By Bobbi Hayes and Larry May
In March of 2020, Congress passed the CARES Act to provide businesses and individuals with various forms of financial relief to help them withstand the COVID-19 pandemic. For businesses, the CARES Act became almost synonymous with the Paycheck Protection Program (PPP) loan program. Many construction companies applied for and received PPP loans last spring and summer.
In the CARES Act, there was also another provision, the Employee Retention Credit (ERC)—a refundable tax credit. When first enacted, the ERC could not be used by any business that also received a PPP loan and, therefore, there was (and still is) limited awareness of its existence.
December Law Lifts Some Restrictions of Use of ERC
On December 27, 2020, another bill was signed into law—the Consolidated Appropriations Act. That bill provided for a second round of PPP loans as well as other provisions. This new legislation also retroactively changed the restriction on use of the ERC by a business that received a PPP loan. Instead of prohibiting simultaneous use of the ERC, the criteria changed so that a business that qualified for the credit could apply for it, as long as an eligible wage dollar was not also used in support for PPP loan forgiveness or another credit program. In other words, a dollar of wage can only be used for one program. The bill provided for the continuation of the ERC for the first two quarters of 2021. On March 11, 2021, the American Rescue Plan Act further extended the availability of the ERC to the last two quarters of 2021 as well. On August 10, 2021, the Senate passed the infrastructure bill which removed application to the last quarter of 2021, making the end date for the program the September 30, 2021 quarter.
We are finding that many businesses remain unaware of the ERC and the benefit that it could bring them if they qualify. It is always worth exploring the possibility of qualification for any company, as the dollars involved can often be startling. No matter the size of the credit, the improved cash flow can always be appreciated.
Meeting Qualifications for Credit
The credit is available for eligible wages paid after March 12, 2020, through the end of 2021, with a different size of credits for each calendar year. The credit is 50% of up to $10,000 of eligible wages for calendar 2020. The maximum potential credit is $5,000 per employee in 2020. For 2021, the credit has increased to 70% of up to the first $10,000 of eligible wages per quarter. The maximum potential credit is $7,000 per employee, per quarter for calendar year 2021 for a maximum potential credit of $28,000 per employee if a business qualifies for all four quarters.
For 2020, a business qualifies depending on specific criteria. The business must demonstrate a decrease of over 50% in gross receipts from a calendar quarter in 2019 compared to the same calendar quarter in 2020. For example, the gross receipts of $100,000 during second quarter 2019 compared to the gross receipts of $49,000 during second quarter 2020 equals a decrease of over 50%. If a business meets the 50% decrease in gross receipts for a quarter, it continues to qualify until the quarter after the calendar quarter where gross receipts recover to at least 80% of the prior year quarterly comparison. A business that qualifies with a 50% decrease for the second quarter of 2020 and has a recovery to 85% of gross receipts in the third quarter is eligible for the ERC for both the second and third quarters.
Besides having a much larger credit available, for 2021, a business qualifies on less stringent rules. The business must demonstrate a decrease of over 20% in gross receipts from a calendar quarter in 2019 compared to the same calendar quarter in 2021. As an alternative, a business can use the immediately preceding quarter to qualify. A business testing for qualification for the first quarter of 2021 can use a 20% decrease for the fourth quarter of 2020 compared to the fourth quarter of 2019, or a 20% decrease for the first quarter of 2021 compared to the first quarter of 2019. The decrease does not have to be related to any specific pandemic caused loss in gross receipts. It’s important to remember you should always compare a 2020 or 2021 quarter to the same calendar year quarter in 2019.
For both 2020 and 2021, if a business did not experience a decrease in gross receipts of the needed level, it may also qualify depending on a national, state, or local governmental order that required a total or partial suspension of business operations. If a business is considered “essential,” as often construction companies were, then it must meet more stringent rules for qualification. Because essential businesses are allowed to continue operations, they are only considered to meet a partial suspension of operations based on available facts and circumstances. Possible qualification circumstances require careful analysis and strong supporting information.
More Than Nominal Suspension of Operations
The IRS issued guidelines stating an essential business could qualify for a total or partial suspension of business operations if a portion of operations that had an impact considered to be more than “nominal” was suspended. “Nominal” has been clarified by the IRS to mean not less than an impact of 10% of the gross receipts of a quarter (compared to the same quarter in 2019).
For example, say a construction company was given notice to suspend a large contract for a tribal entity for five months due to a local governmental order shutting the reservation borders. The impact on operational gross receipts was in excess of 10% of total gross receipts for that period of time compared to the same period in 2019. A different construction company was given notice to suspend operations on a hospital remodel when the hospital closed all but its emergency room and intensive care units. That suspension was for 11 weeks and had a measurable impact that met the more than “nominal” requirements. For a partial suspension, eligible wages must be analyzed for the specific timeframe of suspension, not an entire quarter.
In both cases, the companies were eligible to check if the ERC might apply for those specific periods. Both of those companies had also received PPP loans and had not yet applied for PPP loan forgiveness.
After quantifying the eligible period, the businesses provided payroll details by employee for the specific dates, broken into quarters if the dates overlapped a payroll reporting quarter. In addition, payroll details by employee were provided for the PPP loan forgiveness covered period, which partially overlapped the ERC period.
Related party wages are eligible for inclusion for PPP loan forgiveness (based on program rules) but are not eligible for the ERC. The maximum amount of eligible related party wages was therefore used to support PPP loan forgiveness, and, depending on other expenses available for forgiveness, such as rent and utilities, the remaining amount of minimum wages for PPP loan forgiveness was determined. That provided insight into the amount of wages that were eligible for use in applying for the ERC.
For the two companies used in the example, PPP loan forgiveness was met in full; and the wages eligible for ERC resulted in 2020 payroll tax refunds in excess of $150,000 and $350,000, respectively. If a company has already filed for PPP loan forgiveness and it is determined that it does qualify for ERC, then it only needs to count the amount of qualified wages on the PPP loan forgiveness application up to the minimum amount of payroll costs together with any other eligible expenses reported on the forgiveness application.
For example, if a company used a 24-week covered period for its PPP loan forgiveness and provided support for $1,000,000 of wages for that period for forgiveness of a $400,000 PPP loan, then the excess wages of $600,000 not needed to cover PPP loan forgiveness are considered available for use by other programs.
Due to decreases in year-over-year contract backlog and supply chain constraints, it has become common for a number of construction companies to qualify based on the first quarter of 2021 compared to the first quarter of 2019. Qualification for that first quarter automatically makes a company eligible for the second quarter of 2021 as well as based on using the immediately preceding quarter to qualify. The size of the available credits can be astonishing and, in many cases, can rival the size of PPP loans that may have been obtained.
Specifics About Eligible Wages
However, there are some specifics that must be addressed. Eligible wages, as noted above, do not include wages paid to a related party. A related party is specifically identified as anyone who has any of the following relationships with the employer (business owner individual)—an owner with more than 50% ownership, or his/her child, or a descendant of a child, brother, sister, stepbrother or stepsister, father or mother or an ancestor of either, stepfather or stepmother, niece or nephew, aunt or uncle, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
Eligible wages may also include payments made on behalf of the employee to an employer health insurance plan (the employer portion). If an employee was paid $9,000 in eligible gross wages for a quarter in 2021, and the employer also paid $350 a month in health plan for that employee, the eligible wages are calculated as $10,050 and then limited to $10,000.
Rules Applying to Large Employers
There are rules that apply to large employers. For 2020, a large employer is defined as an employer that averaged more than 100 employees during 2019. For 2021, a large employer is defined as an employer that averaged more than 500 employees during 2019. For a large employer, eligible wages are only those wages or health insurance payments that continued to be paid for employees that were not providing any services. For employers under the employee size limits, wages are eligible for all employees whether they provided services or not.
In order to claim the credit, a business must do so on the Form 941 quarterly payroll tax report. If a quarter is determined to qualify and the 941 has already been filed, an amended 941-X must be prepared. It is best to try to analyze qualification before the 941 is filed for the eligible quarter. While a 941 that can be filed electronically normally generates a refund check within 30 to 45 days, a 941-X must be paper filed. A 941 or 941-X that is filed on paper normally generates a refund check within 75 to 150 days.
For income tax purposes, any ERC obtained reduces the amount of wages deductible on the tax return. If a credit is $30,000, then $30,000 of wages are now nondeductible as an expense. Because the income tax rate on the nondeductible wages is always lower than 100%, the business owner always comes out ahead.
Find Out More
Access Hayes and May’s NASBP Virtual Seminar on this topic: https://learn.nasbp.org/p/EmployeeRetentionCredit. Access all NASBP Virtual Seminars here: https://learn.nasbp.org/. Access free NASBP Podcasts here: https://letsgetsurety.org/episodes/.
R.A. Bobbi Hayes is a leader in the construction services area and partner with the CPA firm of Carr, Riggs & Ingram, LLC, providing accounting, tax, bonding consultation, risk management, auditing, and review services for contractors of all types and sizes throughout the South and Southwest. She serves on the CPA Advisory Council for NASBP. She can be reached at firstname.lastname@example.org or 505.883.2727.
As a leader of the firm’s construction services team, Larry May provides audit, review, and compilation services to road builders, general contractors, and subcontractors. Within the construction industry, he consults with clients regarding maximizing bonding capacity, enhancing working capital, enhancing internal controls, and implementing tax savings strategies. May currently serves on the national board for Associated Builders & Contractors. He can be reached at email@example.com or 601.499.2508.