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EMPLOYEE RETENTION CREDIT – 2020 AND 2021

The Employee Retention Credit (ERC) was originally part of the CARES Act which was signed into law on March 27, 2020. The ERC allows eligible taxpayers a credit against Form 941 taxes (Federal withholding, Employer and Employee Social Security and Medicare taxes). The Consolidated Appropriations Act 2021 was signed into law on December 27, 2020 and made significant changes to the ERC. I will now outline the latest provisions of both the 2020 ERC and the 2021 ERC.

2020 ERC

Who is eligible for an ERC?

The ERC is available to employers of any size that paid wages and meet one of the two following tests:

The first test is for any business that has its operations fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19. As an example, I have a number of hair salons as clients in the New Jersey / New York area. All of these salons were shut down for approximately 3 months from between approximately March 20th through their reopening on June 22nd. These salons would be eligible for the credit for any wages paid during the shutdown period.

The second test is one in which the business had a reduction of its gross receipts of more than 50% when compared to the same quarter of 2019. To use my salons as an example. Each salon was open for 10 days in the 2nd quarter. Gross receipts were down by 80 – 90% in most cases. These salons would be eligible under this second test as gross receipts are clearly less than 50% of the corresponding 2019 quarter. This test allows the taxpayer to count as wages all wages from the first day of the quarter gross receipts fell below 50% up through and including the quarter where gross receipts are at least 80% of the corresponding quarter in 2019.

I will explain this second test by giving an example. Let’s say gross receipts in 2019 were $100,000 in each of the four quarters for an annual total of $400,000. Sales for 2020 were $90,000 in the 1st quarter, $10,000 in the 2nd quarter, $70,000 in the 3rd quarter and $95,000 in the 4th quarter. We now test each quarter. In the 1st quarter sales were down 10%, therefore the taxpayer is not eligible. The 2nd quarter gross receipts are down 90% from the 2019 amount ($100k in 2019 compared to $10k in 2020). The taxpayer is now eligible for the 2nd quarter and the 3rd quarter. The 3rd quarter sales are only 70% of the 2019 figure and therefore since the salon has not reached 80%, it is automatically eligible in the 4th quarter. The 4th quarter is only down 10% compared to the 2019 figure, however, the law states you are eligible up to and including the quarter where gross receipts are restored to at least 80% of the 2019 corresponding quarter. If the 3rd and 4th quarter figures of 2020 were reversed ($95,000 in the 3rd quarter and $70,000 in the 4th quarter), then the salon would not be eligible for a credit in the 4th quarter. The salon reached the 80% threshold in the 3rd quarter which means although it is eligible in 3rd quarter, it is not in the 4th quarter.

The second rule above pertains only to the 2020 ERC credit. The rules change in 2021 and I will get to them shortly.

Please keep in mind the two tests are completely separate. If your business is eligible because you were shut down, and not because your receipts dropped by at least 50%, then you are eligible only during the shutdown period. It is generally more advantageous if a business can qualify under the second test.

Aggregation Rules

I want to point out that related employers (generally companies that share greater than 50% common ownership) must be looked at in total to determine the gross receipts test. Additionally, if just one entity has its operations partially or fully suspended, then all related entities are considered to be partially or fully suspended. Aggregation rules can be complicated and are beyond the scope of this writing. I just want to say if you have companies that may be related discuss it with a professional to ensure that you apply the law correctly.

What wages specifically can be included in the computation?

Qualified wages for eligible employers with greater than 100 full-time employees are wages paid to employees not providing services during the period of eligibility. Full time employees are employees working at least 30 hours per week. If you employ more than 100 full time employees than only wages for employees being paid that are not working are counted. There is a limitation on these employees based on the amount such employees would have been paid for working an equivalent duration during the 30 days immediately preceding the coronavirus crisis. All this last sentence means is that employers were not allowed to boost someone’s pay rate during a period of eligibility in order to increase the credit.

Qualified wages for eligible employers with no more than 100 full-time employees are all wages paid whether or not the employee is working or not during the period of eligibility.

While the 100-employee test focuses on full time employees, the actual computation counts full and part time employees. If a company employs more than 100 full time employees than the wages of all full and part time employees that are being paid but not providing services are counted.

If a company has 100 or less full-time employees than all the wages of the full and part time employees are counted.

Group health benefits of employees are considered qualified wages.

Are there any other limits on eligible wages?

Wages of more than 50% owners and related parties to a more than 50% owner are not eligible wages. In addition, there is a limit of $10,000 per individual in 2019.

There are also exclusions for pre-existing paid time off, severance pay and wages where other credits have been taken such as paid family and medical leave credit.

What is the amount of the credit?

The credit is a 50% credit of qualified wages, or up to $5,000 per individual in 2019. Let’s say an employer has two employees, Employee 1 that earns $2,000 each quarter and Employee 2 that earns $15,000 each quarter. This includes the employee’s wages and health benefits. Lastly, I will assume the entity was eligible for the ERC in the 2nd, 3rd, and 4th quarters of 2019. Employee 1 will earn $6,000 while Employee 2 will have compensation of $45,000 in 2019. The ERC would be 50% of $6,000, or $3,000 and 50% of $10,000 (remember there is a $10,000 limit per employee), or $5,000. The business has an $8,000 credit. In actuality the 2nd quarter would show a $6,000 credit ($1,000 credit on Employee1 and a $5,000 credit on the Employee 2). The 3rd and 4th quarters would each have a $1,000 credit (all on Employee 1 and none on Employee 2 because the limit had been reached). These credits will be taken on Form 941 for each quarter.

If this is such a great credit, why haven’t I heard of it before?

The original law had a provision which stated any employer that received a PPP loan was not eligible. PPP was a better deal and that’s why PPP was in the news every day and there was little mention of the ERC.

The new law passed December 27th, 2020 changes the rules and allows employers that received a PPP loan to also receive an ERC. You must be careful.  Wages considered for PPP loan forgiveness may not be used for ERC purposes.

Further, the law states that we are to assume this was always the law. Eligible taxpayers are able to file amended payroll tax Forms to claim the 2019 ERC. If you are filing an amended Form 941-X solely for the change in the law pertaining to the allowance of PPP borrowers to also obtain an ERC, then you can file one amended 4th quarter 2019 Form 941-X to correct all quarters of 2019.

Reduction in income tax deductions by the amount of ERC

The law requires taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC. In my example of the employer that obtained an $8,000 credit, that same employer would be required to reduce the deductions on their 2019 income tax return by $8,000.

2021 ERC

While the shutdown test remains in place in 2021, the second test has changed. Employers are eligible on a quarter-by-quarter test. If the gross receipts for the 1st or 2nd quarter of 2021 are less than 80% of the gross receipts of the corresponding 2019 quarter the employer is eligible. Additionally, employers have the option of using the prior quarter for the test. Let’s say the 1st quarter of 2021 was only down 15% compared to the 1st quarter of 2019, but the 4th quarter of 2020 was 25% lower than the 4th quarter of 2019. The taxpayer may choose to use the 4th quarter of 2019 for the computation instead of the 1st quarter of 2020. The same would hold true for an employer calculating the 2nd quarter of 2021. The employer could choose to use the 1st quarter for the computation. This is only for purposes of qualifying under the gross receipts test. If an employer is eligible the actual computation of the quarterly ERC would be based on wages on the appropriate quarter (not the prior quarter used for the gross receipts test).

What other changes were made for 2021?

In 2019 there was a limitation of $10,000 of wages per employee for the year. In 2021 this figure has changed to $10,000 per quarter for both the 1st and 2nd quarters of 2021. The last quarter eligible for the ERC is the 2nd quarter of 2021.

The credit has been increased in 2021 from 50% in 2019 to 70% in 2021. This means that while the limit was a $5,000 credit per employee in 2019 ($10,000 multiplied by 50%), it is now up to $14,000 per employee in 2021.

Let’s look at another example. An employer has two employees, Employee1 and Employee 2. Employee 1 makes $6,000 in the 1st quarter and $12,000 in the 2nd quarter. Employee 2 makes $15,000 in each of the quarters. The credit in the 1st quarter would be $6,000 X 70% ($4,200) + $10,000 X 70% ($7,000) or $11,200.

The 2nd quarter would be $10,000 X 70% for both employees or a total of $14,000. The employer is limited to $10,000 of wages on Employee 1 even though that employee did not use the full $10,000 amount in the 1st quarter. In other words, the employer cannot carry over any amount under the $10,000 threshold.

The test of full-time employees was changed from 100 to 500 full time employees; therefore, it is a much easier eligibility test for employers to reach. The advantage of meeting this test is that all wages, not just wages of those being paid and not working, are eligible for the credit.

Reduction in income tax deductions by the amount of ERC

The law requiring taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC remains in place for an ERC taken in 2021.

How this might affect PPP loan forgiveness

We know from the new law that employers that obtained a PPP loan can now also obtain an ERC but cannot use the same wages for both. We also know that borrowers of PPP loans must utilize 60% of the loan proceeds for payroll in order to obtain forgiveness.

Without the passage of the new law, we might just use 100% of wages for PPP forgiveness and be finished. Now it may be beneficial to utilize some of the other allowed expenses (in 2020 it was rent, mortgage interest and utilities) in order to maximize the ERC. Let’s take an example where an employer obtained a $100,000 PPP loan. Let’s also assume the employer had $40,000 of rent during the covered period of the PPP loan. If the employer applies for forgiveness using $60,000 of payroll and $40,000 of rent, then they now have $40,000 of payroll that may be eligible for the ERC. I say may be eligible because there are additional rules ($10,000 cap per individual and/or wages of individuals owning more than 50% of the entity).

These computations may become complex. Take an example of a borrower that obtained a PPP loan before the PPP Flexibility Act passed on June 5th of 2020. This borrower has the option of using an 8-week covered period or a 24-week covered period. There could be a situation where during the 8-week covered period the employer meets the full-time equivalent requirement of their forgiveness because they maintained all employees during the 8 weeks but subsequently reduced their work force based on economic conditions. Using a 24-week covered period might reduce forgiveness, however being able to use 6 months of rent and freeing payroll for the ERC may result in a bigger benefit from the ERC than the reduction in forgiveness. My point is you must coordinate your PPP loan forgiveness with the ERC in order to maximize your benefit.

Is there anything else we don’t know?

Isn’t there always? Currently we are waiting for guidance on how to coordinate PPP forgiveness and the ERC. For example, if an employer chooses a 24-week covered period it is likely that payroll from that period is far more than required for PPP forgiveness. How do we allocate wages for each? Can an employer pick and choose which employees to count for PPP? Must they use a certain percentage of each? Can employers exclude up to $10,000 for each employee to be used for ERC?

There are also questions regarding borrowers that have already filed for forgiveness and submitted payroll in excess of their PPP loan. Can the excess be used for the ERC? What if a borrower used 100% payroll but had other eligible expenses that could have been used? The law does state that if a borrower has applied for forgiveness, but the SBA has not rendered a final decision or reimbursed the lender for forgiven PPP funds, then the borrower may amend their forgiveness application.

I do expect guidance to be issued fairly soon as many borrowers are going to have to file for forgiveness soon.

Join me, Every Monday at 12:30pm (EST) here: https://www.facebook.com/jeffcpaworld/

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation

Article by: Jeff Skolnick, CPA, M.S. Taxation

Like-Kind Exchanges or 1031 transactions allow taxpayers to dispose of property and defer the gain if the property is exchanged for like kind property.

In English, what this means is that if you were to trade real estate, then you would have to exchange it for real estate, an automobile for an automobile, etc.  Keep in mind both the property given and the property received must be used for business or investment purposes.

Like-kind exchange rules may apply to many types of property.  The most common questions revolve around real estate and therefore this will be my focus.

Like-kind exchange rules generally discuss exchanging one piece of property for another simultaneously.  These rules certainly can apply to real estate; however, it is very difficult to find two individuals willing to exchange properties.  The solution to this problem can be found in a delayed exchange.

In a delayed exchange a taxpayer may sell a piece of business or investment property and purchase, at a later date, replacement property and still qualify under the like-kind exchange rules.  While this can obviously be a very attractive way to sell property that has appreciated in value, great care must be taken as the rules are complex and any mistake will disqualify the transaction and render it immediately taxable.

The major requirements of a delayed exchange are as follows:

• Replacement property must be identified within 45 days of the sale of the property relinquished. The identification must be in a written document signed by the taxpayer and delivered to the seller of the replacement property or anyone who is not a disqualified person. It is usually given to the qualified intermediary.

• The taxpayer must close on the replacement property on the earlier of the 180^th day after the sale of the property relinquished or the due date of the taxpayer’s income tax return (including extensions).

• The taxpayer cannot receive the money from the sale of the relinquished property.  In most cases the proceeds of the first sale are held by a “qualified intermediary” until they are needed to close on the replacement property.  While there is no requirement to use a qualified intermediary, the taxpayer is not allowed to use anyone who has had a financial relationship with the taxpayer in the last two years. That rules out the current attorney, accountant, investment banker, broker or real estate agent. Each of these individuals is considered to be a disqualified person. Qualified intermediaries are used to these transactions and in my opinion worth the money to make sure the transaction is completed properly. I have read articles detailing that there is a lack of regulation of Qualified Intermediaries so make sure you do your research and find one that is reputable and bonded.

• The purchase price of the replacement property must be at least as much as the sales price of the property relinquished or a portion of the gain will not be tax deferred.

Once again, if any of the above provisions are violated, then the transaction will become immediately taxable.

It is important to keep in mind that although the rules for what qualifies as like-kind real estate are liberal, neither personal residences nor vacation homes will qualify.  These types of properties may be converted to business or investment use; however, this usually requires significant time (approximately 2 years).  Again, keep in mind properties must be identified within 45 days and generally closed on within 180 days. This can be the most difficult part of the transaction.

It is also important to remember that like-kind exchanges defer taxes and do not eliminate them. In other words the gain you defer will reduce the cost basis of the property you purchase and the gain will be realized upon the sale of the replacement  property unless the taxpayer enters in to another like-kind exchange

In addition, there are a variety of other factors that may come in to play.  This article is meant to give a basic overview of the law.

The rules of like-kind exchanges are complex and stringent, however if followed correctly can be well worth the time and effort. The rules, however, if not followed 100% will destroy the transaction and the deferral will be disallowed and the transaction will become immediately taxable. It is, of course, vital that any taxpayer seek the advice of tax professionals familiar with such transactions.

You can visit me check this out on my latest podcast at: https://anchor.fm/jeffrey-skolnick/episodes/Episode-13-Defer-taxes-on-real-estate-sales-e3ufca

Many people have a fear of April 15^th because they do not understand their tax return or how to make sure they have the right tax accountant. In this article I will explain things to look for in an accountant.

RETURN COMPLEXITY

The first thing you want to do before choosing an accountant is to assess the overall complexity of your own return.  If your return consists of nothing more than a few W2 forms, mortgage interest, real estate taxes and some charitable contributions then you may be able to file it yourself using a program such as Turbo Tax or utilize the services of a tax preparation company such as H & R Block.

If your return has some more complicated items such as a sole proprietorship business, income from “S” corps, LLCs, partnerships, trusts, estates  or some complicated investment items, then you most likely would benefit from the expertise of a professional tax preparer.

TAX PREPARER CREDENTIALS

As with anything else, not all tax preparers are created equal.  Understand the credentials of your potential tax preparer.  Are they a CPA or enrolled agent?  Both CPAs and enrolled agents have passed certain tests in which they have demonstrated a certain level of proficiency of tax laws at a point in time.  Both are also required to complete a certain number of continuing education hours each year in order to retain their accreditation.  Do they have any additional accreditations such as a Masters degree in taxation?  Again this would show that the preparer had to take certain classes focusing on complex tax issues.

TAX PREPARER EXPERIENCE

Think of tax preparers in some sense as doctors.  Just as doctors have a variety of specialties (you wouldn’t go to a cardiologist to treat your broken leg) accountants have specialties as well. I know CPAs who specialize in financial statement audits and have very little tax knowledge at all.  Some accountants may specialize in certain industries.  If an accountant specializes in service businesses (doctors, lawyers, engineers, etc.) you may want to think twice about using him/her if you own a contracting business.  Other things to consider are if you are a sole proprietor that works from home is the accountant well versed in home based businesses.  Lastly, you want to know how many years the accountant has been practicing.  If you have a complex return you probably do not want to use a tax preparer that has been practicing for only 2 or 3 years.

CONCLUSIONThis article gives a quick synopsis of some things I feel you should consider before choosing a tax preparer.  Obviously if you know anyone who has dealt with a particular tax preparer and has a similar situation as you do that is another great way to find a preparer.  Don’t ever be afraid to ask questions and interview your potential preparer.