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Last updated on February 10th at 6pm.
For the average small business owner, it's hard enough to understand how to get some of the latest round of Paycheck Protection Program (PPP) money, let alone how to access Employee Retention Tax Credit (ERTC or "Credit").
In fact, under the CARES Act (the first round of relief that came into force in March last year), employers were not allowed to receive or draw on a PPP loan. As a result, most small business owners gave up learning or thinking about the ERTC at all.
However, as part of this second round of total coronavirus aid, entrepreneurs can get help from BOTH provisions. Yes, you can access the PPP and request the ERTC!
Therefore, the ERTC is a key provision in the 5,500-page Consolidated Funds Act of 2020 that small business owners understand and potentially can use.
Which companies qualify?
Any sole proprietorship, limited liability company (LLC), S corporation, or C corporation is eligible if they meet the additional qualification criteria. Any company with fewer than 500 employees (full-time equivalent employees, FTE) from December 2020 can participate in the program and apply for the ERTC. (Previously, only business owners with fewer than 100 employees were allowed to participate.) In order to take advantage of the loan, a company must have recorded a decrease in gross income of more than 20% year-on-year in each quarter of 2020.
Related Topics: New Stimulus Package Includes Second Round Of Small Business PPP Lending And Changes To Lending Rules That Are Favorable To Borrowers
The following diagram shows the five steps to compare and calculate if you qualify:
What is the credit?
The credit is 70% of Qualifying Salary for the quarterly allowable amount paid between January 1, 2021 and before July 1, 2021. Each employee's eligible wage is $ 10,000 per quarter in 2021, excluding the payroll of all owners and family members with a combined stake in the business of 50% or more (more on this below). The maximum amount an employer can receive in credit per unaffiliated worker in 2021 is $ 14,000 ($ 7,000 per quarter). (This does not take into account the coordination of this loan with PPP. More on this below.) But don't forget that between March 13th and December 31st, 2020 qualified wages were paid! The credit is 50% of the qualifying wage paid during this period, up to a maximum of $ 10,000 per employee of the annual wage paid (more on this below, along with the rules regarding the payslips of the owners and their family members) The employer can act as an employee per employee Received $ 5,000 in 2020. (More below about the ability to go back and get the 2020 loan.)
Example: XYZ Enterprises, LLC (taxed as S-Corporation) plans to have two full-time employees in 2021 who will each receive $ 9,180 ($ 18 per hour) in the first and second quarters of 2021, including three part-time workers in the first quarter of 2021 and five part-timers in the second quarter who receive $ 3,060 ($ 12 per hour) each quarter. The Corp pays pre-tax health insurance premiums for the two full-time employees of $ 500 per month or $ 3,000 per quarter for both combined. Therefore, the total qualified employee wages and the calculation for the ERTC are shown in Table 1 as follows:
* See below how this amount works in conjunction with the PPP and whether an employer can return by 2020.
What payroll counts as qualifying wages for the ERTC?
Qualifying wages are a critical term that should be understood in addition to the information provided when calculating the ERTC. It's more than just gross wages. First, qualified wages include both full-time and part-time employees.
Next, you can add any qualified health insurance expenses / premiums that you have paid on behalf of the employee to this number. This generally includes both the part of the health insurance costs paid by the employer and the part of the costs paid by the employee with pre-tax wage reduction contributions.
However, the expenses for qualified health insurance do not include amounts that the employee has paid with contributions after tax. For more information, please visit the IRS website on How to Determine and Calculate Qualifying Wages here.
As the owner, can you get credit for your personal payroll or profit?
That's the golden question, isn't it? Unfortunately, the answer lies a bit in the gray area. Everything we know about this particular detail comes from the IRS.gov newsroom and the ERTC FAQ section.
For sole proprietorships, the answer is no. The IRS in FAQ # 23 makes it clear that, according to their interpretation of the CARES Act, they will not allow ERTC for sole proprietorships. They also clearly state that the Frequently Asked Questions section has not been updated under the 2020 Tax Liability Guarantee and Tax Relief Act passed December 27, 2020. Most professionals agree that the new legislation does not change the rule for sole proprietorships.
However, FAQ No. 23 is not aimed at companies or, in particular, at owners of S-Corporation. FAQ # 59 even states that S-Corporations are allowed to take over the ERTC for their employees (provided the business owner complies with all other rules, including not using the payroll for the ERTC, which was covered by PPP money).
FAQ # 59 goes on to state that the "Connected Person" payroll of the S Corporation owners cannot be used to calculate the ERTC. However, it is not noticeable that the "owner" is viewed as a related person.
So when it comes to the stockholders of S-Corporations who hold 50% or more of the stock, the safe bet is to consider them a "relative" and hence the owner cannot get the ERTC on their own payroll. This prudent interpretation would be in line with other rules of the Code regarding proprietary or prohibited transactions (i.e., pursuant to Section 1372 of the Internal Revenue Code, 2% or more shareholders must be treated as partners in a partnership for this purpose in order to make themselves -employees instead of employees).
For the purposes of this article and the advice we give our clients, we would do so until we see final guidance and an IRC stance on the payroll issue for owners of an S corporation that owns 50% or more of the business ERTC does not claim their wages.
What we do know, however, is that, according to IRS FAQ # 59, the entire pay slip for a "relative" cannot be used to determine the eligible ERTC in 2020 or 2021. Such individuals include the following individuals with a relationship with an owner of the company who owns 50% or more of the value of the outstanding shares:
A child or a descendant of a child, a brother, a sister, a stepbrother or a stepsister, the father or mother or an ancestor of one, a stepfather or a stepmother, a niece or a nephew, an aunt or an uncle, an Son in law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.
In summary, even if you meet all other qualifications, it is wise not to take advantage of the ERTC, unless you employ a third party who is not personally connected to you.
What if my business recovers later in 2020 or 2021?
Finally, be aware that if your company actually experienced a significant business recovery before the end of 2020, or has one in 2021, your eligibility to the ERTC may expire.
According to the new Covid Act, a business owner may no longer use the ERTC in the quarter immediately following a quarter in which his gross income in the quarter is 80% above that of the same calendar quarter of the previous year.
For example, if a company has a second quarter of 2020 in which revenue is down 33% year-over-year, the company will qualify for the ERTC in the first and second quarters of 2020 and would continue to qualify for the rest of the year. However, in the fourth quarter, in-store revenue increased 82% from the year-ago quarter. From this point in time, the company will no longer qualify for the ERTC in the fourth quarter of 2020. In fact, the company only qualifies to the point where revenue has risen above the 80% threshold and is limited to claiming the ERTC for qualified wages in Q1, Q2, and Q3 2020. See the following figure Figure 3.
In addition, the same rule also applies to the first and second quarters of 2021. So if you have a dramatic increase in sales (80% rule) in the second quarter of 2021 compared to the second quarter of 2020, your eligibility for the ERTC will end in the first quarter of 2021.
How does the ERTC work with PPP?
The good news is (and it is important) that under the new legislation, entrepreneurs are entitled to both the first and second rounds of PPP and ERTC. However, PPP funds and ERTC cannot be used to cover the same labor costs. But all is not lost; it just gets difficult.
If a business owner plans carefully and keeps good records and bookkeeping, they should be able to maximize the benefits of PPP and ERTC and create thousands of dollars in tax-free money!
First, let's say a business owner qualifies for the second round of PPP under the new rule to reduce revenue by 25%.
Since the threshold to qualify for the ERTC is lower than that for the PPP (a 20% rule), it is then obvious that the business owner would qualify for both.
NOTE: In other words, if a business owner qualifies for PPP on the sales comparison test, they automatically qualify for the ERTC. You then also have to "coordinate" the two advantages in order to use both as much as possible.
To get both of these benefits, it is important that the business owner consider the following points and then follow a three-step strategy:
The application deadline for the final round of PPP is March 31, 2021. (It may be necessary for a business owner to postpone applying for PPP until the deadline to maximize ERTC benefits.) Remember, 40% The PPP funds can be used for items other than payroll, such as mortgage interest, rent, ancillary costs, employee protection costs related to Covid-19, costs for uninsured property damage caused by looting or vandalism in 2020, as well certain supplier costs and operating costs. (So it is important not to use more than 60% of the PPP money on payroll, as those payroll dollars cannot be used on the ERTC.) Next, the PPP money must be paid for 24 weeks from the Day spent on payroll and qualified expenses The payout has been received. This is known as the "covered period". (A business owner will most likely want to take advantage of this period every week instead of spending the PPP money quickly to get the most out of the ERTC.) Finally, remember that ERTC is up to 70% Qualified Wages of $ 10,000, which each employee will only be paid in the first and second quarters of 2021 – not in the third or fourth quarter. (However, PPP money can be spent in the third and fourth quarters due to the 24 week period.)
The business owner should only use 60% of their PPP funds on payroll (if possible) and the rest on qualified spending. Next, he should distribute the PPP money used for payroll as long as possible (within the 24 week period). and if you haven't applied for the PPP yet, you might wait until the end of March, but don't miss the application deadline. Then the business owner should max out the ERTC balance in the first and second quarters, with no labor cost using PPP money.
Here is an example to illustrate how this strategy could potentially be used.
Example: Suppose a business owner (not in the lodging or catering industry) qualifies for both the second round of PPP and the ERTC. You will receive $ 80,000 in PPP funding on February 1, 2021. Since they received $ 80,000 in PPP funding, their average monthly wage bill would probably have been $ 32,000 ($ 80,000 / $ 2.5). Your 24-week coverage period would then also be from February 1 to July 19, 2021. Further, we'd like to assume that the business owner has the option to spend 40% of their PPP money on expenses other than payroll. This would require only $ 48,000 (of the $ 80,000) to be spent on payroll over the 24 week period. Therefore, the company will have to spend about $ 8,000 per month on payroll from the PPP money during this period. If it can reach this minimum, then the entire PPP loan should be awarded. Finally, we need to know the number of employees and their expected payroll over the time period that they are eligible for the ERTC and need to spend the PPP money. See the Employee Table below (Table 2) and the Payroll Allocation Chart During Periods (Chart 3).
I think it is important to realize that it is absolutely vital to put all PPP funds received in a separate bank account and carefully keep track of what expenses they are used for so as not to have hot water in the event of a potential audit.
One final nuance to consider when coordinating payroll costs for PPP and ERTC: Qualifying wages include wages and salaries for group health care benefits paid by employees before tax, such as: B. the share of employees in their health bonus. Additionally, ERTC guidelines do not prohibit qualifying wage expenses paid in the first or second quarter from being included in qualifying wages. These are different rules than in the PPP program and must be taken into account when calculating which settlement costs are paid for the ERTC and which are paid with PPP funds.
Can a business owner go back and claim ERTC for 2020 if they haven't already?
Yes. However, the business owner must pass one of the two tests previously set out in the CARES Act to qualify for the ERTC in 2020 (NOT the new rule "20% reduction in sales" only applies to the 2021 credit).
Pursuant to Section 2301 (c) 2 of the CARES Act, a business owner will qualify for the ERTC in 2020 if the company passes either of the following two tests:
You are entitled to this credit if a government regulation completely or partially ceased operations during a calendar quarter due to Covid-19 (you have a high chance that you will experience this in your company in 2020). or your gross earnings for a calendar quarter in 2020 are 50% lower than gross earnings for the same quarter in 2019.
Of course, reducing the sales test by 50% is certainly more onerous and may put some business owners off so they don't even try to apply for the loan. However, I think most companies can pass Part 1 of the test and make the 50% test irrelevant. A reasonable interpretation of this statute would mean that even "1 TAG" of a required government shutdown of your company in 2020 would allow your company to qualify for the ERTC in 2020.
Now one more thing: The ERTC is a different value in 2020 than in the first two quarters of 2021.
For wages paid after March 12, 2020 and before January 1, 2021, the ERTC can be applied to 50% of qualifying wages up to $ 10,000 annual wages. This means that a maximum of $ 5,000 per employee can be credited to your company for the full year 2020 (not quarterly) if they qualify.
How do I get this credit?
First, let me specify what you don't do in order to receive this credit:
You don't apply through your bank. This has nothing to do with your PPP application process. You do not apply through the Small Business Administration (SBA). They don't even send the IRS a specific application for the ERTC (unless requesting an advance payment).
The ERTC is a refundable tax credit that is generally claimed when eligible employers state their total qualifying wages for the purposes of the ERTC for each calendar quarter in their federal tax return (Form 941: Quarterly federal tax return by the employer).
However, employers looking to reduce their payrolls in anticipation of receiving the loan or want to get a prepayment from the IRS can file a Form 7200. This may mean they can get the tax credit back early in the form of a check from the IRS.
The IRS has a dedicated webpage entitled “Applying for Frequently Asked Questions About Retention” that explains how and when to submit certain forms. However, it is advisable to speak with your tax advisor or payroll firm to make sure you are coordinating the application and payments, especially if you plan on using PPP funds as well.
If a company wants to return and claim ERTC for 2020, it will likely need to first determine which payroll was paid with PPP funds, and then calculate what qualifying wages would be eligible.
Next, the business owner would go back and change the appropriate quarterly Form 941 for 2020 and apply for the credit. However, the IRS has not provided any specific guidance on this procedure.
Related Topics: The IRS increases contribution restrictions for SEP IRAs and Solo 401 (k) for business owners around 2021
In conclusion, ERTC is an opportunity for entrepreneurs with W-2 wages for employees to receive significant government assistance. A business owner should carefully verify that they are qualified and seek professional advice from their tax advisor and / or payroll company to ensure that the correct forms are submitted. Be careful not to leave any money on the table under this new legislation if you can help. Get involved in the process. You are the captain of your ship!
Mark J. Kohler is CPA, attorney, co-host of the MainStreet Business podcast, and author of The Tax and Legal Playbook – Game Changing Solutions for Your Small Business Questions 2nd Edition and Business Owners Guide to Financial Freedom: What To Do. Wall Street won't tell you. He is also a partner in the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the auditing firm K&E CPAs, LLP.