The CARES Act passed in March 2020 created an “employee retention tax credit,” which entitled eligible employers to a refundable tax credit for wages paid to employees during periods that the employer’s business was subject to a suspension, a shutdown, or a significant decline in revenues. The tax credit was not widely used by employers with fewer than 500 employees, primarily due to the fact that employers with Paycheck Protection Program (PPP) loans could not take advantage of the credit. On December 27, 2020, the Consolidated Appropriations Act (the CAA) was signed into law. The CAA significantly expanded the usability of the employee retention tax credit by allowing employers with PPP loans to take advantage of the credit. Further, the CAA increased the amount of the tax credit available. In tandem, these changes make the credit an attractive opportunity for employers during 2021 as well as easier to obtain for qualifying wages paid during 2020.
Eligibility for Credit: Under the CAA, employers are eligible for the retention tax credit under two circumstances: (i) the employer’s business was “fully or partially suspended” due to a government order or (ii) the employer experienced a significant decline in gross receipts.
- A suspension of business means that an employer’s operations have been limited wholly or partially because of a government order that affects commerce or travel. Limits on the number of people who may congregate in one place, or an order reducing the hours that a business can stay open, are examples of qualifying orders. Notably, if an employer can carry on business operations on a completely remote basis through teleworking despite the existence of an order affecting physical office presence, the employer will not be deemed to have experienced a qualifying suspension of operations.
- A significant decline in gross receipts means that an employer experienced a decline of at least 20% in gross receipts during a calendar quarter in 2021 compared to the same calendar quarter in 2019 (i.e., gross receipts are 80% or less during Q1 of 2021 compared to Q1 of 2019). Alternatively, for calendar quarters in 2021, an employer may elect to use the immediately preceding calendar quarter and compare gross receipts to the same quarter during 2019 to determine whether the employer qualifies (i.e., to determine eligibility for the tax credit during Q1 of 2021, an employer could compare Q4 of 2020 to Q4 of 2019). “Gross receipts” means all revenue derived from sales, services, investments, and other internal and outside services.
- Note: For wages paid during 2020, a decline in gross receipts had to be 50% or more for a calendar quarter in 2020 compared to the same quarter in 2019. Thus, an employer that was otherwise eligible under this standard but could not claim the credit due to having PPP funds may retroactively take a tax credit for calendar quarters during 2020 if it meets the decline in gross receipts standard.
The gross receipts calculation is made quarterly, such that if an employer qualifies during any particular quarter, all qualifying wages paid to employees during the quarter are eligible for credit.
Amount of Credit: For periods on or after January 1, 2021, the amount of the tax credit available is 70% of “qualified wages” per employee for wages paid through June 30, 2021, up to a limit of $10,000 for each employee (in other words, up to $7,000 per employee). This is more generous than the tax credit available during 2020, which was 50% of qualified wages paid per employee for all quarters (in other words, up to $5,000 total per employee).
Qualified Wages: Qualified wages means cash compensation as well as “qualified health plan expenses” (both the employer and employee portions of premiums paid for group medical coverage).
Time Limits: For credits claimed during 2020, wages must have been paid from March 13, 2020, through December 31, 2020. For credits claimed during 2021, wages must have been paid from January 1, 2021, through June 30, 2021.
- For example, if an employer qualifies during the first quarter of 2021 and second quarter of 2021, and pays $10,000 in qualified wages to an employee during each quarter, then the employer can claim a tax credit of up to $7,000 during each quarter for this particular employee. Further, if the employer qualifies during a particular quarter during 2020 and pays the same employee $10,000 during the quarter, then another $5,000 in tax credits can be taken for the employee, for a total of $19,000.
Limitations Based on Employee Population: For credits available after January 1, 2021, employers with more than 500 employees can only claim a tax credit for wages paid to employees who are not actively providing services to the employer during a qualifying calendar quarter or shutdown period. For employers with fewer than 500 employees, a tax credit may be taken for employees who receive wages during a qualifying period, regardless of whether the employees are actively working for the employer.
- Note: For 2020, the limitation is 100 employees, such that employers with more than 100 employees can only claim a credit for employees who are not providing services, and those employers with fewer than 100 employees can claim a credit for any employee, regardless of whether the employee is actively at work. Thus, the 500-employee threshold rule does not “carry back” for wages paid during 2020.
Other Limitations: As described above, the significant change in the CAA was expanding the availability of the credit to employers who received a PPP loan or who will apply for a “second round” PPP loan. There is a limitation on taking the credit for wages paid with PPP funds. Any qualified wages paid with PPP proceeds that have been forgiven (or for which an employer intends to seek forgiveness) cannot also be used to claim an employee retention tax credit. In other words, there is no “double dipping” on the same wages paid to the same employee.
- Employers will want to track the wages paid with PPP funds in order to keep track of which wages may be eligible for the retention tax credit. Employers may want to take the position that any wages paid over and above the amount of PPP funds received are eligible for the credit.
Claiming the Credit: Employers claim the credit by offsetting applicable employment tax withholdings to the IRS. In connection with the direct offset, an employer reports total qualified wages on their federal employment tax returns (IRS Form 941), which has been amended to include reporting of employee retention tax credits.
Other Changes: A few other notable changes implemented by the CAA with respect to retention tax credits:
- Previously, an employer could not claim a tax credit for increases in an employee’s pay rate made within 30 days before March 13, 2020. This limitation on pay raises has been eliminated for credits claimed after January 1, 2021.
- Previously, governmental and tax-exempt entities were not eligible for the credit. For wages paid after January 1, 2021, these entities may claim the tax credit.
A summary of the relevant provisions of the CAA’s employee retention tax credit is below:
|March 13, 2020–December 31, 2020||January 1, 2021–June 30, 2021|
|Amount of wages eligible for retention tax credit||50% of qualified wages||70% of qualified wages|
|Maximum amount of credit||Limited to $10,000 per employee (maximum of $5,000 total)||Limited to $10,000 per employee per quarter (maximum of $7,000 per employee per quarter, for total maximum benefit of $14,000)|
|Decline in gross receipts to qualify for credit||50% decline in calendar quarter during 2020 compared to same quarter for 2019||20% decline in calendar quarter during 2021 compared to same quarter during 2019, or 20% decline in immediately prior quarter compared to same quarter for 2019|
|Employee threshold for wage payment limitation||Employers with more than 100 employees can only claim credit for wages paid to employees who are not providing services||Employers with more than 500 employees can only claim credit for wages paid to employees who are not providing services|