If your business got beat up by the Covid-19 pandemic—many did of course—you hopefully know about employee retention credits. But what you may not know? You can do things to get bigger employee retention credits.
The only problem? You need to move quickly. Thus, this blog post where I’ll talk about boosting the size of the credits you calculate.
But let’s make sure you’re up to speed on how the employee retention credit works. And then we’ll talk about how you can increase the size of the employee retention credits you calculate.
And by the way, one other note: These credits? They nearly instantly become refunds. Starting next time you do payroll. And in some cases, gigantic refunds.
Employee Retention Credits in a Nutshell
In effect, the federal government will pay an employer, such as a small business, up to a $5,000 credit for wages paid and group health insurance provided to each employee in 2020.
In 2021, the deal gets even better. The federal government will pay up to a $28,000 credit for wages paid and group health insurance provided to each employee in 2021.
Example 1: A small business employs ten workers who each earn $40,000 annually and it qualifies for employee retention credits for both 2020 and 2021. In 2020, the firm receives $50,000 of credits ($5,000 for each employee). In 2021, the firm receives $280,000 of credits ($28,000 for each employee).
The credit formula, by the way, works differently in 2020 and 2021.
In 2020, the employee retention credit formula equals fifty percent of the wages and group health insurance paid but not more than $5,000 per employee. (The 2020 credit formula looks only at the first $10,000 of wages and group health insurance paid for the year.)
In 2021, the employee retention credit formula equals seventy percent of the wages and group health insurance paid but not more than $7,000 a quarter. (The 2021 credit formula looks at the first $10,000 of wages and group health insurance paid during each quarter.)
Unbelievable, right? I agree. The numbers, especially for 2021, get huge. Even for a small business.
Five Basic Employee Retention Credit Rules
Five basic rules apply to the employee retention credit.
The first rule? The credit works, potentially, for wages and group health insurance paid after March 12, 2020 and through December 31, 2021.
The second rule: A firm needs its operations either fully or partially suspended by federal, state or local government restrictions… or a firm needs to suffer a significant contraction in quarterly revenues as compared to 2019. (I’ll talk more about this in a minute, but a firm only gets the credit on wages and group health insurance paid during a full or partial suspension or during a down quarter.)
A third rule says that you can’t “double dip” and thereby get a credit and refund if some other federal government program already provided you money to pay the wages. For example, you don’t get employee retention credits for wages you paid using Paycheck Protection Program funds. Or using an EIDL grant. Or if you received other payroll tax credits that, in effect, funded employee wages.
The fourth rule? Large eligible employers only take the credit only on wages paid to employees for not working. For 2020 employee retention credits, a large eligible employer is a firm employing more than 100 full-time employees in 2019. For 2021 employee retention credits, a large eligible employer is a firm employing more than 500 full-time employees in 2019. For small eligible employers, in comparison, the employer takes the full credit, potentially, on all their workers’ wages (subject to the third rule just mentioned).
The fifth rule: A business owner aggregates the businesses she or he or they own. For example, if you own a restaurant (maybe operated as a sole proprietorship), 100 percent of a consulting business (maybe operated as an S corporation), and a majority interest in a partnership, you aggregate all of these businesses to determine whether your operations qualify (according to rule #2 above), what the wages total and so forth.
And now let’s look at the three big opportunities to maximize employee retention credits. Because for two of these opportunities, time may be running out.
Bigger Employee Retention Credit Tip #1: Savvy PPP Forgiveness Application
Here’s the first technique you may be able to use to maximize your employee retention credits: How you complete the PPP forgiveness application. But let me explain.
Whatever wages you report on your PPP loan forgiveness application? The employee retention credit formula ignores those wages, as mentioned earlier, for purposes of the employee retention credit.
Example 2: Say a small business potentially qualifies for $50,000 of employee retention credits on $100,000 of wages and qualified health expenses due to partial suspension. If this small business received a $100,000 PPP loan, the borrower might get full forgiveness for using the funds for $100,000 of W-2 wages. And it might, just to be efficient, show that same $100,000 of W-2 wages on its PPP forgiveness application. But in that case, it receives no employee retention tax credit on those wages. The business can’t use the same wages for PPP forgiveness and employee tax credits.
Example 3: Say another nearly identical, partially suspended small business also potentially qualifies for up to $50,000 of employee retention credits on some portion of a $100,000 of wages and qualified health expenses. Further, say this PPP borrower also received a $100,000 PPP loan and could have gotten full forgiveness simply by claiming that full $100,000 of W-2 wages and health expenses. But say it instead applied for forgiveness by showing it used the PPP money for $50,000 of W-2 wages and health expenses, $10,000 of other payroll costs including payroll taxes and pension contributions, and then $40,000 of rent, utilities and mortgage interest. In this case, the business should still get employee retention credits on half of the wages. So roughly $25,000 of employee retention credits.
You see the big point here: How you complete the PPP loan forgiveness application affects the leftover wages and qualified health insurance you or your accountant plug into the employee retention credit formula. (The basic trick is, try to get forgiveness for spending other than wages and group health insurance, if that approach protects your ability to get employee retention credits.)
Finally, this bit of bad news: If you already applied for forgiveness, you can’t undo your application. But some first-round PPP borrowers haven’t yet applied for forgiveness. Some borrowers also received a second-round PPP loan. Many of these firms still have the opportunity to apply for forgiveness in a way that maximizes employee retention credits.
Bigger Employee Retention Credit Tip #2: Look at Every Qualification Possibility
A firm qualifies for employee retention credits in two basic ways.
Maybe the most talked about way? Suffering a significant contraction in revenues. Specifically, a greater-than-fifty-percent contraction in 2020 or a greater-than-twenty-percent contraction in 2021.
Note: If a firm suffers a greater-than-fifty-percent contraction in 2020, it continues to qualify for employee retention credits until the quarter after the first quarter its revenues equal eighty percent or more of the same quarter’s revenues from 2019.
Example 4: Say a firm generated exactly $100,000 in revenue each quarter of 2019. If its revenues in 2020 equaled $80,000 in quarter 1, $40,000 in quarter 2, $80,000 in quarter 3, and $100,000 in quarter 4, it qualifies for employee retention credits in quarters 2 and 3.
Example 5: Say the firm from example 4 experienced another contraction in 2021. If revenues for quarter 1 and quarter 2 of 2021 equal $75,000—so seventy-five percent of what the firm experienced in 2019—it qualifies for employee retention credits in quarters 1 and 2 of 2021.
A firm may also qualify if federal, state or local government mandates, directives or proclamations fully or partially suspend its operations.
Example 6: On April 1, 2020, a restaurant reduces the number of tables for diners by fifty percent due to a state government public health directive that stays in effect for the rest of 2020. Say the firm usually generates $100,000 a month of revenues but through the closure generates $70,000 a month of revenues. The restaurant fails to qualify for employee retention credits based on reduced revenues. Revenues “only” decline by thirty percent. However, the restaurant does qualify for employee retention credits based on state public health restrictions that partially suspend operations.
The obvious trick here to maximize the employee retention credit: Look at both qualification rules: the one based on the reduction revenues… and the one based on the federal, state or local government restrictions on activity.
And then the less obvious trick for maximizing the credit and the resulting refund. Be sure to explore whether a firm can stretch out the time frame it qualifies for employee retention credits by looking both at restrictions and revenue reductions.
Example 7: Say a firm that enjoyed $100,000 a quarter of revenues throughout 2019 sees operations restricted on March 15 due to local government directives that continued through June 30. Assume that revenues “only” sag in the second quarter to $60,000 as compared to 2019, then sag in the third and fourth quarters to $40,000. The firm qualifies as partially suspended from March 15 through June based on local government directives. The firm qualifies due to substantial revenue declines for the third and fourth quarter. Accordingly, wages and group health expenses paid between March 15, 2020 and December 31, 2020 potentially produce an employee retention credit.
Bigger Employee Retention Credit Tip #3: Acquiring to Aggregate
One other powerful tax planning opportunity bears mentioning. As noted earlier, the rules for employee retention credits require employers to aggregate businesses. An entrepreneur who owns, for example, two or three (or more) separate businesses aggregates those businesses into a single employer for the purposes of the employer retention credit.
Example 8: An entrepreneur owns a restaurant, an online ecommerce website, and a consultancy. All three businesses generated a $100,000 quarter of revenues in 2019. The employee retention credit formula combines these three businesses. If the aggregated firm experienced a full or partial suspension in any one of the three businesses through the entire second quarter, the entire consolidated operation potentially qualifies for employee retention credits for the second quarter. For example, if local public health officials directed the restaurant to close from April 1 through June 30, but the other two businesses continued to chug along? The entire three-business aggregation counts as partially suspended from April 1 through June 30. That “partially suspended” status means all three businesses qualify potentially for employee retention credits.
And then here’s the planning opportunity related to aggregation. If a business acquires a firm, it can aggregate that firm’s data from before the acquisition date if the acquirer possesses the information needed to calculate the formulas. A couple of examples show how this technique might work.
Example 9: A consultant operates a firm that generates $100,000 a quarter in 2019 but due to Covid-19 only $80,000 a quarter in 2020. Because no government restriction fully or partially suspends the consultancy operation, the consultancy fails to qualify for employee retention credits due to government restrictions. Further with a twenty-percent reduction in revenues, the firm fails to qualify for employee retention credits due to a significant decline in revenues.
However, if the consultant acquires another business, that may result in qualification for employee retention credits.
Example 10: The consultant from example 9 acquires a restaurant on April 1, 2021. If that restaurant enjoyed $100,000 a quarter of revenues in 2019 but only books $70,000 a quarter of revenue in 2020 and 2021, then the consultant’s aggregated businesses qualify for the employee retention credit for the quarter that starts on April 1, 2021. For that quarter, the combined revenues, $80,000 for the consultancy and $70,000 for the restaurant, equal seventy-five percent of the aggregated 2019 revenues. Seventy-five percent falls under that eighty-percent threshold therefore qualifying the aggregated businesses for employee retention credits in the second quarter.
Show Me the Money
A quick comment in case you’re new to this employee retention credit topic. You get the refund created by the employee retention credit using the quarterly 941 payroll tax form.
If you should have claimed a credit on some past 941 forms from 2020? Or on the first or second quarter 941 for 2021? You need to go back and amend those. Or maybe better yet, have your tax accountant do the calculations and prepare the form. (If you didn’t know to include the credit in the first place, maybe you ought to have the accountant take care of this for you.)
Note: Our CPA firm will amend 941 forms for small businesses if you use a outside payroll service (like ADP, Paychex, or Gusto) and if you have an accounting system that supplies quarterly revenue data (so like QuickBooks Online, Xero Accounting, or QuickBooks Desktop). Use our CPA firm’s contact form to reach out.
If you can claim a credit on your original second, third or fourth quarter 941, you just calculate the amount and enter it on the 941 form. (You do need to have workpapers which backup and explain your calculations.) Further, if you know for a fact you’re getting a credit, you can and should reduce your payroll tax deposits immediately so you don’t have to wait a month or two or three for the refund.)
Three quick comments in closing. First, you may unfortunately find you’re too late to boost your employee retention credits by more thoughtfully preparing the PPP loan forgiveness application. Don’t beat yourself up for that. Initially you could not qualify for employee retention credits if you also borrowed PPP money. So probably you or your accountant prioritized getting the PPP loan money. And then prioritized getting that loan forgiven. All that made sense. You want to remember all that if you inadvertently missed that opportunity.
And a second comment: As mentioned earlier, time is running out your ability to maximize your credits. If you want to use aggregation, for example, you need to finish an acquisition as soon as possible. Further, with regard to the PPP loan forgiveness, you probably need to apply soon for forgiveness if you haven’t already. The bottom-line in all this? You probably need to move fast to maximize employee retention credits.
A third comment which may be helpful to some readers trying to make sense of this crazy, new tidal wave of free money supplied by the federal government. Accept the free money element of this. Don’t try to make sense of what may not, once the dust settles, make much sense. The Congressional rationale here? Well, the Covid-19 pandemic restrictions coupled with reductions in consumer demand destroyed millions of small businesses. As I write this in July 2021, one source is reporting that nearly fifty percent of small businesses open in January of 2020 have now closed. And so what Congress did with programs like the Paycheck Protection Program and employee retention credits is shower small businesses with money to keep people on the payroll.