Since its introduction in 2020 as part of the CARES Act, the Employee Retention Tax Credit (ERTC) has been retroactively updated and expanded several times. These retroactive updates make the ERTC more accessible to companies struggling to find their financial footing after two tumultuous years.
However, the backtracking and numerous amendments to the original ERTC legislation has resulted in many outdated ERTC ideas being peddled by bloggers and YouTubers. Even some tax experts have joined the fray, misrepresenting and exaggerating facts about the ERTC to ensure that every customer qualifies, regardless of their actual ERTC eligibility. I hope to dispel some of these myths so you can get a clear picture of your potential ERTC eligibility.
Myth 1: I cannot claim ERTC if I received PPP funds
One of the most common misconceptions about the ERTC is that those who received funds through the Paycheck Protection Program (PPP) may not be eligible for Employee Retention Credit. However, although the CARES Act of 2020 initially prohibited PPP loan recipients from being eligible for ERTC, it was retroactively updated by the Consolidated Appropriations Act (CAA) of 2021 to allow PPP recipients to claim also ERTC, provided they meet the ERTC eligibility requirements.
There are, however, a few caveats to this update that you should consider before rushing to apply for the ERTC:
The Truth: You Can’t Use the Same Wages for PPP Debt Cancellation and ERTC Eligibility
Following the enactment of the CAA, you can now benefit from the ERTC using wages that were not paid using PPP loans. In other words, you cannot use the same salaries for PPP debt cancellation and ERTC eligibility calculations. However, it is possible to have sufficient payroll to benefit from both ERTC and PPP loan cancellation.
For example, suppose Company A received a second PPP loan on January 10 for $300,000, or 2.5 times its average monthly payroll costs. Their covered period will begin on January 10 and end on June 26, making 24 weeks in total.
Let’s say 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 that it doesn’t). there are no other eligible expenses for the PPP exemption), translating to $21,400 per week or $2,400 per employee.
If Company A is an eligible employer for the ERTC in the first quarter of 2021, it can use the first five weeks of its 2021 payroll to meet the eligible salary amount for the ERTC. Indeed, during the first 5 weeks, each of Company A’s employees will generate $12,500 and will be capped at the maximum quarterly salary of $10,000 per ERTC employee in 2021. Company A can then use the remaining weeks payroll until the amount needed to forgive the PPP debt from the second drawing is reached.
Myth #2: Being closed qualifies me for the ERTC
Not all stops are equal when it comes to ERTC eligibility. Throughout 2020 and 2021, some businesses closed due to a government mandate while others closed due to coronavirus-related safety measures. If I were to sit down and review your ERTC eligibility, only the first scenario would qualify.
A critical phrase that is overlooked in many discussions between many tax professionals and clients is “…due to a government order”. The temporary closure of your business is insufficient to qualify for the ERTC. Instead, your closure must be tied to a government order that specifically requires your business to close completely or partially to restrict more than a nominal portion of your business.
What is considered a government-ordered shutdown?
Opinions on what qualifies as a stay are circulating the internet these days, so let’s step back and look at an IRS notice (Notice 2021-20, page 25) for an official definition of a qualifying stop. Examples include:
- — A mayoral order stipulating that non-essential businesses must close for a specified period
- — A local ordinance that imposes a curfew on residents that impacts a business’ hours of operation for a specific period
- — An order from a local health department requiring the closure of a business for cleaning and disinfection purposes. (Note: Example 3 on page 27 of Notice 2021-20 clearly indicates that this only applies to COVID-19 scenarios, not general cleaning or sanitation)
What is considered a nominal part of business operations?
If your business was deemed non-essential, it is quite simple to tie your business closure to a specific government mandate. For essential businesses, however, the IRS only allows possible ERTC eligibility if a nominal portion of their business has been affected due to a government mandate. By reviewing Notice 2021-20 (pages 27-28), we can get some insight into what the IRS considers a “nominal portion” of business transactions:
- — The gross receipts of the affected part of your business represent at least 10% of your total gross receipts before the pandemic
- — The hours of service performed by employees in this sector of your business represent at least 10% of the total number of hours worked by all employees of your business.
Both of these calculations should be determined using gross revenue amounts or the number of hours worked by employees in the corresponding calendar quarter in 2019.
Myth #3: There is no need to document why I am eligible because the IRS is too busy
It is tempting to ignore the need for documentation in the rush to determine ERTC eligibility. But that only sets you up for disaster later. As any tax professional will tell you, documentation is the best defense in an audit. You must support your determination of ERTC eligibility with carefully maintained records. Here are a few tips:
- — Because the ERTC is a very lucrative tax credit, you can expect the IRS to perform a significant number of audits in the coming years.
- — Documenting each of your ERTC claims is not optional, but necessary if you plan to go through an IRS audit regarding your ERTC eligibility. If your claim is based on a drop in gross receipts, stick to the financial statements that show the drop. If you qualify on a suspension basis, keep a copy of the government order that specifically forced you to fully or partially shut down your business.
Complete documentation is essential to ensure that the likely increase in ERTC audits does not pose a problem for you.
Myth #4: I may be eligible for ERTC because my provider has been shut down
This is a dangerously clever inaccuracy that is used to wrongly qualify companies for the ERTC. The reasoning goes like this: “If I rely on supplier A to provide my service and it is closed, I can benefit from the ERTC because my business operations have been affected.” This is somewhat true, however, there are caveats given by the IRS that are not represented in the statement above. In IRS Notice 2021-20 (page 29), we can get the following information from the Employer A example in question 12:
- — Your supplier must have been closed due to a government order, indicating that being closed for non-mandatory reasons is not sufficient
- — You are unable to obtain service or materials from another provider, indicating that if a provider is closed, you should endeavor to find another provider before using the closure of your provider to qualify for ERTC
- — You may only be eligible for the period during which the supplier’s operations have been suspended.
In this article, I’ve 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: this is a great tax opportunity that every business should explore.
Cassidy Jakovickas, CPA, is President and CEO of MBS Accountancy Corp. in downtown Fresno.