Once upon a time, in a Congress not so long ago, there was a relatively little credit to help businesses retain their employees during a mandated business operation suspension, as well as a big forgivable loan program designed to encourage small businesses to pay their employees. The credit and the loan program lived on opposite sides of the forest and were at first not allowed to play together. Their way across the forest was blocked by a mean witch. The Congress called her “Jay.”
When Christmas arrived, the munificent fairies of the Capitol decided that the little credit and big loan program would be good playmates, and that really, they should have been playing together all along. The nasty old witch disappeared. Because this is an American fairy tale, she was squashed by a House. The friendly tax practitioners who lived in the woods and the IRS elves were left to supervise recess. This is the start of the story of how the employee retention credit grew and learned to play nicely with the loan program.
In a real fairy tale, the governing rules are largely implicit. The rules that govern the interaction between the ERC and the Paycheck Protection Program, however, must be extremely clear, and the IRS must slay some dangerous beasts in the forest for taxpayers who have already taken out PPP loans and now would like an ERC, too. Congress could have made things play out a little more happily ever after, but the tax law is never a fairy tale, and things don’t always work out quite the way they should.
A potentially unhappy ending to our tale arrives via the Consolidated Appropriations Act, 2021 (P.L. 116-260), at least for some taxpayers. The removal of subsection 2301(j) cleared the way for them to both reap the benefits of the ERC and receive a PPP loan in 2020, but only if they’d taken out a PPP loan and only if there are wages not paid for with forgiven PPP proceeds.
Congress explained that “the amendments made by this section shall take effect as if included in the provisions of the [Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136)] to which they relate.” Taxpayers that received PPP loans but also paid wages that weren’t paid for with those loans can now claim the ERC for those wages paid in previous quarters on their fourth-quarter 2020 payroll tax filings.
The terms of the PPP and the ERC meant that those who would qualify for each overlapped, but eligibility for the programs wasn’t completely coextensive. The PPP generally allows businesses with fewer than 500 employees to borrow 2½ times their monthly payroll expense, up to $10 million. If a specified portion of the loan amount is used for payroll costs, the loan is forgivable tax free. The PPP provided $525 billion in loans over five months.
To qualify for the ERC of 50 percent of up to $10,000 in wages for each eligible employee under the CARES Act, employers had to have had their operations suspended by a government order or had a greater than 50 percent reduction in quarterly receipts. If a business had 100 or fewer employees, the credit was available for eligible wages of all employees, but businesses with more than 100 employees could take a credit only for wages paid to employees who were furloughed or had their hours reduced.
The retroactive, one-way coordination with the PPP is broadly consistent with the rest of the changes Congress made to the ERC, intending to make it more generous even though it leaves out taxpayers who would have qualified for the PPP but decided not to take out a loan and to take the credit instead.
The Consolidated Appropriations Act also increased the credit rate from 50 percent to 70 percent of qualified wages; expanded eligibility by reducing the percentage of the required year-over-year gross receipts decline; increased the limit on creditable wages per employee; increased the cutoff for determining the qualified wage base from 100 to 500 employees; permitted advancing the credit for businesses with 500 or fewer employees; and allowed new employers who weren’t in business or started their business in 2019 to claim the credit. The bill included two other clarifications regarding the determination of gross receipts for tax-exempt organizations and the treatment of group health plan expenses.
Legislative History
The legislative history is minimal, but two points emerge from the brief Senate discussion of the credit and statements issued by the sponsors of the proposal to expand the credit and make it retroactive. First, and most importantly for the administration of the new statutory rules, the goal was to keep taxpayers from having to amend the payroll tax returns they filed in 2020. This wasn’t a main focus of the discussion by legislators, but it’s probably the most practically important piece of information from the legislative history.
Second, if any member of Congress worried that taxpayers who would have been eligible for a PPP loan could have taken them at their word in March and opted to take the ERC instead, they never said so. There appears to have been no explanatory discussion in March 2020 for why Congress added subsection (j). The sparseness of the legislative history on the retroactive removal of the impediment to claiming the credit is offset by the rest of the changes to the credit being intended to greatly expand it.
Senate Finance Committee ranking member Ron Wyden, D-Ore., proposed the expansion of the ERC with the retroactive piece for borrowers through the PPP. Wyden called the economic situation “an extinction-level event for small businesses,” and labeled critical the need to ensure that businesses could access relief from both the PPP and the ERC. House Ways and Means Committee Chair Richard E. Neal, D-Mass., agreed that the changes to the ERC were significant improvements.
On December 21, 2020, Wyden and Finance Committee Chair Chuck Grassley, R-Iowa, had a colloquy on the Senate floor in which Grassley asked if Wyden agreed that “our intent is to allow struggling small businesses to access the retention credit, even if they have received a PPP loan?” Wyden agreed and explained that businesses that had PPP loans forgiven could claim the credit for wages that were not paid for with PPP loan proceeds and that businesses that don’t have their loans forgiven could claim the credit for any wages (166 Cong. Rec. S7924). Grassley added that the point was to prevent small businesses from having to amend their previously filed payroll tax returns and alleviate some of the burden on taxpayers and the IRS.
Avoiding Taking a PPP Loan?
Some businesses may not have applied for a PPP loan because they wanted the ERC, and that would make the Consolidated Appropriations Act a less than perfectly happy ending for them. However, it appears that most businesses that were eligible for PPP loans took them.
There were 30.7 million small businesses — defined as those with fewer than 500 employees — in the United States at the start of 2019, according to the Small Business Administration. The SBA reported that the total number of firms that received loans in fiscal 2020 was 5.2 million. Many of the small businesses that didn’t receive loans were likely excluded from the PPP to begin with. One study estimated that 70 percent of eligible businesses applied for and received PPP loans.
Congress may have correctly assumed that many of the businesses that qualified for the ERC applied for and received PPP loans, since in many cases the PPP would have been more favorable. If most did, the retroactive nature of the credit doesn’t unduly disadvantage that many businesses, if any. It’s simply an added benefit for those that had already qualified for the PPP loans.
But by forcing employers initially to choose between the credit and the PPP and then making the credit available for employers that chose the loan, Congress might have disadvantaged taxpayers that did the opposite. The relative arbitrariness in how these provisions developed can probably be excused given the circumstances under which Congress made its legislative choices, but it’s not ideal.
The Joint Committee on Taxation estimated that the CARES Act version of the credit would cost $54.5 billion (JCX-11R-20) and that the Consolidated Appropriations Act extension and modification of the credit would add $5 billion in revenue costs. Plenty of PPP borrowers therefore stand to benefit from the retroactive removal of the impediment to taking the credit. The JCT included the other retroactive changes to the ERC in the $5 billion addition, which means that it also comprises retroactive “clarifications” about how tax-exempt organizations determine gross receipts and inclusion of group health plan expenses in the definition of qualified wages even if the employee wasn’t paid any other wages.
Merger Issue
Other issues with the original, mutually exclusive approach to the PPP and ERC suggest why Congress might have changed the rules. The American Institute of CPAs pointed out to the IRS that one difficulty with the mutual exclusivity of the PPP and the ERC was that businesses that merged in 2020 could find themselves having to repay ERCs taken by one of the merged entities if the other entity had taken out a PPP loan. The AICPA noted that this would “effectively increase the cost of the acquisition, which may make the acquisition unviable.”
The Administrative Burden
Grassley and Wyden said in their colloquy that they hoped businesses that received PPP loans and the IRS wouldn’t be overly burdened by determining eligibility for and amount of the newly retroactive ERC. But the legislative text created more work for the IRS and Treasury before anyone starts to file returns seeking the retroactive credit.
For taxpayers, checking eligibility might not be such an easy process, even though claiming the credit doesn’t involve amending prior payroll tax returns. The information employers needed to gather to apply for the PPP doesn’t really overlap with that required for the ERC.
The problem for the IRS and taxpayers is that once an employer clears the eligibility hurdle, guidance is needed on what is in and out of the credit because the statute is unclear. Section 206(e)(2)(A) of the Consolidated Appropriations Act explains that employers can claim the retroactive credit by electing to treat any applicable amount as an amount paid in the fourth quarter of 2020.
The “applicable amount” is defined as wages described in section 2301(c)(5)(B), or permitted to be treated as qualified wages in guidance issued under section 2301(g)(2), of the CARES Act as added by the Consolidated Appropriations Act. They must have been paid in a quarter beginning after December 21, 2019, and before October 1, 2020, and not already taken into account in calculating the ERC.
Section 2301(g)(2) says future guidance will state that payroll costs paid during the covered period will be treated as qualified wages to the extent a covered PPP loan isn’t forgiven, as long as there’s an election in place not to take the wages into account. But as Anthony J. Nitti of RubinBrown LLP pointed out, section 2301(c)(5)(B) refers only to specific health plan expenses being taken into account as qualified wages. This means that the applicable amount is either health plan expenses or wages uncovered by a PPP loan, not both. That choice isn’t what legislators advertised. The headline was that employers who took PPP loans could have the credit “with respect to wages that are not paid for with forgiven PPP proceeds.”
Taxpayers would benefit more from claiming a credit on the qualified wages that aren’t forgiven as payroll costs under the PPP as well as health plan expenses. Whether they can will be either answered by Treasury and the IRS or clarified by Congress in a technical correction. The likeliest scenario is that the elves at Treasury and the IRS will work their magic.