Nonprofits, Don’t Overlook Your Potential Refund Under the Employee Retention Tax Credit
*Please read below for IRS updates on the Employee Retention Tax Credit.
Originally published March 12, 2021, By Steven M. Woolf. Re-posted with permission.
With half a dozen federal COVID relief laws coming out of Washington since the pandemic began – and each new law amending the prior ones – it’s hard to keep up with which provisions provide the biggest benefits for the nonprofit bottom line. That’s the case with the Employee Retention Tax Credit (ERTC), created by the CARES Act in late March 2020. As originally enacted, nonprofits and other employers could not claim the ERTC if it also received a Paycheck Protection Program (PPP) loan. In virtually every case, the PPP loan was more valuable than the ERTC. At year-end, however, Congress changed this restriction so employers can now claim the ERTC for wages not part of their forgiven PPP loan. In short, nonprofits that ignore the ERTC may be leaving money on the table that could be well spent on mission.
What is the Employee Retention Tax Credit?
Designed to provide a financial incentive to keep employees on the payroll despite the hardships caused by the COVID-19 pandemic, the ERTC is a refundable tax credit in 2020 for an eligible employer’s portion of Social Security (payroll) taxes. For 2020, eligible employers were those that met one of two requirements: (1) operations were either fully or partially suspended by a government order limiting commerce, travel, or group meetings due to COVID-19; or (2) gross receipts were less than 50 percent of those for the same quarter in the previous year. The maximum amount of the ERTC was limited to 50 percent of $10,000 of an employee’s qualified wages or $5,000 per qualified employee per year. For smaller eligible employers (100 or fewer full-time employees), qualified wages were those paid to any employee. For a large employer (more than 100 full-time employees), qualified wages were those paid to an employee for time that the employee was not providing services to the employer.
Can you claim the ERTC for 2020?
Provisions in the Consolidated Appropriations Act (CAA) passed by Congress at the end of December 2020 now permit qualifying nonprofits and other employers that received PPP loans to retroactively apply for the ERTC — as long as they are not claiming the ERTC for the same wages that were used for PPP forgiveness.
An employer can’t claim PPP forgiveness and an employee retention tax credit for the same payroll expenses, so it is important to maximize the rules under each program. In calculating which expenses to claim under either the PPP or ERTC, it’s important to keep in mind the PPP 60/40 rule. Last June, Congress directed that employers seeking loan forgiveness must spend at least 60 percent of their PPP loans on payroll expenses. Employers are free to devote the whole loan to payroll expenses but are permitted to apply up to 40 percent on other qualified non-payroll expenses such as rent and utilities. As the IRS recently explained in an example included in Notice 2021-20 (released March 1, 2021), an employer that includes all of its payroll expenses in a PPP loan application, even if there were other non-payroll expenses that would have also counted, can’t later claim the payroll costs under ERTC.
The IRS guidance demonstrates that the nonprofits and other employers should attempt to maximize the amount of qualified non-payroll expenses (up to the 40 percent statutory limit) when applying for PPP loan forgiveness in order to ensure that excess payroll expenses can produce the greatest amount of the ERTC.
How has the ERTC changed for 2021?
The year-end COVID relief law, combined with the newly enacted American Rescue Plan Act, extends and significantly expands the ERTC. For each quarter of 2021:
- Employers need only show a reduction in gross receipts of 20 percent compared to either the same quarter in 2019 or the prior quarter compared to that quarter in 2019. (Note that the partial or full government shut-down order alternative also still applies.)
- The credit for 2021 is now 70 percent of the qualified wages per employee up to $10,000 of wages per quarter, for a per-quarter refundable credit of $7,000 per eligible employee.
- The definition of large employer is now more than 500 full-time employees, meaning that more nonprofits and other businesses will be able to claim the refundable credit for more employees.
How does the ERTC work with PPP Second Draw loans?
Employers applying for and receiving PPP Second Draw loans can also claim the expanded ERTC. However, similar rules apply that prevent payroll costs that are eligible for the ERTC to be eligible for PPP loan forgiveness and vice versa. Similar strategies of maximizing non-payroll expenses should be applied.
Steven M. Woolf, recently retired Senior Tax Policy Counsel for the Jewish Federations of North America and formerly with the National Tax Office of PricewaterhouseCoopers, is Tax Policy Advisor for the National Council of Nonprofits.
*April 14, 2021, Updated IRS Guidance: How to claim the employee retention credit for the first half of 2021
The IRS explained the changes to the employee retention credit (ERC) for the first two calendar quarters of 2021 in Notice 2021-23:
- The increase in the maximum credit amount from 50% to 70%;
- The expansion of the category of employers that may be eligible to claim the credit to include colleges and universities and entities that provide hospital or medical care;
- A modification of the gross receipts test threshold to 80% and changes in how the decline in gross receipts is calculated;
- In the calculation of qualified wages, the revised definitions of small and large eligible employers are used; and
- New restrictions that limit the ability to request an advance payment of the credit to certain small eligible employers with not greater than 500
As a result of the changes made by the Consolidated Appropriations Act, eligible employers can claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after Dec. 31, 2020, through June 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. The maximum ERC available is $7,000 per employee per calendar quarter, for a total of $14,000 for the first two calendar quarters of 2021.
For questions related to the ERC, please consult your financial advisor.