By Joshua Jenson, CPA
Hopefully by now you have heard about the Employer Retention Tax Credit (ERTC).
In a nutshell, it is a payroll tax credit offering up to a $26,000 refund per employee, when totaling the maximum credit of both 2020 and 2021.
If we melt this down, it’s a simple calculation; Multiply the qualifying wages during the qualifying period by the applicable tax credit percentage.
The biggest takeaway is if an employer has not yet obtained the tax credit, they can get cold hard cash (aka a check) back from the IRS! A little bit of salt on that is, presently it may take nine-to-12 months for the money to arrive, but the check will be in the mail eventually. That’s not too bad though, so stay with me.
A qualifying employer is easily looking at a huge benefit as the tax credit is 50 percent of qualifying wages in 2020, and a whopping 70 percent of qualifying wages in 2021. While the maximum qualifying wages per employee is $10,000 for all of 2020, it is that same $10,000 maximum in 2021, but for each of the first three quarters in 2021 (1). This leads to a maximum credit of $5,000 per employee in 2020, and $21,000 per employee in 2021. Boom! That’s a staggering $26,000 possible refundable tax credit per employee.
Take note the maximum $10,000 in qualifying wages includes all employees' compensation subject to social security and Medicare payroll taxes, plus the employer paid health insurance not otherwise used for other payroll tax credits (tip tax credit excluded) or Paycheck Protection Program (PPP) loan forgiveness.
What’s the catch? Well, it’s a double dampener because the credit obtained is a reduction of deductible wages on the income tax return, with a kicker of the IRS requiring this reduction be applied to the year in which the wages were incurred or paid (2). I already hear you on this, but regardless of when the ERTC is applied for, let alone when the check is cashed, this rule applies.
So, how does an employer qualify for this juicy tax credit? Before you digest this, be sure to really understand this is an either/or qualification as an employer does not need to have both qualifying events occur. Next, be sure to fully comprehend that when determining if a business is classified as essential or non-essential, that is never, ever a factor if the qualifying event is due to a reduction in gross receipts. These two exclusive qualifying events are:
A reduction in gross receipts from any quarter available compared to the same quarter in 2019, with a more than 50 percent reduction required in 2020 and a more than 20 percent reduction required in 2021;
A partial or full shutdown due to state, city, county or otherwise official governmental order (governmental suggestions or recommendations don’t count).
Now, I want to pause right here and make sure you are following the recipe. Because, if the qualifying event is due to a reduction in gross receipts, it is the entire quarter's wages that are eligible, but if it is due to a partial or full shutdown, then only the wages during the specific days of the governmental order are eligible (3).
If the employer qualifies due to a reduction in gross receipts, then the determination of gross receipts is the method used for income tax reporting purposes and excludes tax exempt income related to PPP as well as SVO and EIDL grants (4).
For both years, you compare the qualifying quarter to the same quarter in 2019 (yes, even in 2021, it’s compared to 2019). In 2020, the quarter following the quarter in which the gross receipts were down more than 50 percent will automatically qualify, and the employer will continue to qualify through the quarter in which the gross receipts are more than 80 percent (5). For 2021, each quarter is a stand-alone comparison, with an alternative method available that if the correlating quarters gross receipts are not down more than 20 percent, but the immediately preceding quarters gross receipts are down more than 20 percent, then the employer will qualify for the quarter (6).
Let’s switch gears to the other qualifying event; A governmental order causing a partial or full shutdown. Here comes the pepper on essential businesses because you may think essential businesses don’t qualify. While it is easy to see the pepper on that steak, the IRS goes out of their way to show the many ways essential businesses can still qualify (7). Two big components are if the business had its operations sincerely affected by its suppliers or the business also included non-essential operations of income that exceed 10 percent.
Speaking of essential businesses, to knock out a big misconception, employees are never broken out into any category, as all types and classifications are included.
The only time an employee’s compensation is possibly not included for the ERTC is when an employer has more than a 100-employee head count in 2020 or more than a 500-employee head count in 2021. For both years the head count is based on the average number of full-time employees in 2019 (full-time being at least 30 hours per week or 130 hours per month, not based on full-time equivalents). With these larger employer groups, only the compensation and employer paid health insurance for the employees that did not work are included.
Now that you smell what’s cooking, you may be interested to know whether the wages of owners and their families can be included in the ERTC (8). If an owner has 50 percent or less ownership, considering ownership attribution rules, the answer is yes, qualifying wages to owners, their spouse and family can be included (9).
However, applying the same rules, an owner with more than 50 percent ownership can only include their wages, or their spouses, if that owner has no living relatives (10). Take note that spouses are included when determining constructive ownership by family attribution but excluded when determining if (whole or half-blooded) living relatives exist (11). Basically, orphans without children would be the only ones able to benefit from being a majority owner and including their wages.
For owners with a full buffet of businesses, aggregation rules are mandatory and apply with the threshold of 50 percent of more common ownership (12). If an employer is required to aggregate, to determine if they qualify for ERTC, they must aggregate all aspects of the ERTC rules since it looks at the multiple companies as one—regardless if they are different types of businesses (essential or not), in different states with different governmental orders or even different legal or tax structures. If the collective businesses qualify for ERTC, each employer files for its respective ERTC based on its qualifying wages paid under each employer identification number (EIN).
After surfing through the tidal waves of the ERTC, the employer must file an amended payroll tax form (Form 941-X) to get the credit. The good news here is the due date of any Form 941-X is three years from the original due date of the applicable Form 941 (13).
Hold up! Now let’s talk about your fees. Value billing, flat fees, hourly billing, or however you normally charge your client for your fees, are all acceptable by the AICPA. What you cannot charge is contingency fees, as the AICPA’s Code of Professional Conduct only allows a CPA to charge a contingency fee related to an amended return if there is a reasonable expectation that a substantive review will be made by the IRS (14). Ed Karl, CPA, CGMA, Vice President – AICPA Tax Policy & Advocacy makes it clear (15) that contingency fees related to filing a Form 941-X are not allowed.
So now is the time to put on your cape, show those three letters you wear, and proactively communicate with your client that you need to be involved with the process of determining if they qualify for the ERTC, and possibly assisting them in properly obtaining it.
In your quest, refer to IRS Notices 2021-20, 2021-23, 2021-49 and 2021-65, as well as Rev. Proc. 2021-33.
- IRS Notice 2021-49 (Pages 6-11) A “recovery start up business” may qualify for fourth quarter 2021
- IRS Notice 2021-49 (Pages 24-25)
- IRS Notice 2021-20, FAQ #22
- IRS Rev. Proc. 2021-33
- IRS Notice 2021-20, Section E
- IRS Notice 2021-49, Section E
- IRS Notice 2021-20, Sections C & D
- IRS Notice 2021-49, Pages 25-31
- IRC Section 51(i)(1)
- IRC Section 267(c)
- IRC Section 152(d)(2)(A)-(H)
- IRC Sections 52(a) or (b), or 414(m) or (o)
- Form 941-X Instructions (Rev. April 2022) Page 6
- AICPA Code of Professional Conduct, Section 1.510
- AICPA Podcast: “Challenges with Contingency Fees and the ERC”
Joshua Jenson, CPA, has more than 30 years of public accounting experience bringing daily videos & value to his over 81,000 subscribers on YouTube where he has amassed more than 6,600,000 views. He has authored 2 books and traveled to more than 50 cities presenting tax courses to thousands of fellow CPAs, covering the latest tax laws and strategies. Jenson founded his own CPA firm at age 25, and still serves & advises his private clients daily. He also manages his life & disability income insurance practice, Jenson Insurance.