Imagine you parked your 2015 Dodge Durango in the driveway one night and the next day you found a 2021 Porsche Cayenne in its place. Miracle of miracles, your barely adequate vehicle has been replaced with a really fine ride. Well, that’s an especially fanciful fairy tale in this depressed economy. But Congress, with its endless ability to borrow, can make dreams come true for many distressed employers. It is poised to upgrade the lackluster employee retention tax credit (ERTC) with a turbocharged version that could quadruple (or more) its old value.
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), the usual amount of ERTC per employee is the maximum credit of $5,000. Under the Health, Economic Assistance, Liability Protection, and Schools (HEALS) Act, released by House Republicans on July 27, the usual credit amount would be $19,500. Under the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act (H.R. 6800), passed by the Democrat-controlled House on May 15, the maximum ERTC amount is $36,000 per employee (attainable for any employee with an annualized salary of at least $45,000).
With the bigger money amounts and other pro-taxpayer modifications to the ERTC in the works, it raises a question: Why should Congress retain the CARES Act employment incentive that has caused so much confusion and stress for banks, accountants, employers, and the public? The Paycheck Protection Program (PPP) has disbursed more than $0.5 trillion of loans, most of which will likely be forgiven. Of course, that money has done much to stimulate the economy and keep employees on payrolls. But its success has largely been achieved by throwing money at a problem, not through wise decisions about the program’s design and implementation. Now that there is bipartisan agreement on extending a more rational alternative, why not allow that program to play itself out and reroute the proposed additional funding for the PPP to the ERTC?
Hurricanes and a Pandemic
In December 2005 Congress first enacted an ERTC as a temporary general business credit against income tax for employers affected by hurricanes Katrina, Rita, and Wilma (P.L. 109-35). The maximum credit per employee was $2,400 (40 percent of wages up to $6,000). In September 2017 Congress provided a similar credit for employers affected by hurricanes Harvey, Irma, and Maria (P.L. 115-63). And in February 2018, it enacted the credit again as relief for businesses affected by the 2017 California wildfires (P.L. 115-123).
The ERTC in the CARES Act that became law on March 27 is a temporary refundable credit against payroll tax. To be eligible, an employer must be carrying on a trade or business during 2020 and satisfy either a governmental order test or a reduced gross receipts test. Under the first test, the operation of the business is fully or partially suspended during the calendar quarter under government orders that limit commerce, travel, or group meetings because of COVID-19. Under the second test, the business qualifies in any quarter and any succeeding quarter in 2020 if, in the first of those two quarters, gross receipts have declined by more than 50 percent from the corresponding quarter of 2019. The business ceases to be eligible if gross receipts in a quarter in 2020 exceed 80 percent of gross receipts in the corresponding quarter in 2019. A section 501(c) organization qualifies only if it carries on a trade or business. The credit rate is 50 percent, applied to qualified wages, which cannot exceed more than $10,000 per employee. Earnings of self-employed individuals don’t qualify as eligible wages.
Wages used to compute qualified sick leave and extended family medical leave credits under the Families First Coronavirus Response Act (P.L. 116-127), enacted in early March, aren’t eligible for the ERTC, and wages of employees receiving the work opportunity tax credit aren’t eligible for the ERTC.
PPP Over the ERTC
Except for part-timers who will make less than $10,000 in 2020, the ERTC can be considered a flat $5,000 per-employee tax credit. In contrast, loan forgiveness under the PPP varies with payroll cost. Specifically, the PPP provides loans equal to 2½ months of payroll costs, limited to $100,000 (annualized) of wages per employee plus benefits (not subject to any limit). Those loan amounts are forgiven if the employer expends that amount on payroll costs, rent, utilities, and interest over the eight weeks after disbursement (under the original CARES Act) or over 24 weeks (under the Paycheck Protection Program Flexibility Act (P.L. 116-142), signed into law on June 5). With a few exceptions, eligible borrowers may not have more than 500 employees, and the maximum loan amount may not exceed $10 million.
According to March 2020 statistics from the Department of Labor, the average annual salary for a full-time employee in the United States is about $54,000. Assuming employee benefits equal to 20 percent of salary, average annualized per-employee payroll costs for a full-time employee equal approximately $65,000. For 2½ months, that amounts to $13,500. For an employer paying average salaries of $150,000, and again assuming employee benefits equal to 20 percent, the average annualized per-employee payroll cost would be $100,000 plus 20 percent of $150,000 — that is, $130,000. For 2½ months, that amounts to about $27,000 of loan forgiveness per employee. Figure 1 compares the per-employee benefits of current-law ERTC with the PPP for different annualized payroll costs.
![Figure 1. Per-Employee PPP Loan Forgiveness and Current-Law Per-Employee ERTC](http://s3.amazonaws.com/binary.taxnotes.com/image/2020/2020-29160-1_webl-2020-29304.png)
Assuming the ERTC and PPP are both subject to tax, the PPP is preferable if annualized payroll costs exceed $24,000, as indicated in Figure 1 by the intersection of the horizontal line (indicating the benefits of the ERTC) and the lower upward-sloping line (indicating the benefits of PPP loan forgiveness).
The tax status of PPP forgiveness is uncertain. In Rev. Proc. 2020-32, 2020-24 IRB 930, using the principle that expenses giving rise to tax-exempt income shouldn’t be deductible, the IRS ruled that payroll costs and other expenses giving rise to loan forgiveness aren’t deductible, effectively eliminating the benefit of tax-free loan forgiveness ostensibly granted in the statute. It is almost certain that Congress will negate the IRS ruling, especially now that the Joint Committee on Taxation has determined that the official revenue cost of such a provision will be zero.
For a taxpayer with a 32 percent marginal income tax rate, tax-free loan forgiveness of $100 is worth about $147 (100/(1 - 0.32)) before tax. In Figure 1, the upper upward-sloping line assumes the average tax rate of the PPP beneficiary is 32 percent. The benefit of the PPP relative to the ERTC is even greater. In this case, a taxpayer eligible for both benefits will choose the PPP as long as annualized payroll costs exceed about $16,300.
ERTC Over the PPP
The proposed changes to the ERTC are summarized in Table 1. The proposed increases in the credit amounts are striking. Under current law the ERTC is regarded as welcome, but it isn’t generous and it is far overshadowed by the larger benefits available under the PPP. It is sort of a consolation prize for large companies that cannot qualify for the PPP. Those proposed changes move the ERTC out of the shadows and into the limelight.
Under the current Senate Republican plan, the maximum amount of credit increases to $19,500. This maximum amount is easily attainable for full-time employees (paid at least $10,000 per month). Under the House-passed Democratic plan, the maximum amount of credit increases to $36,000. This maximum amount is attainable for employees who are paid at least $15,000 per month. Figure 2 compares the ERTC maximum per-employee benefits under these two plans with the per-employee benefits of the PPP, under the realistic assumption that Congress will legislate tax-free status for PPP loan forgiveness. For the Senate Republican plan, the PPP will now be more generous only if per-employee payroll costs exceed $64,000, indicated by the intersection of the upward-sloping line and the lower horizontal line in Figure 2.
![Figure 2. Per-Employee Tax-Free PPP Loan Forgiveness and Per-Employee ERTC Under the HEROES and HEALS Act](http://s3.amazonaws.com/binary.taxnotes.com/2020/2020-29160-2_webl-2020-29305.png)
Under the current House-passed HEROES Act, the maximum amount of credit increases to $36,000. Under this proposal, the PPP will now be more generous only if per-employee payroll costs exceed about $117,600, indicated in Figure 1 by the intersection of the upward-sloping line and the upper horizontal line.
Unlike current law, the two proposals wouldn’t force employers to choose between the PPP and the ERTC, but would allow them to qualify for both as long as they don’t use the same payroll costs for both benefits. So under these Republican proposals, an employer could receive the full benefit of the PPP in the second quarter of 2020, for example, by repaying $100,000 per employee of payroll costs by June 30 and receiving about $20,000 of tax-free loan forgiveness; the employer could then qualify for $10,000 of ERTC in each of the third and fourth quarters of 2020.
| HEROES Act | HEALS Act | |
Credit amount | 50 percent of qualified wages for each employee for the calendar quarter | 80 percent of qualified wages for each employee for the calendar quarter | 65 percent of qualified wages for each employee for the calendar quarter |
Per-employee limitation (total, not per quarter) | $10,000 of total wages per employee ($5,000 per- employee credit limit) | $45,000 of total wages per employee ($36,000 per- employee credit limit) | $30,000 of total wages per employee ($19,500 per- employee credit limit) |
Threshold for treatment as large employer* | 100 employees | 1,500 employees (or receipts > $41.5 million in 2019) | 500 employees |
Phase-in for eligibility | Starting at 50 percent loss in gross receipts in a calendar quarter, compared with prior year’s quarter; ends once gross receipts are 80 percent of receipts in a quarter, compared with prior year’s quarter | Starting at 10 percent loss in gross receipts in a calendar quarter, compared with prior year’s quarter; ends once gross receipts are 90 percent of receipts in a quarter, compared with prior year’s quarter | Starting at 25 percent loss in gross receipts in a calendar quarter, compared with prior year’s quarter; ends once gross receipts are 80 percent of receipts in a quarter, compared with prior year’s quarter |
Partial credit? | No | Yes, for businesses with a loss in gross receipts between 10 and 50 percent; full credit available beyond 50 percent | No |
Employers can elect alt quarter for gross receipts eligibility? | No | No | Yes |
Clarification on group health plan expenses as qualified wages? | No | Yes | Yes |
State/local governments eligible? | No | Yes | No |
PPP recipients eligible to use ERTC? | No | Yes (with protection against double dipping) | Yes (with protection against double dipping) |
Provisions apply | March 12, 2020 | March 12, 2020 (“as if included in section 2301” of the CARES Act) | July 1, 2020 (some amendments apply March 12, as if included in the CARES Act) |
ERTC ends | January 1, 2021 | January 1, 2021 | January 1, 2021 |
Cost estimate | ??? | ||
*Large employers can take the credit only for the wages of employees who didn’t work in a given calendar quarter, while employers under the threshold can take the credit for all employee wages. Source: Andrew Lautz of the National Taxpayers Union. |
Simplify
Figure 2 shows that the House-passed plan is more generous than the PPP in most cases. According to the latest Small Business Administration figures, $130 billion is still available to lend under the PPP program. If $100 billion of that was redirected to the Senate Republican plan’s ERTC, it could easily be made as generous as the House plan.
Congress isn’t doing anybody — particularly small businesses — any favors by providing two benefits with identical policy goals and arbitrary differences in technical details and administrative procedures. Their redundancy creates needless complexity. Congress should consider taking the SBA and lenders out of the business of giving money away. Let them provide guaranteed loans, but forget about the forgiveness. Right now, there is bipartisan support for a significant expansion of the ERTC. The IRS has a long history of providing tax incentives. Let that agency be the one-stop shop for employment incentives.