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Economic Analysis: A Spreadsheet for the Employee Retention Tax Credit

Posted on Apr. 7, 2020

Preservation of the employee-employer relationship is a major objective of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). Two sections of the new law provide incentives for this. The first provides forgivable loans from the Small Business Administration under the newly created Paycheck Protection Program (PPP). The second provides a refundable payroll credit, usually called the employee retention tax credit (ERTC). Under the new law, employers eligible for both must choose one or the other.

This article describes the calculation of the ERTC and provides a user-friendly ERTC spreadsheet. A coming article will describe the borrower calculations related to the PPP and provide a spreadsheet.

Quick Comparison

The PPP (sections 1102 and 1106 of the act) is available to employers with 500 employees or fewer. There are employer-friendly exceptions to the 500-employee threshold. Self-employed individuals are qualified. Nonprofit organizations are qualified. The employer need not meet any quantifiable distress thresholds.

The maximum loan amount is the lesser of $10 million or prior-year average monthly “payroll costs” (salary plus certain benefits, prorated to exclude annual benefits exceeding $100,000 per employee) times 2.5. The loan can be forgiven. The amount of loan forgiveness is equal to the sum of payroll costs, interest, rent, and utilities paid over the eight-week period following origination of the loan. Under Treasury guidance, forgiveness cannot exceed 133 percent of payroll costs. Loan forgiveness is not included in taxable income.

The ERTC (section 2301 of the CARES Act, not in the Internal Revenue Code) is a refundable payroll credit available to employers in economic distress caused by the COVID-19 pandemic. The credit is equal to 50 percent of qualified wages subject to a $10,000-per-employee annual cap. So in general, the credit is $5,000 (with proportionately lower amounts for employees earning less than $10,000).

To be eligible, employers must either be partially or totally shut down under a government order or experiencing a decline in sales revenue of 50 percent. The credit is available to employers of all sizes, including section 501(c) organizations engaged in a trade or business, but not to self-employed individuals. For employers with more than 100 employees, the credit applies only to the salaries of employees who are not providing services to the employer because of COVID-19. Employers receive credits for wages paid, but there is no requirement to maintain overall employment or payroll levels. Employer deductions for wages are reduced by the amount of the credit.

Some preliminary analysis (not included here) indicates that in most cases, employers eligible for both the PPP and ERTC will find it more advantageous to choose a PPP loan over the ERTC as long as a significant portion of the loan is forgiven. If this analysis stands up to further scrutiny, the ERTC will primarily be used by large employers that do not qualify for the PPP.

Calculating the ERTC

For each employer, the determination of the amount of ERTC can be divided into three major parts. First, there is the overall determination of employer eligibility. Second is the determination of which (if any) calendar quarters in 2020 the employer is eligible to receive the credit. Third is the determination of creditable qualified wages, which may need to be calculated on per-employee and quarter-by-quarter bases. The spreadsheet that accompanies this article is divided into these three corresponding parts.

Employer Eligibility

To be eligible, the employer must be engaged in carrying on a trade or business in calendar year 2020. The employer may be any size (but a more restrictive definition of qualified wages applies to employers with more than 100 average full-time employees in 2019). The employer may be a section 501(c) organization (but more restrictive rules apply to determining eligibility in calendar quarters). The employer may not be a government or governmental organization. Self-employed individuals are not eligible.

There is no overall dollar limitation on the amount of credit an employer can receive. There is no requirement that an eligible employer maintain overall employment or payroll at any prior level.

Importantly, to be eligible an employer may not be a recipient of a loan under the new PPP administered by the SBA. So employers eligible for both must make the critical decision whether to apply for a PPP or to accept ERTCs.

There is no provision that blocks the ERTC if the employer is a recipient of other COVID-19 emergency-related loans, such as loans to large distressed businesses from the Treasury Exchange Stabilization Fund made available under provisions of the CARES Act or economic injury disaster loans from the SBA, whose availability under existing legislation was triggered by President Trump’s nationwide emergency declaration on March 13.

Eligible Calendar Quarters

Before delving into details, it is worth noting that for many — perhaps most — employers, determination of the ERTC does not require all the mathematical calisthenics suggested in the statute. For example, if in the calendar quarter that began on April 1, an eligible employer with 50 full-time employees in 2019 and 2020 paid all its employees at least $10,000, that employer would be eligible to receive a $250,000 refundable payroll credit (50 percent rate times $10,000 in wages times 50 employees) against the employer portion of Social Security tax liability incurred in the second calendar quarter in 2020. Done.

Modifying that example slightly, to the extent any employee was paid less than $10,000 in the second calendar quarter, credits would be available to the employer for wages paid to those employees in a following quarter.

What follows are the details that could matter in other cases, especially if employees are low-wage and the employer moves in and out of financial distress relatively quickly.

Employer eligibility for the credit is determined on a calendar-quarter basis. The credit may be available for any or all of the four calendar quarters of 2020. But which quarters?

There are two ways an employer may be eligible any quarter. The first does not involve any math. If the operation of the business is fully or partially suspended during the calendar quarter because of an order of a government authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) because of COVID-19, qualifying wages paid by the employer during that quarter qualify. So, as pointed out by an IRS FAQ, a sit-down restaurant that is under orders from a local official to provide food only for carryout or delivery would qualify under this provision. Employers who are 501(c) organizations may only qualify in any quarter under this criterion.

The second way to be eligible in any quarter is complicated. It is a gross receipts test comparing gross receipts in each calendar quarter of 2020 with the corresponding calendar quarter in 2019. An employer is eligible beginning in any 2020 quarter when gross receipts in that quarter are less than 50 percent of the gross receipts in the same 2019 calendar quarter. Employer eligibility continues until the employer has a calendar quarter with gross receipts greater than 80 percent of the level in the same quarter of 2019. That greater-than-80-percent quarter would be the last eligible quarter. So if an employer first becomes eligible in a quarter, that eligibility will span at least two quarters (unless the first eligibility quarter is the fourth quarter). The spreadsheet automatically determines eligibility under this method if quarterly gross receipts data for 2019 and 2020 are provided.

For example, if an employer is under orders to partially shut down business in March, April, and May (spanning two calendar quarters), the employer is eligible in the first and second quarters of 2020. If the employer’s gross receipts drop by 50 percent in the second quarter and don't attain 80 percent of their 2019 levels until the third quarter, the employer would also be eligible in the third quarter (assuming the employer is not a 501(c)).

Qualified Wages

For each employee of an eligible employer, “qualified wages” are wages plus allocable qualified health plan expenses. Wages for purposes of the ERTC are the same as the tax base for Social Security payroll taxes (under section 3121(a) of the IRC). Allocable qualified health plan expenses are amounts paid or incurred to provide and maintain a group health plan allocable to wages.

For the first quarter of 2020, only qualified wages incurred after March 12 are included. Excluded from wages is any paid or sick leave mandated and creditable under the Families First Coronavirus Response Act (P.L. 116-127). All wages of an employee are excluded if an employer is allowed a work opportunity tax credit for wages paid to that employee.

In no case can the cumulative creditable amount of qualified wages for any employee exceed $10,000. So in any quarter in which the employer is eligible, the amount of qualified wages is capped at the excess, if any, of $10,000 over the sum of qualified wages paid to that employee in prior eligible quarters.

Back to the Big Picture

While the PPP and ERTC try to maintain the employer-employee relationship, the extremely generous unemployment benefits available until July 31 under the CARES Act work in the opposite direction. In fact, many low- and mid-wage employees who lack employer-provided health insurance will find it monetarily advantageous to be laid off rather than remain on the job.

The national average weekly unemployment benefit in January 2020 was $385. On top of this regular benefit, the federal government is providing an additional $600 weekly benefit through July 31. A weekly payment of $985 works out to $24.63 per hour, which would total to a full-time annual salary of $51,220. The hourly wage of a fast food worker is typically between $10 and $12.

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