New Tax Credit Helps Small Businesses Keep Staff During Pandemic

Employee retention credit could be better choice than PPP loan for some

Roy Maurer By Roy Maurer May 4, 2020
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​The federal government's Paycheck Protection Program (PPP) has received overwhelming interest from small businesses impacted by the coronavirus pandemic—funds even ran out at one point—but it's not the only game in town.

"While struggling businesses have grappled with the complex qualification and application rules of the PPP, those businesses should also consider the employee retention credit (ERC)," said Rick Cox, a corporate attorney with Nixon Peabody in New York City and member of the firm's tax team. "In many instances, the ERC will be a better choice."

Part of the Coronavirus Aid, Relief and Economic Security (CARES) Act, the ERC incentivizes companies to retain employees despite the tough economic conditions that have resulted from the COVID-19 outbreak.

"Applied to payroll taxes paid by the employer, the credit may help businesses retain employees instead of resorting to layoffs or furloughs," said Jimmy Rodefer, CEO of Rodefer Moss, an accounting firm in Knoxville, Tenn.

Bruce Schwartz, an attorney in the White Plains, N.Y. office of Jackson Lewis, explained that the ERC is a refundable tax credit against the employer's portion of Social Security taxes normally paid on W-2 wages to all workers. It is equal to 50 percent of the qualified wages an eligible employer pays to employees after March 12, 2020, and before Jan. 1, 2021—up to $5,000 per worker.

"Qualifying employers may immediately reduce their payroll tax deposits by 50 percent of eligible wages," Rodefer said. "The ERC refund comes into play if the employer's required quarterly payroll tax deposits are less than the credit they would otherwise be eligible to claim. The refundable portion is the amount of the difference on the quarterly payroll report, Form 941."

The tax credit is available to businesses of all sizes, including tax-exempt organizations, although it makes the most sense for employers with 100 or fewer employees, Cox said.

"A business is eligible if either its operations have been fully or partially suspended due to government orders limiting commerce, travel or group meetings due to COVID-19, or its gross receipts for the calendar quarter for which the credit is claimed are less than 50 percent of the gross receipts for the same calendar quarter in the prior year."

Government contractors and self-employed people are not eligible for the credit, Rodefer said. Neither are employers that received aid from the PPP or an economic injury disaster loan. The ERC also cannot be combined with other tax credits.

Mary Burke Baker, a government affairs counselor and tax policy lead in the Washington, D.C., office of K&L Gates, said that qualified wages for purposes of the ERC do not include the amount of qualified sick and family leave wages for which the employer received tax credits under the Families First Coronavirus Response Act. "Other rules apply to avoid double dipping, including restrictions on eligibility of wages on which the work opportunity tax credit is taken," she said.

Schwartz said that for employers with fewer than 100 employees, calculating the credit is easy: Businesses can claim credit for wages paid to anybody whether they are working or not as long as they continue to be paid.

"It's more problematic for businesses with more than 100 employees," he said. "There the credit is available for nonworked wages if you are paying employees who are not working at all or working reduced hours but still being paid. The difficulty is calculating that worktime for salaried employees. The IRS has not offered any clue as to how you do that."

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Worth It or Not

Cox said that employers considering a PPP loan—especially those concerned about their ability to meet the loan's forgiveness criteria—should crunch the numbers to determine whether the ERC is a better option.

"Not only is it easier to qualify for the ERC than the PPP—there is no loan application or forgiveness process, no limited pool of money, and no requirement that a certain amount be spent within a compressed eight-week period on specified expenses—but the ERC also generally offers more flexibility for businesses to decide when to bring back employees, and how many."

Schwartz recommended employers interested in the ERC go ahead and try it but that for most businesses, getting a PPP loan is a better option. "The credit isn't enough of an incentive to change pay policy and if you can get the loan, with the forgiveness aspect of it, I think that's worth more," he said. "I think the main impact of claiming the credit has to do with the timing of tax payments. It allows employers to write a smaller tax check and keep the money for the time being. It's more of a cash flow benefit to the employer to help fund operations now."

Both attorneys said that it may make sense for businesses that have already applied for a PPP loan to calculate what the ERC could do for them. "To date, no guidance has been issued about whether a business that applied for a PPP loan, or even received the loan, but later withdrew its application or returned the proceeds of the loan, can claim the ERC," Cox said.

Schwartz noted another wrinkle in the law, which states that employers that receive a PPP loan can't claim the credit. "That raises the question, what about the wages paid up until the employer received the loan? The answer to that is unknown." 

Schwartz added that the CARES Act also allows any employer to defer payment of their portion of Social Security taxes through the end of the year without interest or penalty, whether affected by COVID-19 or not. Whatever amount is deferred will be owed in two installments—half by Dec. 31, 2021, and the remainder by Dec. 31, 2022. Businesses that received a PPP loan can defer Social Security tax payments up until the day the loan is forgiven, he said.  

Baker said that Congress may still make modifications to the employer retention credit. "This could include expansion of eligibility to employers who are not directly affected by a government order but whose suppliers or customers are … [or] could also include an increase in the maximum amount of credit allowable."

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