Special issues for employers that use third-party payers
- Substantiation requirements