On Dec. 27, 2020, the President signed into law the Consolidated Appropriations Act 2021 (CAA), which significantly bolsters the Employee Retention Credit (ERC) originally introduced by the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. The CAA includes several amendments to the ERC regarding eligibility, maximum potential credit, impact on Payroll Protection Program (PPP) loan recipients and a more expansive definition of what constitutes qualified wages.
The ERC is a refundable payroll tax credit available to taxpayers who either experienced a full or partial suspension of business operations due to government orders or had a significant drop in gross receipts during 2020 or 2021.
- For 2020, an employer may qualify for the ERC if their business operations were fully or partially suspended by a government order or if gross receipts for a quarter are less than 50 percent of gross receipts compared to the same quarter in 2019.
- For the first two quarters of 2021, an employer may qualify for the ERC if their business operations are fully or partially suspended due to a government order or if gross receipts for a quarter are less than 80 percent of gross receipts compared to the same quarter in 2019. (Eligible employers can also elect to compare Q4 2020 to Q4 2019 to determine Q1 2021 eligibility).
- Eligible Period – The program has been extended through the first two quarters of 2021, but each quarter should be considered separately for eligibility.
- Credit Percentage – The credit percentage has increased from 50 percent of qualified wages in 2020 to 70 percent of qualified wages for each of the first two quarters of 2021.
- Qualified Wage Limit – For 2020, qualified wage is limited to $10,000 per qualified employee for the entire year. For the first two quarters of 2021, the qualified wage limit is $10,000 per quarter per qualified employee, for a total of $20,000.
- Maximum Potential Credit – For 2020, the maximum potential credit per qualified employee is $5,000 (50 percent of the qualified wage limit). For the first two quarters of 2021, the maximum potential credit is increased to $7,000 per quarter (70 percent of the qualified wage limit) per qualified employee, for a total of $14,000 maximum for 2021.
- Definition of Qualified Wages – For eligible employers in 2020 with 100 or fewer full-time employees (small employer) – all wages and healthcare costs paid to employees during the eligibility period are considered qualified wages. For eligible employers in 2020 with more than 100 full-time employees (large employer) – all wages and healthcare costs paid to employees who are not providing services (full or partial reduction) during the eligibility period are considered qualified wages (including health care premiums paid for furloughed employees).
For 2021, the definition of small employer increases to employers with 500 or fewer full-time employees, so all wages and healthcare costs paid during eligibility period can qualify for purposes of the credit calculation. Consider for example:
- For 2020, eligible small business employer with 100 employees could receive up to $500,000 in credit.
- For 2021, eligible small business employer with 500 employees could receive up to $7 million in credit.
- PPP Loan Impact – For 2020, companies that received a loan under the PPP were previously unable to claim the ERC, even if such loan was not forgiven. With changes from the CAA, companies are now retroactively (back to the date of the original CARES Act) eligible to claim both an ERC and a PPP loan. However, any wages used for forgiveness of the PPP loan are ineligible to also be claimed for the ERC. Employers should consult with their tax advisors to assess next steps.
Potential Synergies with Research and Development (R&D) Tax Credits
The R&D tax credit is a tax incentive for companies that incur R&D costs in the U.S. and allows a company to offset its U.S. tax liability.
- Credit Carryforward - The R&D tax credit can be carried forward for up to 20 years.
- Offset Payroll Taxes - The R&D tax credit also allows “qualified small businesses” to offset up to $250,000 of the employer portion of FICA per tax year.
- Qualification criteria - Activities in engineering, technology, biological sciences or physical sciences performed to achieve new/improved functionality, performance, reliability or quality is likely to qualify as R&D, specifically when the activities are conducted to resolve technical uncertainties through an iterative process of design, development and testing/experimentation.
Companies involved in the following activities in the U.S. are likely to qualify for R&D tax credits:
- Software – Design, development and testing, including internally used software.
- Hardware – Design, development and testing.
- Engineering – Design, development and testing.
- Sciences – Design, development and testing.
- Manufacturing – Manufacturing of new/improved products.
- Process Improvements – Process improvement activities related to activities listed above.
- Support/ Supervision – Direct support or supervision of the above activities.
There are potential synergies between the ERC and R&D tax credit projects, specifically with the overlapping aspects of project data, approach and processes. These are demonstrated in the diagram below.
DHG has extensive experience assisting clients navigate the ERC and R&D credits for various industries and offers a multidisciplinary approach to help companies navigate and manage potential opportunities for the ERC and R&D tax credits. For more information about how DHG can help your company estimate the credits and develop a project plan, please contact any of our article contributors, or reach out to us at firstname.lastname@example.org.