Answers to 12 Employee Retention Credit (ERC) QuestionsTax Planning
As you likely know, it’s not too late to file for the ERC. And now is a good time to get this done.
You can qualify for 2020 credits of up to $5,000 per employee and 2021 credits of up to $7,000 per employee for each of the first three quarters. That’s a possibility of $26,000 per employee.
How many employees did you have during 2020 and 2021? John had 10, for example, and he qualified for $260,000 of tax credits (think cash). You could be like John.
With this in mind, here are answers to 12 questions.
I received my ERC money, but I made a mistake in applying for it. How do I return the money?
Answer 1. You should create an amended Form 941-X correcting the error or multiple 941-Xs correcting the errors. (Yes, this could mean that you are filing a 941-X amending a prior 941-X—no problem.)
- You pay separately for each 941-X.
- You can pay using the Electronic Federal Tax Payment System (EFTPS), by credit or debit card, or by a check or money order.
- Send the 941-X via certified mail to the appropriate location listed on page 6 of the instructions.Note that there’s a special address on page 6 if you use a private delivery service such as FedEx or UPS.
For the ERC aggregation rules, do I include all the business entities I own—even those with no employees?
Answer 2. Yes. And this includes those real estate rentals that you treat as businesses rather than as passive investments.
We filed our 2020 and 2021 S corporation income tax returns. We are now preparing 941-Xs to claim the ERC, which will increase our reported income in those prior years. When do we amend the 2020 and 2021 corporate returns to reduce the wages?
Answer 3. You have until March 15, 2024 to amend the 2020 S corporation return. You could amend now, but we
recommend waiting until you receive the ERC monies, for two reasons:
- You may not yet have the money needed to pay the increased federal income taxes caused by the ERC, which you will receive later.
- You may not receive the money—this is unlikely, but possible for a variety of reasons.
Under the ERC aggregation rules, we have two companies to aggregate. One of the companies started on July 1, 2019. How does that work?
Answer 4. For the July 1, 2019, company, you use the gross receipts from the third quarter of 2019 as the gross receipts for quarters one, two, and three, and the gross receipts of the fourth quarter of 2019 for the fourth quarter.
In the quarter when I suffered a partial shutdown, does that shutdown also carry over to the next quarter? For example, for a shutdown in Q4 2020, does that carry over to Q1 2021?
Answer 5. No, no, no. First, the ERC for a shutdown applies only to the time of the shutdown. Thus, there’s likely no full quarter for Q4 in your question. For example, if you were shut down for three weeks in Q4, you can qualify for the ERC under the shutdown rules for those three weeks only.
The North Carolina governor issued a state of emergency order requiring a shutdown. It lasted for one week. What’s my ERC qualification?
Answer 6. You have one week of qualification under the shutdown order. But you may have much more should you qualify under the decline-in-gross-receipts test.
Ignoring the test for a “significant decline” in gross receipts, is the COVID-19 shutdown effect on a business defined only by gross receipts?
Answer 7. No, for the government-ordered shutdown, you have three possibilities for determining the effect:
- Demonstrate by facts and circumstances that you suffered either a more-than-nominal effect or, in the case of a modification, an inability to provide goods and services.
- Use the safe harbor for nominal effect. This requires looking at either your 2019 quarterly receipts or your 2019 quarterly hours worked by employees.
- For the modification safe harbor, the IRS deems that the federal, state, or local COVID-19 government order had a more-than-nominal effect on your business if it reduced your ability to provide goods or services in the normal course of your business by not less than 10 percent.
Is the “ability to provide goods or services” demonstrated by production volume or unit sales?
Answer 8. The IRS says this is a facts-and-circumstances test. To use this safe harbor means you need a reasonable basis that demonstrates a 10 percent or more reduction in your ability to provide goods or services.
Production volume and unit sales seem like good candidates to demonstrate the effect of the government order that modified your ability to provide goods and services.
To qualify under the modification of our business, does the supply of rubber need to suffer by not less than 10 percent?
Answer 9. No. It’s the effect the COVID-19 government shutdown order had on your business’s ability to provide goods and services because it could not obtain the rubber.
If there was no shutdown order and no reduction in income or profit, could a business still qualify for the ERC?
Answer 10. Possibly, but unlikely. Without a shutdown order, you have to compare the gross receipts quarter by quarter to those in 2019. You need a drop of more than 50 percent in 2020 and a drop of more than 20 percent in 2021 to trigger any ERC.
If inside dining was more than 10 percent of revenues prior to the shutdown, does the business qualify for the ERC during the shutdown even if it has three times the profit and revenues?
Answer 11. You determine nominal effect by looking back at the 2019 numbers, and if the shutdown action affected not less than 10 percent of the quarterly revenues or hours of work, you earn the ERC for the time of the shutdown. For this test, you are not looking at 2020 or 2021. You look at 2019.
So, yes, you can qualify for the ERC even with larger profits and revenues.
I am a home builder. My generally accepted accounting principles (GAAP) financials, which are based on the percentage-of-completion method, show that my total revenues in 2021 are significantly higher than those in 2019.
But my 2021 quarterly income tax revenues compared with 2019, which are based on the completed-contract method, show a greater than 20 percent decline in quarters one and three.
It seems wrong to me that I qualify for the ERC.
Answer 12. First, yes, you do qualify, because the ERC is based on Section 448(c) of the tax code, and that uses your tax accounting method.
Now that you know you qualify, you have two choices:
- Thank the government for the gift, claim the ERC, and take the money.
- Satisfy your guilt by not claiming the ERC.
You claim and adjust the ERC using IRS Form 941-X.
For an S corporation, you can file the Form 941-X anytime before March 15, 2024 (three years from the due date for the Form 1120-S).
You have three ways to qualify for the ERC:
- Significant decline in gross receipts. Here, you compare the gross receipts quarter by quarter to those in 2019. You need a drop of more than 50 percent in 2020 and a drop of more than 20 percent in 2021 to trigger any ERC.
- Government order that causes more than a nominal effect. Here, your best bet is to use the safe harbor for nominal effect. This requires looking at either your 2019 quarterly receipts or your 2019 quarterly hours worked by employees and seeing that the shutdown order affected these figures by more than 10 percent.
- Government order causes a modification to your business. Here, you also have a safe harbor. The IRS deems that the federal, state, or local COVID-19 government order had a more-than nominal effect on your business if it reduced your ability to provide goods or services in the normal course of your business by not less than 10 percent.
The ERC can help all businesses that qualify, even those businesses that did not suffer during the COVID-19 pandemic.