The Section 2301 Employee Retention Credit gets a little bit complicated once you dig into the details.
But if you’re a small business owner, you want to learn how this credit works. The credit may be one of the key tools you use to work your way through the COVID-19 crisis.
Furthermore, the money available through the employee retention credit? Yeah, that money may be the fastest cash you receive. Maybe even available in a few days or so. (I’m thinking about the first quarter’s payroll returns due soon.)
But let’s dig in to the details.
The Section 2301 Formula in a Nutshell
At a high level, the Section 2301 formula works pretty simply. For eligible employers paying qualified wages, the formula works like this:
Employee Retention Credit = (Qualified wages + Qualified Health Plan Expenses) x 50%
Let me provide three quick examples to show you how this works…
Example 1: Suppose you pay an employee $1,000 of qualified wages. You get a credit equal to 50% or $500.
Another example because, in many situations, employers also provide health insurance which plugs into the formula…
Example 2: Suppose you pay an employee $1,000 of qualified wages and also provide $500 of qualified employee health insurance. In this case you get a credit equal to 50% of $1,500 or $750.
Another wrinkle: Section 2301 essentially limits the employee retention credit to $5,000 because the formula looks only at the first $10,000 of qualified wages and health plan expenses.
Example 3: Your firm employs two workers. One worker you pay $10,000 in wages. And for him, you receive a $5,000 employee retention credit. A second worker you pay $20,000 in wages. And for her, you also receive a $5,000 employee retention credit.
Collecting the Cash
Okay, a key question: How do you get this cash? And how quickly can you get it?
The employee retention credit goes on your employment tax returns. Presumably on those quarterly 941 forms you file (or your payroll service files) at the end of the quarter.
Further, the credit works as a refundable credit. That means—and we need to wait for some of the details on this—that you don’t just get to reduce your employment taxes to zero. You can even use the credits to get a refund of taxes you haven’t even actually paid.
The bottom-line: Once the IRS figures out the mechanics, this should be easy and fast.
Eligibility Requirement #1: You Were in Business
Tax law sets out three eligibility requirements for employers who want to use the Section 2301 employee retention credit.
The first eligibility requirement that all employers must meet? Carrying on a trade or business during calendar year 2020. You don’t get an employee retention credit if you don’t “retain” employees and don’t continue operating during the 2020 COVID-19 crisis.
This makes sense. Congress provides this generous credit to subsidize employers who continue to operate.
Eligibility Requirement #2: You Were Disrupted
The second eligibility requirement looks at whether or not a business has been disrupted. And one of two “disruption” tests need to be met:
The first “disruption” test? An appropriate governmental authority must issue orders “limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to the coronavirus 2019 (COVID-19).”
Example 4: In Washington state where I work, for example, our governor issued orders that all non-essential businesses should close on March 23, 2020 through at least April 6, 2020. (See here if you’re interested.) A bunch of businesses including restaurants, bars, athletic clubs, and any other business where large groups congregated got shut down. That decree from the governor counts as an “order.” Affected employers are disrupted and therefore eligible for the credit for at least that time interval.
The second “disruption” test? If gross receipts for the quarter equal less than 50% of the gross receipts for the same quarter in 2019.
Example 5: Suppose you run a trucking service that delivers food to grocery stores and restaurants in Washington state. Food distribution firms (like a trucking company delivering food to grocery stores) don’t need to suspend operations. But government orders closing restaurants and bars due to COVID-19 would surely damage your business. If your firm generated less than $50,000 of gross receipts in the first quarter of 2020, but generated $100,000 or more of gross receipts in the first quarter of 2019, you qualify for the employee retention credit.
An important point about the second test: A firm eligible due to a 50 percent drop in quarterly revenue loses its eligibility the quarter after its quarterly revenues exceed 80% of the revenues for the same calendar quarter in the prior year.
One other note: You would probably (possibly?) use both tests described above. The goal would be to have enough eligibility that your firm accumulated $10,000 of qualified wages for each employee.
Eligibility Requirement #3: No “Small Business Interruption” Loan
A third eligibility requirement exists, too. That rule? If an eligible employer receives a small business interruption loan, also known as a “paycheck protection program” loan, that employer loses eligibility for the employee retention credit.
Specifically, the statute says this, “If an eligible employer receives a covered loan under paragraph 36 of section 7(a) of the Small Business Act (15 U.S.C. 636 (a)), as added by section 1102 of this act, such employer shall not be eligible for the credit under this section.”
Note: Just so you know, this loan program basically provides you with free money if you meet the requirements. And no, I am not kidding. (I’ve got a blog here that explains how to get one of these loans: Paycheck Protection Program Loan: A Small Business Life Saver.)
Qualified Wages
The 50% employee retention credit applies to qualified wages and qualified health plan expenses. What counts, however, as “qualified wages” depends on the size of the employer organization. Furthermore, not everything you might guess counts actually “counts.”
Employers with more than 100 Employees
If the average number of full-time employees employed by your firm during 2019 exceeds 100, qualified wages refer to amounts paid to employees not providing services due to COVID-19.
Note: Section 2301 uses the “Obamacare” definition of “full-time employee”… so someone “employed on average at least 30 hours of service per week.”
Example 6: Again, suppose you operate a trucking company that historically delivers food both to grocery stores and restaurants. Assume that half of your drivers deliver food to grocery stores (essential businesses that continue to receive food deliveries) and half the drivers deliver to restaurants (deemed nonessential businesses which suspend food deliveries due to the COVID-19 crisis.) If you continue to a pay wages to truck drivers who used deliver food to restaurants, those wages count as “qualified wages for” purposes of the employee retention credit formula.
Example 7: Assume the same facts as in example 6 but with one twist: You furlough or layoff all of the truck drivers who previously delivered food to restaurants. In this case, your firm pays no qualified wages. The wages paid to the truck drivers delivering food to grocery stores don’t count. You don’t get an employee retention credit.
Employers with 100 or Fewer Employees
The “qualified wages” accounting works differently for employers with 100 or fewer employees.
For these employers, all wages paid while the firm maintains eligibility count as qualified wages.
Example 8: Assume one last time you operate an “eligible” trucking company that delivers food both to grocery stores, (an essential business) and to restaurants (a nonessential business). Say that economic conditions require you to lay off all of your truck drivers who deliver food to restaurants. But say you continue to employ the shop employees and the truck drivers delivering food to grocery stores. In this case you get to take the employee retention credit on all of the wages your firm pays. You don’t lose the credit because you couldn’t continue to employ everyone.
The Limitation and “Look Back” Rules for Qualified Wages
Two rules to note: First, the employee retention credit doesn’t include as “qualified wages” sick leave or family leave provided by Section 7001 or Section 7003 of the Families First Coronavirus Response Act.
Second, Section 2301 limits qualified wages based on the pay rate the employee earned in the preceding 30 days. Essentially, qualified wages may not exceed the amount an employee was paid for work during the 30 days immediately preceding eligibility.
Example 9: An employee earns $20 an hour of qualified wages during a month your firm is eligible for the employee retention credit. However, in the preceding month the employee earned $10 an hour for the same work. In this situation, only $10 an hour of the employee’s wages paid during the period of eligibility count as qualified wages. Not the entire $20 an hour.
Qualified Health Plan Expenses
One final thing to mention. Qualified wages, per section 2301, include “an eligible employer’s qualified health plan expenses.”
More specifically, qualified health plan expenses include amounts paid or incurred by an employer to provide and maintain a group health plan (as defined in section 5000(b)(1) of the Internal Revenue Code), but only to the extent such amounts are excluded from the gross income of employees by reason of section 106(a) of the tax code.
Note: Qualified health plan expenses therefore do not include self-employed health insurance such as an S corporation shareholder employee might receive.
The Section 2301 statute doesn’t specify how you’re supposed to allocate or calculate what “qualified health plan expenses” count as wages. And the law directs the Secretary of Treasury to provide rules for doing this. But presumably, you can (and will need to) use some sort of common-sense pro rata allocation works.
Other Resources You Might Find Useful
Interested in more practical information about COVID-19 and your small business?
We did a quick overview of the small business tax breaks included with the CARES act earlier this week here: COVID-19 Small Business Tax Breaks
And then last week, we did a post about redoing your business plan for this Corona Virus thing: Small Business Survival Guide to the Corona Virus Crisis.
This is a really helpful post. Thank you!
Does this apply for only one quarterly payroll cycle?
Let’s say I don’t get a SB loan elsewhere and instead choose to opt for the Payroll 50% Tax Credit this quarter. Do I get to do this again in Q2?
Alternatively, can I opt for the payroll credit in Q1 and then apply for a loan in Q2?
You’re limited to $10,000 of wages. So the most you can get is $5,000 per employee.
It seems the Paycheck Protection Program can be used for an advance of “free money,” as you say, in sums far greater than the employee retention credit. But, as you also say, you can’t sue both.
I don’t understand why the credit is even worthy of consideration, given that the PPP can provide multiples of that number, with cash up-front.
I agree based on what I see, except that the requirements are different so some who don’t qualify for payroll reduction (based on number of employees, for example) might qualify for the other.
The credit could pay more if your business has mostly low-wage and/or part-time employees. The “loans” will pay up to 2.5 times your monthly payroll, while the credit tops out at a flat $5,000 per employee.
If your average employee makes less than $2,000 per month, $5,000 is more than 2.5 times their monthly pay. Your business will need to be eligible for the credit for several months to have the credit amount surpass the “loan.” One quarter with a 50% revenue drop seems to be sufficient in that regard, since that triggers eligibility for a minimum of two (or is it three?) calendar quarters.
I agree. Good point, Seattle Cyclone.
Another way to say this, definitely you want to run the numbers.
The other thing, and I should have thought of this yesterday, to borrow you need to self-certify. Here’s the key bit of language, “a good faith certification… that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient…”
Some folks won’t be able to honestly make that statement. And I think we should all hope that when that’s the case, someone doesn’t grab a PPP loan… that someone lets some other firm that really needs the money do that.
Here’s the best source I’ve found for the Payroll Protection Program:
https://www.uschamber.com/sites/default/files/023595_comm_corona_virus_smallbiz_loan_final_revised.pdf
Thank you David. I think this paycheck protection stuff will really be a lifesaver for many firms. And if you can do a paycheck protection loan, I agree, that seems preferable to a retention credit. As Michael notes, though, someone may not able to get the paycheck protection thing to work. (I can also imagine that someone might prefer a retention credit as opposed to a small-ish loan that gets forgiven.)
A more general comment: I guess we’ll have to pay the price somewhere down the road, but gosh, the Feds unleashed a massive amount of aid and assistance for businesses. Wow…
Thanks for the info! We are a bar in CA that was forced to close and we use a staffing company for our employeess. How would we go about getting this credit if the staffing company handles all of the filing and paying of payroll, including payroll taxes etc.?
Thanks again!
This is really helpful, thanks! It seems like our company may not be eligible for Paycheck Protection because at some points in 2019 we had more than 500 employees. Does that seem accurate for the litmus test?
For the disruption requirement, our business has multiple locations, including states where there are currently “stay at home” orders. How would we determine eligibility if we are still open as an essential business in all locations, but where business is very definitely interrupted and revenues are much lower than same quarter last year (but likely not quite meeting the 50% requirement)?
Thanks!
>Does that seem accurate for the litmus test?
Yes, but double-check that because the statute’s language provides a little flexibility.
>How would we determine eligibility if we are still open as an essential business in all locations?
So if you have more than 100 employees and you’re not “under” government orders to suspend fully or partially your operation, I read the statute to say that you’ll only get “eligibility” when a quarter’s revenues fall to less than 50% of the same quarter last year.
I hate it when people say “we need more guidance”… because I think people can read the statute and have a REALLY good idea about how this will work… however that said, it’s also possible that once we see IRS notices or regs, we’ll learn that “partially suspended” includes businesses like yours … and mine.
Question! Does the ERTC only apply for current employees at the time of the shutdown, or can the max $5,000 be taken for any employees hired/employed/paid during the qualified period (i.e. an employee is newly hired after reopening our biz and our sales keep us qualified until 12/31/20). We are a restaurant with under 100 employees (approx 60), and we forecast sales to be down more than 20% the remainder of the year. We assume we will lose some employees but if we can get credit on the new hires, 60×$5,000= $300,000, which is far more advantageous than 2.5x monthly payroll (PPP forgivable loan), which would be about $200,000. This is a risky game to play though if only employees on staff at the time of the shut down are eligible, because to maximize our benefit we would need to be very confident we can keep at least 41 employees (41x$5,000=$205,000). Thank you!
I think the math works the way you hope. And your situation illustrates how the retention credit can be a better option that the PPP loan.
BTW the one thing I think is a little scary about the retention credit though… You won’t know in your example whether you get the full $5K per employee at the time of hire. Your operations either need to be fully or partially suspended… or you need to have fallen below 50% of previous year quarter and then “lost eligibility” too quickly. Not to be too optimistic, but what if things spark back quickly.
Thanks for the response Steve!
All restaurants were shut down so the industry is eligible. We all know Q2 will be qualified, since all of April and at least part of May will be gone due to mandated shut down…there’s no way business could catch up to 80% of 2019 Q2. By having a qualified Q2, that means at a minimum, all of Q3 is covered (correct?).
If the above assumption is correct, the “risk” is Q3 bounces back faster than expected and we do not get the credit for Q4…which would be major. But in this scenario, I think we would have hit 10k per employee by this point, so will we’d be losing is “gravy”, i.e. late hires that are just an additional credits.
Let me know your thoughts, the whole industry would is definitely looking for guidance!
Steve- one more question/point to make in here for clarification, because it will have HUGE implications.
Do aggregation and affiliate rules apply here?
It sounds like they do, which mean it will knock out small restaurant groups with common ownership (like us, between all 3 restaurants we have approx 150 employees), and any groups who use VC funding.
Keep the email articles coming, they’re great! Since a lot of your list is probably sole proprietors who used your e-book to decide what to pay themselves…
Along those same lines, is there any way for a “one man shop” to take advantage of either of these programs? I’m an llc filing as s-corp, so I pay myself a salary and I have taken a major hit to business, but I obviously can’t fire myself, therefore “retaining” myself is a bit strange as well. Any way to get some help? thanks
I think you do get the retention credit (so up to $5K)… and then in some cases, you may actually be able to get that PPP loan. And any of that amount you use to Pay Chris the shareholder-employee (up to $8K a month for a couple of months)… for health insurance… for rent… for utilities will be forgiven.
You would just need to be able to “certify” you need the loan.
I am in the same boat as Chris.
I thought you could not take both the Retention credit and PPP loan.
You are right. You can’t.
1) This is such a great post. Can the credit be applied to offset all employer Social Security Tax liability for the applicable calendar quarter? Sorry if this is a dumb question – if not, this credit would be useless, no?
2) Example – can you confirm that this is correct?
-Company has 10 employees, 5 for whom the company is eligible to claim the credit.
-All employees at the company have wages of $5k per month (or $15k for the applicable quarter).
-Quarterly payroll is $450k (6.2% social security tax is $27,900)
-The employer would be eligible for a credit of $25k for the applicable quarter and can use that credit to offset its $27,900 Social Security tax liability for the quarter. Correct?
3) Additional question – in order to receive the maximum quarterly credit, the minimum the employer could pay its employees who are credit eligible would be $10k per quarter, correct?
I think you want to approach this differently. First, think about how long your firm is eligible. If you’re a restaurant shut down for two months, for example, you’ll be eligible for two months.
Then look at the wages you’ll pay during the period of eligibility. If you’ve got ten workers earning $5K a month, that means you’ve got $10K of wages for ten different employees.
You’ll get a full $5K credit for of the ten employees. So $50K.
Thanks for this great info. If an employer participates in Paycheck Protection Program, are they ineligible for the Employee Retention Credit ONLY in the quarter they received the loan? Or, are they ineligible for ALL quarters where they would otherwise qualify for the Employee Retention Credit.
Participation in PPP makes you ineligible for the retention credit.
Hi Steve –
Your site came up on a Google search for “Employee Retention Credit” and yours is the best analysis I’ve seen so far after two days of looking around. Your writing is excellent.
The IRS just published today an FAQ on the ERC as well as the draft form (#7200) and instructions for claiming the credit on their website. FAQ is here: https://www.irs.gov/newsroom/faqs-employee-retention-credit-under-the-cares-act
I’m a general contractor in Brooklyn, NY, so we’re completely shut down. If we were over 100 employees (we’re nowhere close to that) the ERC would be a bit trickier. As it happens, the ERC is probably better than the PPP for us:
– With the PPP I’m worried that if we apply and get the money we won’t be able to put it to use on payroll. Say we receive payment within the next 30 days – I’m not confident that we’ll be allowed back to work (or that we’ll feel safe working) immediately after that. We don’t have a lot of overhead, my living room is the office, so with no payroll there’s no forgiveness amount.
– Because of this, to your points made in earlier comments, I can’t guarantee the government that the loan would support operations. We’re sidelined until the government tells us to get back to work, regardless of the loan they give to us.
– Looking back at last year’s revenues, we had very strong first and second quarters. We can start the clock of disruption with the first quarter ending March 31 and I know there’s no way that we’ll get to 80% of our second quarter revenues – if we do then I’d be happy to forego the credit. Meaning that our payroll is eligible for the credit at least until September 30.
– The nature of our work is such that we have only a handful of full-time workers, most of the rest of the work is by guys who work part time, or full time for a few weeks. They might go work another construction job and then come back to us. So we have a lot of employees, many of whom draw a relatively low total salary. The $10K maximum wages for credit in the ERT could represent the majority of yearly wages to most of the guys who appear on the payroll. Basically, this is a really good option for a business with a relatively high number of low (total, not weekly) wages – similar to the bar example given by your previous commenter.
Most crucially for me in figuring out which credit (and I’ll call both the ERT and PPP credits) is better for us, there is a great deal of flexibility in who qualifies as an eligible employee for the ERT. By my reading (and I’m curious if you agree), new hires are eligible and almost preferable for the purposes of the credit, since the maximum credit for their wages is not related to any prior wage, whereas for anyone who was working with us before that individual’s prior wage limits the current wage I can take for credit. The legislation does appear to exclude as eligible employees close relatives of majority owners – I certainly understand why, otherwise it would be tempting to start adding mom and dad to the payroll.
Thanks again.
Hi Isaac, I think you’re thinking this through the way business owners need to. And the only thing I’d add to your analysis is this: The Feds want you to put your guys back on the payroll. I think, for example, that even though NYC is shut down (same here in Seattle), you can pay your “permanent crew” to “shelter in place.” I believe doing this–paying guys to stay at home–meshes with the spirit and letter of the law.
One other thing I’d note… In the chaos and confusion that exists right now, probably some folks will get funding and receive forgiveness for stuff that doesn’t really make sense. Not saying you shouldn’t employ mom and dad, but in some cases, employing mom and dad might be an example of this nonsense. And folks don’t want take actions that will in retrospect later look fraudulent. Maybe it’s not same thing, for example, but I’m a tax accountant. And you see people sometimes talk themselves into deductions that make sense in the privacy of their own home, after a couple of beers. And sometimes those deductions don’t look very good in the bright lights of an auditor’s office.
Hi Steve-
Thanks for the great article. Couple questions:
1) I see you noted that all wages count for the credit if less than 100 employees. Do you have a source? I can’t seem to find anything.
2) Also for the 100 employee limit, have you seen anything that ties entities together for this calculation. I have a group of bar owners who own a number of bars all in their own entities. If we combine them all, they are over the 100, if not each one has less.
thanks in advance
Regarding the rule for 100 employees or less…It’s in the statute. Very explicit.
Regarding the group of bar owners, I don’t think you’d group businesses unless they were in effect the same entity. BTW, the PPP loan application has you disclose all the other entities applicant owns interest in.
Hello,
I have read conflicting articles on how to calculate the credit. We are a non-profit preschool and have been closed for the school year by our governor; however, we continue to do some online teaching and collect 50% of our tuition and pay our teachers full salary. We meet the first disruption test for the credit so I thought we would qualify for the credit. I’m not sure we’d qualify for the 50% reduction test as (1) we are still collecting some tuition (not all students are paying but some are paying extra), and (2) we had a different number of students last year —- the math will be close so I was happy to use the first disruption test to qualify and not worry about the close math on the revenue test. However, some articles have said that to actually calculate the credit, you need to start in the quarter where your revenue dropped by more than the 50% -which to me seemed to mean that you really did have to meet the 50% revenue reduction test if that is when you started to calculate the credit. But not all articles have said that, and so I’m confused. My question then is (1) can we take this credit if we have the government order disrupting our business but not a 50% reduction in revenue, and (2) if so, when do we start to calculate the credit (with the first pay period since the shutdown)? Thank you!
You need to first determine your period of eligibility.
If you’re using full or partial suspension to become eligible, the eligibility started the day the governor closed or partially closed your school. It ends the day you guys are back in action. Within that interval, you’ll be able to take the 50% credit on up to $10,000 of qualified wages per employee subject to the rules described in the blog post.
Hope that helps.
Are 100% owners of s corporations wages eligible for the credit?
Yes.