On March 1, 2021, the IRS released Notice 2021-20 to provide comprehensive guidance on the Employee Retention Credit (ERC) and formalize the IRS’s FAQs, thereby allowing taxpayers to rely on the guidance for penalty prevention purposes. The notice explains the tax treatment of the ERC and, significantly, provides long-awaited instructions on how Paycheck Protection Program (PPP) loan borrowers may qualify for and claim the ERC for wages paid after March 12, 2020 and before January 1, 2021. Therefore, borrowers who can potentially claim the credit are now better positioned to proceed with applying for PPP loan forgiveness.
Interaction of the ERC with PPP Loans
Under the CARES Act, the ERC and the PPP were mutually exclusive provisions, with employers required to choose which benefit to utilize. The Consolidated Appropriations Act enacted on December 27, 2020 provided that employers who receive PPP loans may still qualify for the ERC with respect to wages that are not paid for with forgiven PPP proceeds, and this change was made retroactive to the CARES Act’s enactment. However, there has been uncertainty regarding how PPP loan borrowers can identify what wages were not utilized for loan forgiveness and therefore could be used to claim the ERC.
Under Notice 2021-20 an employer that received a PPP loan is deemed to have elected to “not take into account certain wages for purposes of the ERC, for those qualified wages included in the amount reported as payroll costs on a PPP Loan Forgiveness up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP Loan Forgiveness Application, sufficient to support the amount of the PPP loan that is forgiven.”
The good news about this clarification is that if a PPP borrower paid qualified wages during the Covered Period that exceeded the amount of the loan, the excess qualified wages can be used to claim an ERC. However, if the borrower also incurred eligible nonpayroll costs which would have reduced the payroll costs required for forgiveness, the IRS is saying that the borrower must report these nonpayroll costs on the loan forgiveness application to free up wages from the PPP to claim an ERC. Therefore, the bad news is that, absent further guidance, those borrowers who have already submitted loan forgiveness applications without reporting the eligible nonpayroll costs will not be able to utilize those costs to reduce the qualified wages allocated to their PPP loan.
Examples
The IRS’s position is illustrated by the following examples:
- Example 1: Employer A received a PPP loan of $100,000 and paid $100,000 of qualified wages that would qualify for the ERC during the second and third quarters of 2020. Employer A submitted a PPP Loan Forgiveness Application and reported the $100,000 of qualified wages as payroll costs to support forgiveness of the entire PPP loan, and the entire loan amount was forgiven. Employer A is deemed to have elected not to take into account $100,000 of the qualified wages for purposes of the ERC and therefore cannot claim an ERC for that $100,000.
- Example 2: Employer B received a PPP loan of $200,000 and paid $250,000 of qualified wages that would qualify for the ERC during the second and third quarters of 2020. Employer B submitted a PPP Loan Forgiveness Application and reported the $250,000 of qualified wages as payroll costs to support forgiveness of the entire PPP loan, and the entire loan amount was forgiven. Employer B is deemed to have elected not to take into account $200,000 of the qualified wages for purposes of the ERC and therefore may claim an ERC for the remaining $50,000 as qualified wages.
- Example 3: Employer C received a PPP loan of $200,000, paid $200,000 of qualified wages that would qualify for the ERC during the second and third quarters of 2020 and paid other eligible expenses of $70,000. Employer C submitted a PPP Loan Forgiveness Application and reported the $200,000 of qualified wages as payroll costs to support forgiveness of the entire PPP loan, but did not report the other eligible expenses of $70,000. The entire PPP loan amount of $200,000 was forgiven. Employer C is deemed to have elected not to take into account $200,000 of qualified wages for purposes of the ERC, and therefore no portion of the $200,000 of qualified wages reported as payroll costs may be treated as qualified wages for purposes of the ERC, even though Employer C could have reported $70,000 of eligible nonpayroll expenses and $130,000 of payroll costs on its loan forgiveness application.
- Example 4: Same facts as Example 3, except Employer C submitted a PPP Loan Forgiveness Application and reported the $200,000 of qualified wages as payroll costs, as well as the $70,000 of other eligible expenses, to support forgiveness of the PPP loan. The entire loan amount of $200,000 was forgiven. In this case, Employer C is deemed to have elected not to take into account only $130,000 of qualified wages for purposes of the ERC, and therefore $70,000 of the qualified wages reported as payroll costs may be treated as qualified wages for purposes of the ERC.
- Example 5: Same facts as Example 4, except Employer C paid $90,000 of other eligible expenses, and reported the $200,000 of qualified wages as payroll costs, as well as the $90,000 of other eligible expenses, to support forgiveness of the PPP loan. The entire loan amount of $200,000 was forgiven. In this case, because a minimum of $120,000 ($200,000 * 60%) of payroll costs was necessary to support full forgiveness, Employer C is deemed to have elected not to take into account $120,000 of qualified wages for purposes of the ERC, and therefore $80,000 of the qualified wages reported as payroll costs may be treated as qualified wages for purposes of the ERC.
Tax Treatment of ERC
Not surprisingly, Notice 2021-20 confirms that an employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the ERC. However, the IRS takes a taxpayer-friendly position that an employer does not reduce its deduction for the employer’s share of social security and Medicare taxes by any portion of the credit and does not include any amount of the credit (neither the portion of the credit that reduces the employer’s applicable employment taxes, nor the refundable portion of the credit) in gross income for federal income tax purposes.
Next Steps
Employers, including PPP loan borrowers, should determine whether they are eligible to claim an ERC for the 2020 tax year. Under Notice 2021-20, an eligible employer that received a PPP loan and did not originally claim an ERC may file an amended payroll tax return (Form 941-X) for the relevant calendar quarters in which the employer paid qualified wages, but only for qualified wages for which no deemed election was made. Further, the notice provides guidance for borrowers who can claim an ERC regarding how to file a PPP loan forgiveness application. Notwithstanding this guidance, the Small Business Administration notes in the instructions of the revised PPP loan forgiveness applications (Forms 3508S, 3508EZ and Form 3508 dated 1/19/2021) that PPP loan borrowers “do not include qualified wages taken into account in determining the Employee Retention Credit.”
Contact Us
We will continue to monitor developments related to the Paycheck Protection Program and Employee Retention Credit and communicate any significant changes that will impact our clients.
For further questions regarding Notice 2021-20 please contact your tax advisor, and to request that our credits and incentives team assess your eligibility and documentation requirements for the ERC, please contact Zack Leder, Chris Frederick or Tim Watt by calling 770.396.2200.
