First, say thanks to the Consolidated Appropriations Act, 2021 (CAA), enacted December 27, 2020. It opened the door (retroactively and going forward) for Paycheck Protection Program (PPP) participants to also claim the employee retention credit (ERC).
Reminder. Tax credits are the best. They usually reduce taxes dollar-for-dollar.
(The ERC is not quite as good as the usual tax credit because you increase taxable income by the amount of the credit. But it’s still good—very good.)
The CARES Act, enacted on March 27, 2020, created the PPP money, but it prohibited you from getting both PPP money and tax credits from the ERC; you had to choose one benefit or the other. Now, thanks to the new December law, you can have both tax-free PPP money and tax credits from the ERC.
And perhaps the best news of all comes from the IRS in its recently released, business-friendly guidance on how the rules work when you want to claim both PPP and ERC benefits.
With this knowledge, you might now claim tens of thousands of dollars in tax credits for tax year 2020 in addition to your tax-free PPP loan monies.
Employee Retention Credit Overview
Be sure you have a basic understanding of how the employee retention credit works by reading COVID-19 Relief Law Turbocharged Employee Retention Credit.
You are eligible for this credit if
- a government order fully or partially suspended your operations during a calendar quarter due to COVID-19 (under this rule, you qualify for the ERC even if you did not lose any money), or
- your gross receipts for a 2020 calendar quarter are less than 50 percent of gross receipts from the same quarter in tax year 2019 (in which case your credit ends in the quarter when gross receipts exceed 80 percent of gross receipts from the same 2019 quarter).
How the Law Changed
The CAA made four important changes retroactive to 2020:2
- You may now qualify (yes, retroactively) to claim the ERC for 2020 wages even though you had a 2020 PPP loan.
- You may not claim the ERC on PPP wages used for PPP loan forgiveness.
- You can elect not to claim the ERC, so as to increase your tax-free PPP monies.
- If your lender denies your PPP loan forgiveness, you can claim the ERC for the qualified wages even when you made the election not to claim the ERC for those wages.
Congress made the changes retroactive to March 13, 2020, allowing you to now amend your 2020 payroll tax returns to claim the employee tax credits for which you are eligible.
Planning point. You likely hadn’t thought of amending payroll tax returns, because it’s not often done. But you have the three-year statute of limitations for amending payroll taxes just as you have it for your income tax returns.
On the quarterly Form 941s filed anytime during a calendar year, the statute of limitations begins on April 15 of the following year.
IRS Guidance on the Law Changes
Newly released IRS guidance tells us to retroactively claim the ERC.5
To help you avoid getting tangled up, we will use examples to clarify how you can qualify for this 2020 retroactive credit of up to $5,000 per employee. If you have 10 employees, you could be claiming a tax credit of $50,000.
The net effect of these rules is that you can precisely decide which wages to use for the ERC versus for generating PPP loan forgiveness.
Here are few examples to show you how this works.
Your business got a PPP loan during tax year 2020 for $100,000; therefore, you had to have at least $60,000 in eligible payroll costs to get full forgiveness during your covered period, assuming you had at least $40,000 in other eligible expenses.
Let’s say you had $110,000 in payroll costs during the covered period, and such costs are qualified wages for the ERC. In addition, you had $50,000 in other eligible expenses.
Example 1. You list $110,000 in payroll costs and no other eligible expenses on your approved PPP loan forgiveness application.
Result 1. You’ve made an election to waive the ERC on $100,000 of qualified wages, which is the minimum required for full loan forgiveness based on the application you submitted. The remaining $10,000 of those wages is eligible for the ERC.6
Example 2. You list $110,000 in payroll costs and $50,000 of other eligible expenses on your approved PPP loan forgiveness application.
Result 2. You’ve made an election to waive the ERC on $60,000 of qualified wages, which is the minimum required for full loan forgiveness based on the application you submitted. The remaining $50,000 of those wages is eligible for the credit.7
Example 3. You list $110,000 in payroll costs and $50,000 of other eligible expenses on your denied PPP loan forgiveness application.
Result 3. All $110,000 of the qualified wages is eligible for the ERC.8
Strategies to Consider
Consider the following strategies to potentially maximize your retroactive ERCs for tax year 2020.
Include all non-payroll expenses on your PPP loan forgiveness application. This reduces the payroll used for the PPP and increases the payroll eligible for the ERC.
Track qualified wages and non-qualified wages per employee, and document what benefits you claim with those wages. Doing this precisely allows you to optimize your tax benefits.
Omit ERC-qualified wages from your PPP loan forgiveness application. By omitting the ERC-qualified wages from your PPP forgiveness application, you clarify the wages for the ERC and the wages used for the PPP.
Claim the ERC on wages outside of your PPP loan covered period. Your maximum qualified wages per employee are $10,000 over the entire 2020 tax year. If you can reach the maximum wages without including wages paid during the PPP loan covered period, you avoid the overlap issue, and thus potentially minimize the number of amended payroll tax returns you need to file.
With the CARES Act, Congress made you choose between tax-free PPP loan forgiveness or the ERC. You couldn’t do both.
The CAA changed that retroactively and allows you to amend your Form 941s for 2020 to claim the credit (if you qualify).
And here’s more good news: the IRS issued guidance on how your PPP loan interacts with the ERC, so you can amend your 2020 payroll tax returns to claim this valuable credit.
If you have already submitted for PPP loan forgiveness, what you put on the application controls the options you have now. But if you have not yet submitted your PPP loan forgiveness application, consider the·following strategies to obtain the largest ERC possible:
- Include all non-payroll expenses on your PPP loan forgiveness application.
- Track qualified wages and non-qualified wages per employee, and document what benefits you claim with those wages.
- Omit ERC-qualified wages from your PPP loan forgiveness application.
- Claim the ERC on wages outside of your PPP loan covered period.
When you can get this right, you qualify for both 100 percent PPP loan forgiveness and the ERC.