By Drew Hinrichs, CPA, CEO of Engage Advisors
The Employee Retention Credit (ERC) is a broad-based refundable tax credit designed to encourage employers to keep employees on their payroll. The credit is 50% of up to $10,000 in wages paid by an employer whose business was fully or partially suspended because of COVID-19 or whose gross receipts declined by more than 50% during the specified period.
When the ERC first came out in 2020, the law stipulated that any business that had received money from the Paycheck Protection Program (PPP) would not be eligible for the ERC. Since the PPP loans delivered a much larger benefit to employers, most didn’t take the ERC. Congress amended the rules when it passed the Infrastructure Investment and Jobs Act, enacted on November 15, 2021. Some businesses that had received PPP loans are now eligible to receive the tax credit.
While this change creates an opportunity for dental practice owners, there are many unanswered questions about how the ERC and PPP loan forgiveness mesh from a tax perspective. Consequently, we are waiting on guidance from the IRS around specific issues.
We want to let you know where things currently stand with the ERC, including information about actions you should take if your business is eligible for the tax credit.
Who is Eligible for ERC
The credit is available to all employers regardless of size including tax exempt organizations. There are only two exceptions: (1) state and local governments and their instrumentalities and (2) small businesses who take Small Business Loans. To qualify, businesses must meet one of the following two tests:
- Your gross receipts (less refunds) in any calendar quarter of 2020 were less than 50% of your gross receipts for the same calendar quarter in 2019.
- You had a full or partial suspension of operations due to a governmental order which limited commerce, travel, or group meetings due to Covid-19.
If your practice qualifies based on one of these two criteria, here are additional details depending on which category you qualify under.
Businesses with 50%-of-gross-receipts:
- Once you meet this test in any quarter in 2020, you will be eligible for the ERC from the beginning of that quarter unless it is the first quarter. If you are eligible for the first quarter, the eligibility will start on any qualified wages paid to employees after March 12, 2020.
- The ERC time period will end when your gross receipts are greater than 80% of the gross receipts from the same calendar quarter in 2019 or 12/31/20.
- Some of our clients will qualify for the Employee Retention Credit starting in the second quarter of 2020. In addition, many will have gross receipts that rebounded to the greater-than-80% mark by the third quarter of 2020 (as compared to the third quarter of 2019). That means the time period to use for the Employee Retention Credit is 4/1/20 to 9/30/20 (the full second and third quarter). If you did not meet the 80% gross receipts test until the fourth quarter, you will receive the credit through 12/31/20.
Businesses with Suspended Operations:
- This time period will be based on the government mandate given by the state where your business operates.
- Several states mandated that dentists only treat urgent health care procedures, which stopped a major part of their business. We have reviewed this situation with a few attorneys, and based on our research, we believe the mandate to provide only urgent care qualifies as a suspension of operations.
- If you are a dentist practicing in Oregon, Washington, or Alaska, here are the dates when you were mandated to close:
- Oregon – 3/23/20 to 4/30/20
- Washington – 3/19/20 to 5/18/20
- Alaska – 3/28/20 to 5/4/20
How to Calculate and Report the ERC
Based on current, albeit incomplete, information, here are some details about how the tax credit is calculated and reported, depending on whether you meet the gross receipts test or experienced a full or partial suspension of operations.
- You can receive a credit of 50% on any wages or health expenses paid up to $10,000 per employee or a max $5,000 credit per employee for 2020.
- Wages are based on gross wages paid during the ERC time period. This excludes:
- Wages from the Families First Coronavirus Response Act (FFCRA) paid during the same time period.
- Related individuals and their family if they own > 50% of the entity (e.g., the business owner and family are excluded).
- 1099 contractor pay.
- Severance payments made to former employees following a termination of employment.
- Any wages paid with PPP money that was forgiven.
- Health plan expenses include group health insurance premiums paid, HRA contributions, and FSA contributions. This excludes:
- After tax deductions from an employee’s payroll for health insurance premiums
- Employer H.S.A. contributions
- Employer Archer M.S.A. contributions
- Any health benefit associated with FFCRA pay in which a credit was received during this period.
The calculation of the ERC can be quite complex. For example, you can’t double up on wages and health expenses allocated to the PPP loan and the ERC, which means if the time period for the ERC and PPP loan are the same, the allocation becomes complicated. The current ordering rules are FFCRA first, ERC second, and then the remaining wages are used for the PPP loan. This is one of the areas where we need the IRS to provide additional guidance.
We believe the ERC will be reported on an amended Form 941x as a credit. This means you will receive a refund based on the credit amount calculated on Form 941x (since you already paid the tax that the credit offsets). Keep in mind that you cannot get a deduction for payroll expenses AND get a credit for the same deduction. You will have to back out the deduction equal to the credit. Tax credits are better than deductions, because credits offset taxes dollar-for-dollar. Deductions reduce your taxable income but do so before the calculation of the tax bill. The bottom line is that you are better off reducing your deductions to get a matching credit.
What does this mean for you?
If you are eligible for the ERC, we will probably need to file an extension for your corporate tax return. At this point, the IRS still needs to issue guidance on how this credit will be reported for all 2020 quarters impacted by the Employee Retention Credit. We may also need to file an extension for your personal tax return depending on when the IRS issues guidance for the credit. The IRS has confirmed that filing for an extension does not increase your chances of getting audited. Even with an extension, it is very important to send your tax information to us as soon as possible. We need your information to plan effectively.
Here are examples of other questions we have for the IRS:
- If you have already submitted for PPP loan forgiveness and had more wages listed on the PPP application then needed, are you able to allocate part of the wages to the Employee Retention Credit? This could have a big impact on the credit you receive.
- If the PPP loan forgiveness application has already been submitted, are you able to allocate any non-payroll costs not reported on the application to allow more wages to be used for the ERC?
- If you have not submitted for PPP loan forgiveness yet, are the ordering rules going to remain the same, or will the IRS let you pick and choose wages per employee or time period? This strategy would help maximize the Employee Retention Credit while still making sure all the eligible PPP funds are used for loan forgiveness.
As we said at the start, we are waiting on clarification from the IRS for some of the rules related to the ERC before we can complete your corporate and personal tax returns for 2021. We will keep you apprised of any developments related to the Employee Retention Credit, as well as any other news that could impact your business and personal taxes. In the meantime, if you have questions about the ERC, schedule a call with our team at Engage Advisors. You can rely on us for the most up-to-date and accurate information available on this complex issue.