More Than Just PPP Forgiveness Now: Employee Retention Credit eligibility
It has only been 65 days since President Trump signed the final stimulus bill of 2020. With the exception of Patrick Begorra, who makes his home at Disneyland, we’ve never actually seen a leprechaun. However, the pot of gold at the end of the rainbow created by the Consolidated Appropriations Act (“CAA”) is slowly getting easier and easier to see.
Unlike the leprechaun’s gold, you don’t need to go on a frustrating and potentially pointless quest. Instead, you just need patience and planning. With a little bit of both, this pot of gold should come to you.
Before we get into details, we need to make something clear: This is potentially a very big pot of gold. We start with forgiveness of the original PPP loans and then from the CAA we add version two of the Employee Retention Credit (for both 2020 and the first half of 2021) plus forgiveness of PPP second draw loans. And just last week we learned that Congress is considering version three of the ERC (Employee Retention Credit eligibility) which will run through the end of 2021. In just the right (and admittedly rare) circumstances, payments to and for a single employee could result in loan forgiveness and tax credits of over $100,000.
That’s a lot of gold. So, you won’t be surprised that it requires a lot of patience and planning.
We’re almost sure that we don’t need to remind you. Almost. So, one more time:
The earliest that a PPP loan payment can be required is 10 months after the end of the 24-week covered period. That’s a little more than 15 ½ months after funding. So, if your PPP loan funded on 5/1/2020, the earliest a payment could be due is 8/16/2021.
When you apply for forgiveness, all payments are automatically deferred until both your lender and the SBA have completed their reviews of your loan forgiveness application. That could take up to 5 months.
By the way, you could wait until two years after funding to apply for loan forgiveness, but you might have to make payments or apply separately for a payment deferral.
Ok, so you agree that you can wait to apply for forgiveness. Why do you want to? We will get there. We promise. But first let’s consider what happened to those who listened to their well-meaning but over eager bankers or itinerant tax credit consultants instead of their ever faithful, trusted, and at least so far, seemingly clairvoyant accountants.
Case Study 1
Hypothetical Company A has great management. Despite California’s restrictions, the company was able to maintain its pre-pandemic employment practices, no cuts to salaries or pay rates and no reduction in hours. This means the company’s payroll during the covered period was more than double its loan amount. And, when you consider the eligible non-payroll costs, the total expenditures eligible for forgiveness could be over 3.6 times the loan amount. Knowing that full forgiveness was practically locked in, company A jumped to apply for forgiveness soon after the bank’s portal became available. To keep things simple, the forgiveness application only listed the payroll for the entire 24 week covered period. After a minimum hassle, company A received full forgiveness. Both the company and its banker are happy.
But should they be?
Let’s consider what could have gone wrong. While it’s possible that company A will have no trouble qualifying for the 2020 ERC using wages outside of the covered period, it’s also possible that it won’t. Do you remember the first lockdowns? They line up nicely with most borrowers’ covered periods. And, since significant operational restrictions are one of the two ways to qualify for the ERC, let’s assume these are the only wages that company A can use. We recognize that this is the worst possible case. The credit lost could be up to $5,000 per employee.
Wait a second, you say. How can all those extra wages be ineligible for the ERC? Because Treasury says they are. Specifically, it’s Treasury’s position that company A made an irrevocable election to forego the ERC on any wages listed on the loan forgiveness application. If you think this is unfair, the AICPA agrees with you. It has been lobbying Treasury on the issue for months. We are not optimistic. When Treasury decided that PPP loan forgiveness should be taxable despite clear language in the CARES Act to the contrary, no amount of lobbying was sufficient. It literally took a second act of Congress to get Treasury to comply.
We hope that President Biden and Congress will support small businesses in line with their rhetoric. However, since over a third of the current stimulus bill is made up of direct payments to states, we wonder where their future focus will be. And in any case, the recent guidance from Treasury and the SBA reminds us of early PPP guidance that was anything but business friendly. We hope that President Biden will nudge the pendulum back in favor of small businesses.
And there’s another problem. We haven’t talked about California. Even though California is projecting a budget surplus of at least $15 billion, both the legislature and the FTB want your PPP loan to be taxable in 2020. By applying for and receiving forgiveness, company A has guaranteed them just that. The issue of California taxation of the PPP could be a blog post of its own. Trust us when we tell you that nothing is settled. There are multiple bills pending before the legislature and there are many strong opinions about what last year’s AB 1577 actually accomplished. Stay tuned.
Case Study 2
Hypothetical company B isn’t doing as well as company A. Using a combination of safe harbors and eligible non-payroll costs, it has just enough in eligible expenditures to receive full forgiveness.
But that was before it applied for the ERC. Let’s assume it receives the full $5,000 credit for 2020 and that the wages again came from the covered period. How much loan forgiveness did company B lose? In 2020, the ERC (Employee Retention Credit eligibility) rate is 50%. That means that it takes $10,000 in wages to get a $5,000 credit. When we divide the $10,000 in wages by 60%, we see that the wages also support up to $6,667 in additional forgiveness related to non-payroll expenditures. So, in extreme cases, the $5,000 of ERC could cost company B over three times as much in loan forgiveness. And to add insult to injury, company B must reduce its payroll deductions by the $5,000 credit received.
Ouch. Either one of those hypotheticals hurts. A lot.
For both company A and company B, similar arguments will apply in 2021. But the stakes could be even larger since the ERC can be up to $7,000 per quarter for the first half of the year. We will have to wait and see what Congress does for the third and fourth quarters.
Case Study 3 – What you should do now.
First be patient. We still believe that the forgiveness process will continue to become more streamlined and more certain over time. We are still hopeful that we will receive additional guidance about pay rate and FTE safe harbors, particularly those added by the Paycheck Protection Program Flexibility Act. We are also hopeful that we will receive significant guidance about qualifying for the ERC under the “partial shutdown” or significant restriction of operations standard. And, finally, we know that a $1.9 trillion stimulus bill is on its way. Who knows what its final form will be or what Congress will fancy in the next few months?
Second, plan, plan, and plan. We have shown you how interrelated the PPP and ERC can be. These are simple examples. Each business will have its own unique challenges when trying to maximize both PPP loan forgiveness and eligibility for the ERC. In general, the best approach will be to maximize loan forgiveness first, and then use any leftover payroll costs for the ERC.
So, what should you do? Take a deep breath, be patient, plan, and watch this pot of gold come to you.
As always, if you have questions about your specific situation, please don’t hesitate to contact your LSL partner or team member.
Happy Saint Patrick’s Day!
Employee Retention Credit eligibility