Written by Gabriel Dillard
Since it was introduced in 2020 as part of the CARES Act, the Employee Retention Tax Credit (ERTC) has been retroactively updated and expanded numerous times. These retroactive updates make the ERTC more accessible to businesses that are struggling to find their financial footing after a tumultuous two years.
However, the backtracking and numerous amendments to the original ERTC legislation have resulted in many outdated ideas about the ERTC being peddled by bloggers and YouTubers. Even some tax professionals have joined in the fray, misstating and exaggerating facts about the ERTC to ensure every client qualifies, regardless of their actual ERTC eligibility. I hope to dispel some of these myths so you can gain a clear picture of your potential ERTC eligibility.
Myth 1: I can’t claim the ERTC if I received PPP funds
One of the more common misconceptions about the ERTC is that those who received funds through the Paycheck Protection Program (PPP) cannot be eligible for the Employee Retention Credit. However, although the 2020 CARES Act initially forbid PPP loan recipients from ERTC eligibility, it was retroactively updated by the 2021 Consolidated Appropriations Act (CAA) to allow PPP recipients to also claim the ERTC, provided they meet the ERTC eligibility requirements.
There are a few caveats to this update, however, that you should consider before rushing to apply for the ERTC:
The Truth: You cannot use the same wages for PPP debt forgiveness & ERTC eligibility
Following the enactment of the CAA, you may now qualify for the ERTC using wages that were not paid using PPP loans. In other words, you cannot use the same wages for PPP debt forgiveness and ERTC eligibility calculations. However, it is possible to have enough payroll to qualify for both ERTC and PPP loan forgiveness.
For example, let’s say that Company A received a second draw PPP loan on January 10th for $300,000 which is 2.5 times their average monthly payroll costs. Their covered period will begin on January 10th and end on June 26th, which is 24 weeks total.
Let’s say that Company A has 10 employees and sees a decrease in their 2021 monthly salaries compared to 2019. As a result, it will take them 14 weeks to incur $300,000 in payroll expenses (for simplicity, this example assumes there are no other qualified expenses for PPP forgiveness), translating to $21,400 weekly or $2,400 per employee.
If Company A is an eligible employer for the ERTC in 2021 Q1, it can use the first five weeks of its 2021 payroll to fulfill the qualifying wage amount for the ERTC. This is because, in the first 5 weeks, each of Company A’s employees will generate $12,500 and be capped at the ERTC’s 2021 per-employee quarterly wage maximum of $10,000. Company A can then use the remaining weeks of payroll until the amount needed for second draw PPP debt forgiveness is met.
Myth #2: Being shut down qualifies me for ERTC
Not all shutdowns are equal when it concerns ERTC eligibility. Throughout 2020 and 2021, some companies closed down because of a government mandate while others closed their doors due to coronavirus-related safety precautions. If I were to sit down and look at your ERTC eligibility, only the first scenario would be eligible.
A critical phrase that’s overlooked during many discussions between many tax professionals and clients is “…due to a government order.” Temporary closure of your business is insufficient to qualify you for the ERTC. Instead, your shutdown must be tied to a government order that specifically mandates your business to either close completely or partially restrict more than a nominal portion of your business.
What is considered a government-ordered shutdown?
Opinions about what qualifies as a suspension are flying all around the Internet these days so let’s step back and look to an IRS notice (Notice 2021-20, page 25) for an official definition of a qualifying shutdown. Examples include:
- — An order from the mayor stating that non-essential businesses must close for a specific period
- — A local ordinance that imposes a curfew on residents that impacts a business’ operating hours for a specific period
- — An order from a local health department mandating a business closure for cleaning and disinfection purposes. (Note: Example 3 on page 27 of Notice 2021-20 makes it clear that this only applies to COVID-19 scenarios, not general cleaning or sanitation)
What is considered a nominal portion of business operations?
If your business was considered non-essential, it is fairly straightforward to tie your business closure to a specific government mandate. For essential businesses, however, the IRS only allows for possible ERTC eligibility if a nominal portion of their business was affected due to a government mandate. While examining Notice 2021-20 (pages 27-28), we can gain some insight as to what the IRS considers a “nominal portion” of business operations:
- — The gross receipts from the affected portion of your business are at least 10% of your total pre-pandemic gross receipts
- — The hours of service performed by employees in that area of your business are at least 10% of your company’s total number of hours worked by all employees.
These two calculations should be determined using the gross receipts amounts or number of employee hours worked within the corresponding calendar quarter in 2019.
Myth #3: Documenting why I’m eligible is unnecessary since the IRS is too busy
It’s tempting to brush past the need for documentation in the rush to determine ERTC eligibility. But doing this only sets you up for disaster later on. As any tax professional will tell you, documentation is the best defense during an audit. You must support your ERTC eligibility determination with carefully kept records. Here are some tips:
- — Because the ERTC is a highly lucrative tax credit, you can expect the IRS to conduct a significant number of audits in the coming years.
- — Documenting every one of your ERTC claims isn’t optional, but necessary if you plan on navigating through an IRS audit regarding your ERTC eligibility. If you claim based on a decline in gross receipts, hang on to financial statements that show the decline. If you qualify based on suspension, retain a copy of the government order that specifically forced you to fully or partially close your business.
Thorough documentation is critical to ensuring that the likely increase in ERTC audits is not a problem for you.
Myth #4: I can qualify for the ERTC because my supplier was shut down
This is a dangerously clever misstatement that is used to wrongfully qualify businesses for the ERTC. The reasoning goes something like this, “If I count on Supplier A to deliver my service and they are shut down, I can qualify for the ERTC because my business operations were affected.” This is somewhat true, however, there are caveats given by the IRS that are not represented in the above statement. In IRS Notice 2021-20 (page 29), we can get the following insights from Question 12’s Employer A example:
- — Your supplier must have been shut down due to a government order, which indicates that being shut down due to non-mandated reasons isn’t sufficient
- — You are unable to obtain the service or materials from another supplier, which indicates that, if a supplier is shut down, you should make efforts to find an alternative supplier before using your supplier’s closure to qualify for the ERTC
- — You would only be able to qualify for the period during which the supplier’s operations were suspended.
In this article, I discussed the myths you may have heard about the ERTC, but you can learn more about the ERTC in my previous article, “Are You Overlooking The Employee Retention Tax Credit Opportunity?”. Despite the misconceptions surrounding the Employee Retention Tax Credit, one point remains clear: it is a great tax opportunity that should be explored by every company.
Cassidy Jakovickas, CPA, is president and CEO of MBS Accountancy Corp. in Downtown Fresno.