But let me dig into the details here so you know whether your firm qualified. And so you know what your firm needs to do to get any refund you missed. One comment here too: The refunds get big fast. If you qualified you’re probably talking tens or even hundreds of thousands of dollars of refunds.

First Some Background About the ERC

The Coronavirus Aid, Relief, and Economic Security Act (Cares Act), enacted in March of 2020, provided several aid packages for employers and employees. The primary goals were to keep businesses afloat and prevent employee furloughs.

Initially, employers had to choose between two programs, the Paycheck Protection Program or Employer Retention Credits. You could not participate in both.

The PPP program generally provided more money to business owners, and, not surprisingly, became the more popular choice.

In December of 2020, however, Congress passed the Consolidated Appropriations Act (CAA). And the CAA allowed businesses to participate in both the PPP and the ERC. Tax practitioners and employers then scrambled to learn about the ERC program in early 2021.  And as we all learned, there was serious aid money available to qualified employers.

A final thing to know up front. Employers potentially got ERC funds, or employee retention credit refunds, for wages paid in 2020 and in 2021. But the ERC deadline for refunds based on 2020 wages ended roughly a year ago. What I’m talking about here then are ERC refunds for 2021 wages. But that’s okay. That’s where the big money is.

How to Qualify for ERC?

To qualify for the ERC, businesses must generally meet one of three criteria:

1. Significant decline in gross receipts, or
2. Full or partial suspension of operations due to a government closure order, or
3. Start a new trade or business after February 15, 2020 and before the end of 2021.

From a practitioner’s perspective (and based on experience with many ERC claims), qualifying via a significant decline in gross receipts is usually easiest to substantiate and prove to the IRS. For 2021, an employer needed a decline of more than 20% in gross receipts compared to the same quarter in 2019.

Government shutdown orders, the second way to qualify, introduce nuances that can complicate qualification and implementation. If you’re interested, you can read more about ERC and government shutdown orders here. But you probably want to know that much of the ERC fraud appears to have involved employers alledgedly qualifying based on government orders.

The third way to qualify is to start a new trade or business. To qualify for an ERC refund based on starting a new trade or business, you need to be a small business with average gross receipts over three previous years equal to $1,000,000 or less. This revenue limit looks at the total revenues from all your businesses. And you get the ERC refund based on the wages paid in any of the businesses.

Qualified Wages for ERC

Not all wages qualify for employee retention credits. Some do. Some don’t.

Qualified wages for ERC in 2021 include the following:

• Wages subject to FICA taxes
• Certain health plan expenses allocable to wages
• Employers had to have 500 or fewer employees

Non-Qualified wages for ERC include:

• Wages that were used for PPP
• Greater than 50% owner wages
• Greater than 50% owner family member wages (spouse, children, grandchildren, parents, siblings, in-laws etc.)

How is ERC Calculated

The 2021 ERC formula works differently depending on the credit.

If you qualify based on either a substantial decline in gross receipts or a goverment order, the ERC equals 70% of qualified wages, up to $10,000 per employee per quarter for the first, second and third quarters of 2021.

Example: Suppose in 2021 you have three employees earning $12,000 each quarter throughout the year. Qualified wages in this case equal $10,000 per employee per quarter for quarter 1, quarter 2 and quarter 3. The ERC in this case equals $10,000 × 70% × 3 employees or $21,000 per quarter. So $63,000 in total.

The startup business employee retention credit only applies to the third and fourth quarter of 2021. And the startup business employee retention credit tops out at $50,000 per quarter.

Example: A small construction company enjoys roughly $800,000 of average annual gross receipts. The owner invests in a rental property in late 2020 (so, a new trade or business.) The aggregated business doesn’t qualify for ERC refunds on the basis of either a substantial decline in gross receipts or a government closure order. But it does qualify because a new business started: the rental property. Say the construction company employed ten employees earning $12,000 each in quarter 3 and quarter 4 of 2021. The ERC in this case equals the greater of either $10,000 x 70% x 10 employees, or $70,000 for quarter 3 and $70,000 again for quarter 4., or $50,000 a quarter. In this case, the actual credit equals $50,000 a quarter for the third and fourth quarter, or $100,000 in total

ERC Deadline Depends on Year

The deadline to amend returns and claim the refund depends on the year.

For 2020 ERC claims, the ERC deadline was April 15, 2024. Accordingly, employers cannot still make claims based on 2020 wages.

For 2021 ERC claims, however, the ERC deadline is April 15, 2025. Employers can therefore make claims based on 2021 wages.

Thus, if you operated a small business in 2021, had employees, and never took advantage of the ERC program, reach out to your CPA or tax preparer now. You potentially have large ERC refund claims that will shortly expire.

Also if you started a new trade or business in 2020 or 2021, check in with your CPA or tax advisor. Many small business employers will also qualify for ERC refunds based on this lesser known method.

Tip: If your tax advisor wasn’t able to help you? Or if you’re a tax professional who didn’t gear up to provide this service? We’d be happy to talk about providing you or your client with help. The ERC refund program has restarted. You should have time to apply before the deadline. Contact us here: Nelson CPA inquiry form.

Two Final Words of Caution on ERC Claims

First, carefully vet anyone you engage for ERC work. Unfortunately, the program has been exploited by some (many?) unqualified ERC “mills” that have prepared allegedly fraudulent claims, often leading to significant consequences for businesses. Also if you believe you may have been a victim of ERC fraud, address the issue promptly. (The IRS has a voluntary disclosure program that allows businesses to rectify improper claims and potentially mitigate penalties. You can find more information about this process on the IRS Voluntary Disclosure Program webpage.)

But another caution or suggestion: Don’t not apply for ERC refunds if you legitimately qualify. The ERC has provided life-changing financial relief for many businesses. The window to claim these credits is still open. Therefore don’t miss your chance to file before the April 15, 2025 ERC deadline.

Other Resources

The rules for determining whether you had a substantial decline in gross receipts provide you more flexibility and wiggle room that I describe in the paragraphs above. This blog post gives more detail: 16 Ways of Qualifying for Employee Retention Credits.

More information about the startup business  employee retention credit appears here: Startup Business Employee Retention Credit and here: The $100,000 Real Estate Employee Retention Credit Windfall.

Many houses of worship qualified for employee retention credits. If you participate in a faith community where your group was affected by government closure orders, you may want to research this more specialized situation. This blog post provides more details about what went on in Washington state and should be applicable to many other states as well: Washington State Houses of Worship All Qualify for Employee Retention Credits.

The post April 15, 2025 ERC Deadline Approaches appeared first on Evergreen Small Business.

But the rules? Complicated from the beginning. And fluid. Lots of changes in how the credits work.

In this blog post, therefore, I want to identify the three basic ways in which professionals who own their own practice can qualify for and claim these credits. I’m mostly going to use healthcare professionals in the examples that follow. But the tactics and tricks described work for any self-employed professional or small business owner. Law firm partnerships. CPA firms. Consultants. You get the idea.

Three Notes to Start

Three quick notes to start: First, these tax credit refunds connect to non-owner and non-owner-family employee wages paid in the last three quarters of 2020 and then usually for the first three quarters of 2021. Some employers also get tax credit refunds for the fourth quarter of 2021.

Second, the credit formula gives a per-employee refund equal to as much as 50 percent of the first $10,000 in wages paid in 2020 and as much as 70 percent of the first $10,000 in wages paid in a quarter in 2021.

A third point: This blog post talks about how the rules work for small employers. Small means 100 or fewer employees in 2020 and 500 or fewer employees in 2021. Different rules apply to large employers.

And now let’s talk about the ways you or the professional services firm you own may qualify.

Quarterly Revenues Sagged

The standard and most straightforward way to qualify for the credits? Compared to 2019 revenues, your firm’s revenue sagged some quarter by more than fifty percent in 2020 or by more than 20 percent in 2021.

Suffer the specified quarterly decline, and you usually get tax credit refunds.

Example: A group medical practice saw quarterly revenues drop from its typical $1,000,000 a quarter to $750,000 a quarter in 2021. That 25 percent drop qualifies the practice for employee retention tax credits. If the practice employs ten workers who each make $20,000 a quarter, credits equal 70 percent of the first $10,000 in wages paid each of the ten workers. That probably means a $70,000 tax credit for the first three quarters of 2021. So, $210,000 in total.

By the way? If you should have gotten credits but didn’t, that oversight may connect to your Paycheck Protection Program loan. Initially, the rules said you could not get employee retention tax credits if you borrowed and then received forgiveness for a PPP loan.

The rules later changed, however, and said only that you could not get tax credit refunds for wages paid with PPP funds.

Government Orders Suspend All or Portion of Operation

Probably the easiest way to qualify for most employers? Getting hit by a government order that shut down either the entire operation or some part of it.

Specifically, if a state or local government order suspended more than a nominal part of your operation? You qualify.

And two quick clarifications: First, the “more than nominal” standard means at least a ten percent drop in your revenues or in the hours people work.

Second, a government order that impacts your own operation qualifies your firm. But so does a government order that impacts a vendor or supplier you rely on.

An example illustrates how this works even for an essential professional service.

Example: A orthopedic surgery practice finds itself subjected to a state order which prohibits elective surgery from May 15, 2020 through August 15, 2020. That order triggers a ten percent reduction in revenues while it’s in effect. This surgical practice therefore qualifies for tax credits on wages paid during the last half of the second quarter and the first half of the third quarter. If the practice employs ten workers who each make $20,000 a quarter, probably credits equal 70 percent of $10,000 in wages paid each of the ten workers in both quarters. So, a $70,000 tax credit for the second quarter and again for the third quarter.  Or $140,000 in total.

And another example to show how easily government orders trigger eligibility.

Example: A law firm found itself impacted more than nominally by a county health order that closed courtrooms during the last two quarters of 2020. The firm qualifies for employee retention tax credits for both quarters. If the firm employed five employees who each made at least $10,000 during that government order? The employee retention tax credits should equal 50 percent of the first $10,000 in wages paid each employee, or $5,000 per employee. In total, that means $25,000 of tax credits for 2020.

Your Business Operation Bigger than You Think

A subtle thing to note about all this: Tax law combines the businesses a taxpayer owns using the same principles as apply to pensions. This aggregation can produce surprising results, as another example shows.

Example: A physician’s professional practice employs 15 high wage employees. He also owns a winery that employs three modest wage employees. A government order shuts down the winery. Because the winery represents more than ten percent of the physician’s businesses’ operation in terms of hours worked, however, he can claim the $7,000 per employee per quarter credit on all 18 employees—or $126,000 per quarter.

New Business or Rental Investment

Some small business owners enjoy a third way to qualify for employee retention tax credits in the third and fourth quarter of 2021.

If the employer averages $1,000,000 or less of revenue for the three years prior to 2021, starting a new trade or business sometime after February 15, 2020 and before 2021 ends qualifies the business owner for tax credit refunds.

Note: You need to start the new business before the quarter ends to get the credit for the quarter.

But this special version of the employee retention tax credit—called the recovery startup business employee retention credit—provides a credit of up to $50,000 a quarter.

A final example illustrates how this credit works.

Example: A dentist operates a small dental practice with $1,000,000 of average annual revenues. She also bought a rental property in late 2020. That rental property probably counts as a new trade or business and means she gets to take the employee retention tax credit for the third and fourth quarter of 2021 on her dental practice wages. If the practice employs five workers who each make $20,000 a quarter, probably credits equal 70 percent of first $10,000 in wages paid each employee. So, a $35,000 tax credit for each quarter or $70,000 in total.

If You Missed Employee Retention Tax Credit Refunds?

If you missed refunds you’re entitled to? Or maybe you did? Not a problem. Only a minor headache.

Confer with your tax accountant. See if she or he can help. Probably they can. (You need to amend your payroll tax and income tax returns to get the credits.)

And if they can’t help, consider talking with other tax accountants who have developed specialty practices in this area. Many CPA firms, including ours, did learn the ins and outs of the law. (We’d be delighted to help you. Contact us here.)

The one awkward warning I’ll share: My opinion is you should avoid the self-proclaimed employee retention credit consultants.

At least one of the larger firms providing this service appears to be subject to an FBI and Department of Justice investigation due to other tax credit and deduction work they’ve done. That’s scary.

And other firms whose work product we’ve learned about in various ways have often been extremely, extremely, extremely aggressive about the tax positions they take on the refund claims. I personally believe many of these refund claims won’t withstand scrutiny by the Internal Revenue Service.

Other Resources

This recent blog post at our CPA firm website provides a fuller description of the precise ways employers qualify for employee retention tax credits: 16 Ways of Qualifying for Employee Retention Credits.

If you want or need a lot more detailed information? Grab our paperback book: Maximizing Employee Retenion Credits.

And for readers who really want to dig into the details, three IRS notices provide most of the guidance one wants to know: IRS Notice 2021-20, IRS Notice 2021-23 and IRS Notice 2021-49.

The post Employee Retention Tax Credits Still Windfall for Professional Service Firm Owners appeared first on Evergreen Small Business.

But those programs have now ended. While the WOTC is still around.  Accordingly, small business owners should be aware of it.  So, let’s run through what the WOTC is and how it works.

Work Opportunity Tax Credit Background

The WOTC is a tax benefit to encourage employers to hire targeted groups that face barriers to employment.  Once set to expire after 2019, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 extended the WOTC through 2025.

In general, the WOTC is equal to 40% of up to $6,000 of wages paid to an individual who is in their first year of employment, performs at least 400 hours of services, and falls into one of these ten qualifying groups:

• Temporary Assistance for Needy Families (TANF) recipients,
• Unemployed veterans, including disabled veterans,
• Formerly incarcerated individuals,
• Designated community residents living in Empowerment Zones or Rural Renewal Counties,
• Vocational rehabilitation referrals,
• Summer youth employees living in Empowerment Zones
• Supplemental Nutrition Assistance Program (SNAP) recipients,
• Supplemental Security Income (SSI) recipients,
• Long-term family assistance recipients and
• Long-term unemployment recipients.

The last group is interesting since so many people have been out of work due to the Covid pandemic.  A long-term unemployment recipient is someone out of work for 27 consecutive weeks who collected unemployment benefits at least part of the time.  Many people rejoining the workface are probably in this group.

Qualified Wages  

Wages subject to Social Security and Medicare taxes are qualified wages for the WOTC.  But qualified wages can be zero if:

• The employee worked less than 120 hours,
• The wages were used for another employment credit (ERC, Qualified Sick and Family Leave, etc.)
• The employee worked for you previously (be careful if you furloughed employees during the pandemic and rehired them),
• The employee is your dependent,
• The person is a replacement employee during a strike or lockout,

Now let’s discuss the mechanics of how to claim the credit.

State Paperwork

The first step to claiming the credit is filling out Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit.  You have 28 days from the hire date to file this with your state.  The form asks the employee if they fit into one of the ten groups mentioned above, along with their name, address, and social security number. Consider making this form part of your standard onboarding process so you don’t forget about the work opportunity credit!

If the employee fits into one of the qualifying categories, the next step is to complete ETA 9061, Individual Characteristics Form.  It is similar to Form 8850 with a bit more detail.

When both forms are completed they are sent to the state.  We send the forms to the Employment Security Department in Washington State, for example.

The state then makes a determination if that employee qualifies.  A couple points on that…

First, the state may require additional documentation.  To qualify a veteran in Washington you need to submit the applicant’s DD214 or a letter from the Department of Defense or National Personnel Records that show active duty start and ends dates.  For a disabled veteran in Washington you must also submit a Veterans Administration Disability Letter.

Second (at least in Washington), you can file an appeal if your claim is denied.  Probably you will need to supply additional supporting documentation.  You may need to include a copy of the applicant’s SNAP benefits letter, for example.

Claiming the Work Opportunity Tax Credit

Assuming the state approves your applicant, the credit is claimed when you file your annual income tax return on Form 5884, Work Opportunity Credit.  Corporations claim the credit at the entity level and pass-through entities claim the credit at the individual level.

The credit is non-refundable, meaning you cannot claim it in a year without sufficient tax liability.  However, the IRS lets you carry any unused credits forward for 20 years.  Chances are, you will get to utilize it at some point if you find yourself unable to claim it in year one.

Higher Limits for Veteran Employees

Earlier I mentioned the credit is generally equal to 40% of up to $6,000 of qualified wages per employee, or $2,400.  Certain qualified veterans have considerably higher limits as follows:

• $12,000 of wages ($4,800 credit) if the veteran is entitled to compensation for a service-connected disability and hired not more than 1 year after being discharged or released for active duty
• $14,000 of wages ($5,600 credit) if the veteran is unemployed for a period(s) totaling at least 6 months in the 1-year period ending on the hiring date
• $24,000 of wages ($9,600 credit) if the veteran is entitled to compensation for a service-connected disability and has been unemployed for a period(s) totaling at least 6 months  in the 1-year period ending on the hiring date.

Final Thoughts

The WOTC has been easy to forget about lately.  It was going to end in 2019.  Then the PPP and ERC programs overshadowed it.

Those bigger programs ended in 2021, but the WOTC is still soldiering on.  It might not be as sexy, but saving $2,400 or $4,800 per year is nothing to sneeze at.

This fairly straight forward credit should not be forgotten.  So I will say it one more time: Don’t forget about the Work Opportunity Tax Credit!

The post Don’t Forget About The Work Opportunity Tax Credit! appeared first on Evergreen Small Business.

That misconception? That distributions from partnerships, S corporations and other pass-through entities get taxed. (They usually don’t, by the way.)

The misconception regularly leads to a minor financial tragedy. Because often times a business owner sits on a huge cash balance in their business checking account. That money, they actually need to use on, you know, life things like rent or mortgage payments, insurance, taxes, day care, food, clothing, vacations and so forth.

But the business owner doesn’t want to distribute the profits. Because she or he fears paying tax on the money. Which is ironic. And wrong.

So this article explains what’s going on here. I’ll discuss what you get taxed on. When you get taxed. I’ll explain how the mysterious thing the accountants call “basis”works. And then I’ll end with a warning about a common error you want to avoid because it unnecessarily triggers additional taxes.

To start, a quick discussion about taxable income and basis…

Taxable Income from Your Business

Each business entity type calculates taxable income in basically the same way. Taxable income equals taxable revenues minus deductible expenses. This number gets reported in box 1 of the K-1 form you receive from the business, which in turn gets plugged into and taxed on your individual 1040.

For example, you start a business at the beginning of the year and collect $100,000 of revenues and pay $50,000 of deductible expenses.  Your business’s taxable net income at the end of the year equals $50,000. Suppose you only used the revenue you collected to pay the business expenses and now have $50,000 in your business checking account.

Money left over in the bank is the confusing part. Because you might think you avoid taxes on this money if you leave it in the business. And that you only pay taxes on the money when you take it out of the partnership or S corporation or sole proprietorship.

But that’s not the way the accounting works. You pay taxes on the business profit. Not, usually, on the distributions of profit paid to an owner.

Now let’s have a quick chat about basis.

Basis and Why It Matters

I want this discussion to remain as simple as possible. (If you would like to dive deeper, you can read the statute for S Corporations here and the statute for Partnerships here.) But to generalize, a business owner’s basis consists of the cash and adjusted-for-depreciation cost of property contributed to a business, adjusted for certain items that increase and decrease said basis.

Let’s look at the common increases and decreases…

Increases to Basis:

• Contributions of cash and property into the business
• Taxable income from the business
• Sale of appreciated property the business owns
• Non-taxable income (think PPP and EIDL grants)
• Recourse and qualified non-recourse debt for partnerships
• Partner loans to the business
• Credit cards used for business issued personally to the shareholder for S Corporations

Decreases to Basis:

• Distribution of cash and property from the business
• Loss from the sale of property the business owns
• Non-deductible expenses (meals, entertainment, etc.)
• Decreases in partner loans and decreases in recourse and qualified recourse debt
• Payments made by the business to pay off S Corporation owner owned credit cards

The general rule: As long as you have basis, you pay no taxes on distributions. Which is why basis matters.

Examples Show How Mechanics Work

But the problem here? Basis constantly fluctuates from year to year. That reality means you or your accountant need to carefully track the basis each tax year in order to know whether distributions trigger tax.

Let me show you some examples so you see how this works.

Example 1

Let’s circle back to our example where you earned $50,000. Pretend you spent no money funding the startup for this business because there is little to no overhead.

Your basis at the beginning of the year is $0.00. The $50,000 of net income increases your basis by $50,000. Now what?

You can take the total $50,000 as a distribution and pay $0.00 in taxes. In this case, your basis at the beginning of year 2 is $0.00. Remember, your basis increased by the net income of $50,000 (what you paid tax on), and decreased by the distribution of $50,000.

Alternatively, you decide to leave the whole $50,000 in the business in year 1.  Maybe you are living off of savings.

But remember, you are still taxed on $50,000 of income, regardless of where the money goes.

By the way? If in year 2 the business loses $25,000 and you never extracted any profits from year 1? You can still distribute $25,000 to yourself tax free at the end of the year, so year two, ending year 2 with $0.00 basis.

Example 2

Another example. You start your business with a personal contribution of $100,000.  You use the money to buy some equipment, lease an office space, and hire an employee.  Year 1 net income equals $200,000, and you distribute $100,000 to yourself to pay your personal expenses.  Your basis looks like this:

Year 1

You pay tax on $200,000 of income, the distribution is tax free, and you end the year with $200,000 of basis.

Year 2 profits are down a bit, and net income equals $50,000 for the year. You took the same distribution of $100,000, and your basis at the end of the year is $150,000.

Year 2

Year 3 you try to aggressively expand and require more capital to do so. Your business secures a $500,000 loan to pay for more equipment, employees, advertising and general overhead. This year you are also purchasing an investment property to take advantage of the deductions offered by a short term rental.

The aggressive expansion is a success, and you end the year with $200,000 of net income. But you had to distribute $400,000 to yourself to put a down payment on your rental property and pay the same living expenses. Whoops, now part of your distribution is taxable. Lets break it down:

Year 3

You probably noticed that doesn’t foot out. And it’s because basis can’t dip below $0.00.

In this third year, you are taxed on $200,000 of net income (taxed at ordinary income tax rates) and are left with $350,000 that can be distributed tax free.

But the additional $50,000 of distribution?  This is called “a distribution in excess of basis.” The $50,000 of distribution which you do not have basis for becomes a capital gain and gets taxed at capital gains rates.

Guaranteed Payments or Distributions?

One final important point. I want to discuss a mistake we often see on partnership returns.

Distributions to partners are commonly but incorrectly coded as guaranteed payments.  And this can have negative income tax consequences.

But first, a little background on guaranteed payments. A company uses guaranteed payments to incentivize a potential partner to join a partnership, most often in professional service firms. The partnership pays a specified amount to the partner each year, regardless of how the company performs. Their payment is “guaranteed,” kind of like a salary.

However, a majority of partnership agreements I read have no clause for guaranteed payments. And still, tax preparers frequently incorrectly code distributions as guaranteed payments.  Why does this matter?

Reason #1

Guaranteed payment income is not eligible income for the Section 199A, Qualified Business Income Deduction (QBID).  The partner forfeits a 20% deduction because their distribution is coded incorrectly.

Reason #2

Limited partners are not subject to self-employment taxes.  But guaranteed payments are subject to self-employment taxes.  A limited partner unnecessarily pays an additional 15.3% in taxes when their distribution is incorrectly coded as a guaranteed payment.

Pretend a tax preparer codes a $50,000 distribution as a guaranteed payment.  The partner pays income tax on $50,000 instead of $40,000 by missing out on QBID.  Assume a 25% tax rate and that’s an additional $2,500 they pay in income taxes.

Additionally, the partner pays $7,065 ((92.35% x 50,000) x 15.3%) of self employment tax on the $50,000!

The point I’m trying to make is you want to get this right for partners.

Final Thoughts

I hope this clears up some confusion on what actually gets taxed when a flow-through business generates profits.  And also that the discussion not only eases your anxiety about taking distributions–but allows you to avoid the one or two bookkeeping blunders that trigger tax.

The post Why Profit Distributions Usually Don’t Get Taxed appeared first on Evergreen Small Business.

And then why I bring this up, even though tax season only ended a couple of weeks ago? That checklist? It probably belongs in the organizers we tax accountants send our business clients in just a few weeks.

So, in an effort to help tax accountants and small businesses everywhere? I present the employee retention credit checklist shown below.

Note that the checklist items appear in the headings. Those go on your organizer.

The text under the headings? Those explain why you and I want to ask the questions. And how we process client answers.

Did your firm suffer  a 50% decline in 2020 or a 20% decline in 2021 in quarterly gross receipts?

A first task? Because many people thought (correctly at the time) that they could not receive both Paycheck Protection Program loans and take employee retention credits? Lots of people missed getting employee retention credits. Even though they qualified.

Accordingly, we need to check to see if folks qualified for employee retention credits. And the easiest way to qualify? Due to a substantial decline in quarterly gross receipts as compared to (usually) 2019.

Specifically, we should double-check if an employer suffered either more than a 50% decline in 2020 as compared to 2019 or more than a 20% decline in 2021 as compared to 2019.

If an employer did get that beat up? Bingo. They probably qualify for employee retention credits. If some employer does qualify, you probably want to extend the 2021 tax return. And then file employee retention credit refund claims as soon as you can. Then, after that work is done, return to the 2021 income tax return.

Two reasons for this suggestion. First, as you already know, those credits can add up to big numbers. Up to $5,000 per employee for 2020. And up to $7,000 per employee for each quarter in 2021. (But clients don’t always know that. So we ought to double-check.)

And then, a second reason for this suggestion: If you should file employee retention credit refund claims? You need to finish  that work in order to know what deductions you take for wages on the tax return. A taxpayer needs to reduce its wages deductions for employee recention credits.

The upshot of all this? If a client is eligible for employee retention credits, first get the 2020 941 payroll returns amended. As soon as possible. Start the long slow wait for the refunds. And then pivot to the income tax returns.

Did COVID-19-related state or local government orders close your business or part of your business?

A related point? Verify an employer didn’t have its operations either fully or partially suspended by state or local government orders related to the COVID-19 pandemic.

This is the harder way to gain eligibility. But if such a suspension did occur? Check to see whether the employer qualifies for an employee retention credit on that basis.

A full suspension in operations should qualify an employer for employee retention credits for the duration of the suspension.

A partial suspension in operations qualifies an employer for credits if the part of the operation suspended amounts to more than a nominal chunk of the business. Nominal in this context means ten percent or more of gross receipts or ten percent or more of hours of service.

Note: We’ve got a longer discussion about how suspension triggers employee retention credit eligibility here: Solving the Employee Retention Credit Partial Suspension Puzzle.

Again, however, if you or I do find ourselves with clients who deserve but didn’t get employee retention credits? Probably we immediately extend all the affected tax returns. Then do the employee retention credit refund claim. Probably after tax season ends? And then, after that, finish the 2021 tax returns. And maybe amend the 2020 tax returns.

Did you start another trade or business sometime after February 15, 2020?

Many small business employers who began the “carrying on” of a new trade or business after February 15, 2020 qualify for employee retention credits for the third and fourth quarters of 2021. Automatically. (The only real requirements? The employer needs average gross receipts to not exceed $1,000,000 over the three preceding tax years.)

This is a little absurd. As a policy thing. But your clients will want to know about this. Recovery startup business employee credits run as much as $50,000 for the third quarter of 2021 and $50,000 again for the fourth quarter of 2021. So dig into this wrinkle when you go to prepare your first business entity return for a taxpayer.

Note: We’ve got a longer discussion here of how the recovery startup business employee retention works. See that to get up to speed.

Did you invest in rental property sometime after February 15, 2020?

Even more curious–to me, at least? If a business owner happened to buy a rental property sometime after February 15, 2020? That new rental property counts possibly as beginning to carry on a new trade or business. Which means some business owner who’s bought a rental as a personal investment may inadvertently qualify for recovery startup business employee retention credits.

In other words, the guy who owns an S corporation with employees? If he bought rental property in late 2020, he probably qualifies for up to $100,000 of employee retention credits for 2021. And you need to know that before you do the 2021 tax return.

Note: We’ve got a longer discussion of how real estate recovery startup business credits work here: The $100,000 Real Estate Employee Retention Credit Windfall.

Have you amended 941 returns for 2020 or 2021 for employee retention credits?

You want to know whether an employer amended 941 tax returns for employee retention credits. And for this reason.

If a firm has amended a 941 for employee retention credits, it needs to reduce its wages deduction for the credit. And that accounting may not have gotten done right. So you need to check that.

Example: Some client amended 2020 941 payroll tax returns, claimed a $50,000 refund, but then recorded the $50,000 refund as a reduction in 2021 wages when it got the check in 2021. That sounds right. But it puts the $50,000 reduction in wages into the wrong year. (You need to show the employee retention credit as a reduction in the wages to which the credit applies.)

Have you received employee retention credit refunds?

You probably also want to check on whether an employee has received her, his or their employee retention credit refund claims if they’ve already applied.

One issue here is same one as just discussed. You want to check that the refund transaction gets treated correctly on the tax return.

But a second issue pops up here, too. Those employee retention credits were often tricky to calculate. Especially for small business owners. Accordingly, a good possibility exists that the IRS changed the refund amount once it got around to processing the amended 941-X return.

You and I therefore probably want to use the appearance of the actual refund to double-check the accounting. And to maybe identify when an incorrect amount needed to be fixed.

Example: The client with your help filed a tax return for 2020 that either didn’t reduce the wages deductions for employee retention credits (because you didn’t know then you should do that) or that reduced wages for the wrong amount. In either case, the time to double-check on this? And make any necessary corrections? When the refunds arrive.

Have you applied for Paycheck Protection Program forgiveness?

The PPP loan a client may have gotten only indirectly connects to the employee retention credit.

That connection? An employer can’t use wages it paid with forgiven PPP loan money for employee retention credits.

But the thing is, the PPP forgiveness application provides flexibility to PPP loan borrowers. And a borrower can gain forgiveness for spending that doesn’t “use up” wages that could also plug into the employee retention credit calculations.

Accordingly, you and I probably want to check on whether PPP loan forgiveness has been applied for. And if it hasn’t, we may want to help clients optimize their PPP forgiveness application.

The obvious tricks? Get as much forgiveness as possible for non-payroll-spending. The rules allow a borrower to spend up to 40 percent of the PPP money on things like mortgage interest, rent, utilities, and other items.

Then for the remaining 60 percent that must be spent on payroll? Get as much forgiveness as possible for payroll costs that count toward PPP loan forgiveness but which don’t lead to employee retention credits. So retirement benefits, state and local payroll taxes, group life insurance benefits, owner payroll, owner family payroll and so on.

This approach means you use the least possible amount of payroll that would otherwise produce employee retention credits… Specifically wages for non-owner and non-family employees. And group health insurance benefits for non-owner, non-family members.

Need More Information or ERC Training for Staff?

If you realize some of your staff need more training about how the employee retention credits work, no problem.

We’ve got economical $14.95 paperback book that represents a great way for staff, managers and partners to learn how employee retention credits work: Maximizing Employee Retention Credits.

We’ve also got a number of related articles and blog posts about the employee retention credit and many may be useful for folks still getting up to speed.

The post Employee Retention Credit Checklist appeared first on Evergreen Small Business.

So even if our costs rose? We sort of ignored that. We were more concerned with helping people get through the last couple of years. Helping readers of our blog and then our clients get PPP loans, for example. And helping folks maximize employee retention credits.

And when the pandemic or regulatory changes pushed up costs? Okay. Keep this under your hat. It’s a little embarassing. Because we’re accountants. But we also pretty much ignored that. We were doing tax returns.

And so now after a couple of years of mostly flat prices, we need to get serious about repricing for inflation. And why I’m talking about this openly in a blog post?

Well, I am very sorry to suggest yet another task for your crowded to-do list. But I suspect you too may need to think about how to raise your prices for the effects of inflation.

But let’s go over the arithmetic and the accounting.

Why You Need to Raise Your Prices

The rationale for raising your prices? Well, if you haven’t yet experienced it in a big way, inflation is coming.

But probably? You’ve already been experiencing inflation. Stuff costs more now. People, Technology. Insurance. Rent.

And then the other issue that you may be confronting? The way you may have compensated for inflation in past? You know, just making it up on volume? So by selling more?

Supply and capacity constraints maybe won’t work in this environment. At least for a while. (See this article from Forbes.)

Accordingly, to stay economically viable? You may have to rise prices. Regularly. Diligently.

A Really Simple Example: What Not to Do

Let me construct a really simple example of what you don’t want to happen.

Let’s assume your revenues run $1,000,000, your cost of goods sold runs $500,000, and your overhead (rent, salaries, advertising and so on) run $300,000.

That means you make $200,000 a year if things work as you want. Now probably you use a chunk that $200,000 of profit to grow your business. We both know that’s the way small business works.

But let’s ignore that complexity. And with that simplification, your baseline year looks like this:

That’s pretty good, right? I agree.. But danger lurks.

What Inflation Does to your Profitability

The problem you face now is how to respond to inflation. Probably your costs of goods sold is inflating. Maybe even sharply.

And then your overhead costs—salaries, rent, advertising and so on–are surely coasting up, too.

If cost of goods sold increases by five percent and overhead costs increase by four percent for each of the next couple of years—and you don’t adjust your prices—things might be pretty bleak, as shown below.

Just to point out the obvious: For the baseline year, cash profits equal $200,000.

But after two years of steady inflation, cash profits shrink to $125,000 if you can’t raise your prices.

That’s brutal.

And this sidebar because some business owners and most non-business owners miss this point: Those cash profits do not equate to owner wages.

Some of the  money represents owner wages. But some of it represents payroll taxes. Some of it represents the fringe benefits like the employees get. And much of it goes to grow the business (by investing in inventory, fixtures and equipment.)

How Price Bumps Fix Profitability Problems

You can see what you need to do: You need to raise your prices so you don’t continually experience shrinking profits

Suppose you increase your prices by four percent, across the board.

In that situation, even if cost of goods sold increase by five percent and overhead costs increase by four percent for each of the next couple of years, things look way better.

Which probably shows you what you need to do. And what we need to do. And for the record? I agree regularly raising your prices to deal with inflation isn’t very pleasant.

But the pandemic changed a lot of stuff. And getting used to dealing with the impact of inflation on your profit margins and bottomline profits? Yeah, probably just another new task you need to deal with. Sorry.

Related Blog Posts

How to Grow Your Small Business

Hidden Magic of Arithmetic Growth

Pricing Small Business Services Profitably

The Small Business Long Game: Compound Growth

Has Your Business Stopping Growing?

The post Psst. Time to Raise Your Prices. appeared first on Evergreen Small Business.

If you’re reading this, you know about the $100,000 recovery startup business employee retention credit.

You know, for example, that if you start a new trade or business after February 15, 2020, you can get up to a $50,000 credit for both the third and again for the fourth quarter of 2021. So, $100,000 in total. Just for starting the new venture.

You maybe even know the credit formula gives you up to seventy percent of the first $10,000 in wages you pay each worker in a quarter.

You may even have worked out that you need employee wages for slightly more than seven employees, minimum, to get the $50,000 credit for the third quarter. And then again for the fourth quarter.

But the tax law leaves some awkward questions unanswered. So, this blog post asks those questions. And it gives my guesses as to how they get answered.

One other note: My thinking here flows from the statutes, the one revenue procedure, and then the three IRS notices that had appeared as of August 16, 2021.

Awkward Question #1: Does the New Trade or Business Need its Own Employees?

The employee retention credit looks at wages an employer pays employees. Accordingly, you might assume that an entrepreneur’s new startup venture needs to pay wages to get the credit.

That’s incorrect though. The entrepreneur just needs one of the trades or businesses he or she owns to pay wages.

Example 1: An entrepreneur owns and operates a restaurant which employs eight employees who together make $72,000 during the third and fourth quarters of 2021. The entrepreneur also opens a second trade or business in early 2021, a plant nursery. But the plant nursery hires no employees in 2021. Nevertheless the new plant nursery trade or business lets the entrepreneur get the $50,000 of employee retention credits on the restaurant employee wages.

What happens, by the way, is the trades or businesses an employer operates get aggregated. That’s why the new trade or business doesn’t necessarily need its own wages. Which is weird, I grant you…

Awkward Question #2: Can the New Trade or Business have Activity Prior to February 15, 2020?

A new trade or business needs to start sometime after February 15, 2020 in order to qualify an employer for recovery startup business employee retention credits. The IRS guidance also makes it clear the new trade or business needs to be fully operating and a going concern in order to get the credit.

Here is the language the only IRS guidance provides on this matter (from IRS Notice 2021-49):

In general, for purposes of section 162, a taxpayer has not begun carrying on a trade or business “until such time as the business has begun to function as a going concern and performed those activities for which it was organized.”

But this begs another awkward question: What if investigation of the new venture begins before the required start date? Or what if preopening activities occur in, say,  2019? Or in January of 2020?

My best-guess answer here: I think the recovery startup business doesn’t start for employee retention credit purposes until a new trade or business meets the Section 162 definition (shown above) and is past the Section 195 startup phase. In other words, what happens before the thing being created actually starts? That doesn’t matter.

This approach means investigation and pre-opening activities (including market research and feasibility studies) occurring on or before February 15, 2020 should not matter.

One would want to be very cautious about a position where some activity half starts in January of 2020 and then only reaches full going concern status after February 15, 2020. But in that situation, that new trade or business would seem to create eligibility for the employee retention credit.

Awkward Question #3: Does the New Trade or Business need to Operate in Third and Fourth Quarter of 2021?

That $50,000 credit a firm may get in 2021 for quarter 3 and again for quarter 4? You’d assume the trade or business that triggers that credit needs to operate in quarter 3 or 4. But I don’t think that requirement in fact does exist.

The requirement says a new trade or business needs to start after February 15, 2020. A new trade or business started on, say, February 16, 2020 might have started, operated and then closed before the start of the third quarter of 2021.

I know. Weird. But that’s the way Congress wrote the law.

One other weirdness here. In order to get a credit for that third quarter of 2021? The new trade or business started after February 15, 2020 needs to start before the end of September 2021. And in order to get a credit for the fourth quarter of 2021? The new trade or business started after February 15, 2020 needs to start before the end of December 31, 2021.

But note that a business started in March of 2020 which then closes in, say, March of 2021? That timing works.

Again, I know. Weird…

Awkward Question #4: What if the New Trade or Business Fails?

A related awkward question: What if the new business fails? Is that a problem?

I think not. Congress knows businesses fail. Presumably, it enacted the recovery startup business credit to address the fact that millions of small businesses have failed during the COVID-19 pandemic.

But here, for the record, I think the business owner needs to be careful. The Section 162 standard for what qualifies as a trade or business? It says the entrepreneur needs to be seeking profits and operating with regularity and continuity.

A real, legitimate trade or business might conceivably fail very quickly. But if the new venture fails too quickly? Gosh, one may want consider the possibility that a quick failure would push an IRS auditor to think about whether the regularity and continuity requirements get met.

Accordingly, if employee retention credits are in play? Possibly a business owner needs to show a little extra patience before deeming the venture a failure and then ending operations.

I also think if you’re trying a risky venture that will probably fail but also might potentially generate a giant reward? You probably want to have a business plan that documents that risk-reward trade-off.

Awkward Question #5: Is there a Minimum Length of Operation Requirement?

A second related question: Is there a minimum length of time the new trade or business needs to operate to get the credit?

The answer here? No, not really. Once you meet the continuity requirement.

And by the way? If you’re thinking this whole recovery startup business credit makes less and less sense, just as policy? Yeah, that thought pops into my head every so often too.

Awkward Question #6: Is there a Size or Income Requirement?

Another good question to ponder, at least for a few minutes: Is there a size or income requirement for the new trade or business?

I think the answer is “No, but…”

Theoretically someone with an existing business generating two million dollars of revenue in 2020 might start a tiny micro-business that generates a few hundred dollars of profits in 2021. And that technically sort of half works.

A quick sidebar: To get the recovery startup business credit, the three-year average revenues for the aggregated employer need to not exceed $1,000,000 a year. So, a firm that generates $100,000 of gross receipts in 2018, $900,000 in 2019 and then $2,000,000 in 2020 has a three year average equal to $1,000,000. And that works.

But I think the problem appears when one looks at the requirement that the new trade or business be operated for profit. Someone with a big small business probably isn’t starting a new microbusiness that generates a few hundred or a few thousand dollars of profit in the pursuit of profit.

Let Me Show You Some Examples

But this would be very relative, at least in my mind.

Example 1: Tom operates a small business that generates $500,000 in annual profits but potentially qualifies for the recovery startup business employee retention credit. He wonders if he can start a new tiny business that will generate $5,000 a year in profits.

Example 2: Pete, Tom’s brother, also operates a small business. It generates $30,000 in annual profits and potentially qualifies for the recovery startup business employee retention credit. He also plans to start a new tiny business that will generate $5,000 a year in profits.

Think about the two preceding examples… It’s hard to argue that Tom’s new tiny business seeks profits if Tom operates a trade or business that already makes a mid-six-figures profit.

Pete’s situation differs from Tom’s situation in my mind. A new business that adds $5,000 a year to his existing $30,000 a year of profits? A nearly seventeen percent bump in profits? Gosh, yeah, sure. That seems very likely profit motivated.

One other thing about this to consider. You the entrepreneur make a decision to pursue some venture based on what you hope might happen. If your tax return with the employee retention credit ever gets examined by the IRS? The IRS auditor will be looking at what revenues or income your venture actually generated. This difference in perspective might cause issues during an audit.

Example 3: You start a business you hope generates $100,000 in annual profits. You spend hundreds of hours working on the opportunity. And you get $100,000 of employee retention credits. The venture fails to live up to your expectations, unfortunately, producing only $1,000 of annual profits. If the IRS audits your employee retention credits, it may view the venture as less profit motivated than it actually was.

The only thing I can come up with here? Do a business plan. Document the hope that the new venture may deliver a big reward.

Awkward Question #7: Does Rental Property Count as a Trade or Business?

I’m a little nervous about this. But yes, I think you buying a new rental property probably can count as a new trade or business.

An earlier blog post here goes into the details: The $100,000 real estate employee retention credit windfall.

Awkward Question #8: Can an Acquisition of an Already Operating Trade or Business Count?

Good question… So just to be clear, if you go open up a new retail store that probably counts as a new trade or business. This should be the case, for example, if you’re not already a retailer.

But what about if you go buy a retail store that’s already operating. The retail trade or business is new to you. The way a used car is new to you. Does that count?

I think so based on the language that comes right out of the statute Congress wrote and the President signed:

The term “recovery startup business” means any employer… which began carrying on any trade or business after February 15, 2020,

So mull that over. And then consider the scenario where you or I go out and buy an already operating retail store sometime after February 15, 2020… That would pretty clearly seem to be you or me beginning the “carrying on” of a trade or business after February 15, 2020.

Awkward Question #9: What are the Chances of Audit?

A final question: What chance or risk is there you’ll be audited?

First the stipulation: Whether or not you risk an audit should make no difference in you claiming the credit. What matters is whether you can meet the law’s and the notices’ requirements.

I know, I know. We both already know that. But I wanted to say it anyway.

But second, this comment because some folks will maybe tend to think about the employee retention credits like the Paycheck Protection Program (PPP) operated by the Small Business Administration.

In comparison to the PPP, where your odds of getting audited run very, very low, I think the odds of an audit of an employee retention credit refund claim run pretty high.  In relative terms.

This is back of the envelope math. But my thinking focuses on fact that the Treasury Department and the IRS employ a large number of employees including an army of IRS auditors. So way, way way more manpower to deploy in looking at employee retention credits. (The IRS employs more than 80,000 employees. The Small Business Administration employs about 3,000 employees.)

And then far fewer employee retention credits look to be claimed than PPP loans got made. More than five million borrowers got PPP loans. At mid-year, according to news reports, maybe 30,000 employers had requested employee retention credits.

Combine the larger number of auditors with the small number of taxpayers, voila, I think the odds of a firm getting audited on an employee retention credit run way higher than the odds of a PPP audit by the SBA.

A wild guess? Say a thousand times higher?

The point I’m offering up then: Don’t think the employee retention credit opportunity works like the PPP loans. You’ll need to be more careful. And do a better job with your calculations.

Closing Comment

You know those people who didn’t get PPP loans because they just couldn’t believe they were real? You don’t want to make that sort of mistake with employee retention credits. No way…

But spend some time asking the awkward questions now. If you do get asked the same questions later on, you will have better answers by doing so.

More Information

You can get our Maximizing Employee Retention Credits book from Amazon here: Maximizing Employee Retention Credits.

Dan Chodan’s blog post about owner wages. explains how owner wages plug into the employee retention credit formulas. That’s really important stuff.

This blog post talks more about the Recovery Statup Business Employee Retention Credit.

Finally, this blog post talks about steps an employer can take to boost their credits: Three Tips for Bigger Employee Retention Credits.

The post Recovery Startup Business Employee Retention Credit: Nine Awkward Questions appeared first on Evergreen Small Business.

And then the reason I’m writing this. And sorry to suggest this. But I’m thinking you may be a member of a local church, mosque, temple or synagogue which has similarly missed this opportunity. Or that maybe you spend time working with a local charity and that that organization has bungled the opportunity.

So I want to go over the details of the employee retention credit as it connects to tax-exempt organizations. Give you some examples of tax exempt employee retention credits. And then end with providing some next steps you may want to take so the tax-exempt organizations you care about get a tax benefit that Congress intended and provided them.

Section 501(c) Organizations Qualify

The first thing to know: Tax-exempt organizations get to take employee retention credits on W-2 wages.

More precisely, any of the tax-exempt organizations described in Section 501(c) qualify. That means the house of worship you attend. It probably means the not-for-profit organization you volunteer at. It probably includes any social or fraternal organizations you join.

The credits can be as much as $5,000 per employee per year in 2020 and as much as $7,000 per employee per quarter in 2021.

In 2020, the employee retention credit equals up to 50 percent of the wages paid to an employee but no more than $5,000 for the year.

In 2021, the employee retention credit equals up to 70 percent of the wages paid to an employee but no more than $7,000 for the quarter.

Eligibility Works Roughly the Same

Next thing to note? A tax-exempt organization becomes eligible the same way a regular for-profit trade or business does.

It can start a new trade or business.

A government order can fully or partially suspend its operations.

Gross receipts can decline by more than fifty percent in 2020 or more than twenty percent in 2021.

Different Accounting for Gross Receipts

The one wrinkle about the above rules? The gross receipts accounting works differently for tax-exempt organizations.

For-profit trades or businesses use the accounting rules described in Section 448 of the Internal Revenue Code. Tax-exempt organizations use the accounting rules described in Section 6033 of the Internal Revenue Code.

In one of the IRS notices that explain how to calculate and claim refunds, the IRS goes into the details. But I’m going to copy and paste the meat of that guidance here:

‘gross receipts’ means the gross amount received by the organization from all sources without reduction for any costs or expenses including, for example, cost of goods or assets sold, cost of operations, or expenses of earning, raising, or collecting such amounts. Thus, gross receipts includes, but is not limited to, the gross amount received as contributions, gifts, grants, and similar amounts without reduction for the expenses of raising and collecting such amounts, the gross amount received as dues or assessments from members or affiliated organizations without reduction for expenses attributable to the receipt of such amounts, gross sales or receipts from business activities (including business activities unrelated to the purpose for which the organization qualifies for exemption), the gross amount received from the sale of assets without reduction for cost or other basis and expenses of sale, and the gross amount received as investment income, such as interest, dividends, rents, and royalties.

Tax Exempt Employee Retention Credits vs. Paycheck Protection Program

One other thing to mention. In talking with staff at tax-exempt organizations, I’ve heard people mention that they believe they don’t qualify for employee retention credits because the organization received a PPP loan.

That’s sort of true. Or was true. But you want to understand the history and the details here.

Originally, an employer chose between employee retention credits and the paycheck protection program (PPP). Firms that received a PPP loan, in the beginning, got disqualified from getting an employee retention credit.

Later changes to the law tweaked this, however. And the new rule says you cannot not get employee retention credits for wages paid using PPP money.

For example, say a nonprofit organization paid $300,000 in wages but used a PPP loan to pay $100,000 of the wages. In this case, it can only get employee retention credits on the $200,000 of wages not funded by PPP money.

Some Examples of Tax Exempt Employee Retention Credits

Let me quickly provide some examples of tax-exempt organizations getting employee retention credits.

I’m going to paint in broad brushstrokes here to get you thinking about how this might work for tax-exempt organizations where you participate.

Government Orders Closed Worship Services

A first example: Say state or local government orders prevented your church, temple, synagogue or mosque from holding worship services from March 15, 2020 through May 31, 2021. You guys should qualify for employee retention credits during that period time. Even if you cobbled together some sort of online substitute service.

Substantial Decline in Contributions

A second example: Say a not-for-profit organization saw contributions and activity decline as the pandemic ramped up as compared to 2019. Maybe the organization usually collects dues and fees from members for activities and those activities stopped in the spring of 2020 and are only just now beginning to restart.

If gross receipts declined by more than fifty percent for some quarter of 2020 as compared to the same quarter of 2019? Your non-profit qualifies.

If gross receipts decline by more than twenty percent for some quarter of 2021 as compared to the same quarter of 2019? Your non-profit qualifies.

Note: This other blog post explains how substantial declines in gross receipts work: Full or Partial Suspensions.

New Trade or Business

Employers may also qualify for employee retention credits in the third and fourth quarter of 2021 if they begin carrying on a new trade or business after February 15, 2020. That may not happen as commonly with tax-exempt organizations, but a couple of quick examples show how a new program or initiative might work.

Suppose a tax-exempt school opens a food bank to support some of its students’ families. Perhaps the food bank is response to the economic hardship created by the COVID-19 pandemic. That food bank can probably qualify the tax-exempt organization for employee retention credits.

Another example: What if a religious organization buys rental property to provide housing to families threatened with homelessness due to pandemic-related unemployment. That rental property can probably qualify the tax-exempt organization for employee retention credits.

Note: We talked about how the recovery startup business employee retention credits works here, Recovery Startup Business Employee Retention Credits, and how rental properties can trigger employee retention credits here, $100,000 Real Estate Employee Retention Credits. But the same general principles should apply for a tax-exempt organization.

Next Steps for Tax Exempt Employee Retention Credits

Talk with your tax-exempt organization’s treasurer. Or the accountant or the bookkeeper. (If they don’t understand the rules well enough to help you, you can contact us here. We will even do an initial free consultation.)

You want to move quickly. The easiest way to get the credit is when you file the quarterly 941 payroll tax return.

You can also go back and amend prior quarter 941 payroll tax returns. That’s more work. And the organization waits many weeks for the money.

Need More Information or ERC Training for Staff?

If you realize some of your staff need more training about how the employee retention credits work, no problem.

We’ve got economical $14.95 paperback book that represents a great way for staff, managers and partners to learn how employee retention credits work: Maximizing Employee Retention Credits.

We’ve also got a number of related articles and blog posts about the employee retention credit and many may be useful for folks still getting up to speed.

The post Houses of Worship and Nonprofits Miss the Boat on Employee Retention Credits appeared first on Evergreen Small Business.

The only problem? You need to move quickly. Thus, this blog post where I’ll talk about boosting the size of the credits you calculate.

But let’s make sure you’re up to speed on how the employee retention credit works. And then we’ll talk about how you can increase the size of the employee retention credits you calculate.

And by the way, one other note: These credits? They nearly instantly become refunds. Starting next time you do payroll. And in some cases, gigantic refunds.

Employee Retention Credits in a Nutshell

In effect, the federal government will pay an employer, such as a small business, up to a $5,000 credit for wages paid and group health insurance provided to each employee in 2020.

In 2021, the deal gets even better. The federal government will pay up to a $28,000 credit for wages paid and group health insurance provided to each employee in 2021.

Example 1: A small business employs ten workers who each earn $40,000 annually and it qualifies for employee retention credits for both 2020 and 2021. In 2020, the firm receives $50,000 of credits ($5,000 for each employee). In 2021, the firm receives $280,000 of credits ($28,000 for each employee).

The credit formula, by the way, works differently in 2020 and 2021.

In 2020, the employee retention credit formula equals fifty percent of the wages and group health insurance paid but not more than $5,000 per employee. (The 2020 credit formula looks only at the first $10,000 of wages and group health insurance paid for the year.)

In 2021, the employee retention credit formula equals seventy percent of the wages and group health insurance paid but not more than $7,000 a quarter. (The 2021 credit formula looks at the first $10,000 of wages and group health insurance paid during each quarter.)

Unbelievable, right? I agree. The numbers, especially for 2021, get huge. Even for a small business.

Five Basic Employee Retention Credit Rules

Five basic rules apply to the employee retention credit.

The first rule? The credit works, potentially, for wages and group health insurance paid after March 12, 2020 and through December 31, 2021.

The second rule: A firm needs its operations either fully or partially suspended by federal, state or local government restrictions… or a firm needs to suffer a significant contraction in quarterly revenues as compared to 2019. (I’ll talk more about this in a minute, but a firm only gets the credit on wages and group health insurance paid during a full or partial suspension or during a down quarter.)

A third rule says that you can’t “double dip” and thereby get a credit and refund if some other federal government program already provided you money to pay the wages. For example, you don’t get employee retention credits for wages you paid using Paycheck Protection Program funds. Or using an EIDL grant. Or if you received other payroll tax credits that, in effect, funded employee wages.

The fourth rule? Large eligible employers only take the credit only on wages paid to employees for not working. For 2020 employee retention credits, a large eligible employer is a firm employing more than 100 full-time employees in 2019. For 2021 employee retention credits, a large eligible employer is a firm employing more than 500 full-time employees in 2019. For small eligible employers, in comparison, the employer takes the full credit, potentially, on all their workers’ wages (subject to the third rule just mentioned).

The fifth rule: A business owner aggregates the businesses she or he or they own. For example, if you own a restaurant (maybe operated as a sole proprietorship), 100 percent of a consulting business (maybe operated as an S corporation), and a majority interest in a partnership, you aggregate all of these businesses to determine whether your operations qualify (according to rule #2 above), what the wages total and so forth.

And now let’s look at the three big opportunities to maximize employee retention credits. Because for two of these opportunities, time may be running out.

Bigger Employee Retention Credit Tip #1: Savvy PPP Forgiveness Application

Here’s the first technique you may be able to use to maximize your employee retention credits: How you complete the PPP forgiveness application. But let me explain.

Whatever wages you report on your PPP loan forgiveness application? The employee retention credit formula ignores those wages, as mentioned earlier, for purposes of the employee retention credit.

Example 2: Say a small business potentially qualifies for $50,000 of employee retention credits on $100,000 of wages and qualified health expenses due to partial suspension. If this small business received a $100,000 PPP loan, the borrower might get full forgiveness for using the funds for $100,000 of W-2 wages. And it might, just to be efficient, show that same $100,000 of W-2 wages on its PPP forgiveness application. But in that case, it receives no employee retention tax credit on those wages. The business can’t use the same wages for PPP forgiveness and employee tax credits.

Example 3: Say another nearly identical, partially suspended small business also potentially qualifies for up to $50,000 of employee retention credits on some portion of a $100,000 of wages and qualified health expenses. Further, say this PPP borrower also received a $100,000 PPP loan and could have gotten full forgiveness simply by claiming that full $100,000 of W-2 wages and health expenses. But say it instead applied for forgiveness by showing it used the PPP money for $50,000 of W-2 wages and health expenses, $10,000 of other payroll costs including payroll taxes and pension contributions, and then $40,000 of rent, utilities and mortgage interest. In this case, the business should still get employee retention credits on half of the wages. So roughly $25,000 of employee retention credits.

You see the big point here: How you complete the PPP loan forgiveness application affects the leftover wages and qualified health insurance you or your accountant plug into the employee retention credit formula. (The basic trick is, try to get forgiveness for spending other than wages and group health insurance, if that approach protects your ability to get employee retention credits.)

Finally, this bit of bad news: If you already applied for forgiveness, you can’t undo your application. But some first-round PPP borrowers haven’t yet applied for forgiveness. Some borrowers also received a second-round PPP loan. Many of these firms still have the opportunity to apply for forgiveness in a way that maximizes employee retention credits.

Bigger Employee Retention Credit Tip #2: Look at Every Qualification Possibility

A firm qualifies for employee retention credits in two basic ways.

Maybe the most talked about way? Suffering a significant contraction in revenues. Specifically, a greater-than-fifty-percent contraction in 2020 or a greater-than-twenty-percent contraction in 2021.

Note: If a firm suffers a greater-than-fifty-percent contraction in 2020, it continues to qualify for employee retention credits until the quarter after the first quarter its revenues equal eighty percent or more of the same quarter’s revenues from 2019.

Example 4: Say a firm generated exactly $100,000 in revenue each quarter of 2019. If its revenues in 2020 equaled $80,000 in quarter 1, $40,000 in quarter 2, $80,000 in quarter 3, and $100,000 in quarter 4, it qualifies for employee retention credits in quarters 2 and 3.

Example 5: Say the firm from example 4 experienced another contraction in 2021. If revenues for quarter 1 and quarter 2 of 2021 equal $75,000—so seventy-five percent of what the firm experienced in 2019—it qualifies for employee retention credits in quarters 1 and 2 of 2021.

A firm may also qualify if federal, state or local government mandates, directives or proclamations fully or partially suspend its operations.

Example 6: On April 1, 2020, a restaurant reduces the number of tables for diners by fifty percent due to a state government public health directive that stays in effect for the rest of 2020. Say the firm usually generates $100,000 a month of revenues but through the closure generates $70,000 a month of revenues. The restaurant fails to qualify for employee retention credits based on reduced revenues. Revenues “only” decline by thirty percent. However, the restaurant does qualify for employee retention credits based on state public health restrictions that partially suspend operations.

The obvious trick here to maximize the employee retention credit: Look at both qualification rules: the one based on the reduction revenues… and the one based on the federal, state or local government restrictions on activity.

And then the less obvious trick for maximizing the credit and the resulting refund. Be sure to explore whether a firm can stretch out the time frame it qualifies for employee retention credits by looking both at restrictions and revenue reductions.

Example 7: Say a firm that enjoyed $100,000 a quarter of revenues throughout 2019 sees operations restricted on March 15 due to local government directives that continued through June 30. Assume that revenues “only” sag in the second quarter to $60,000 as compared to 2019, then sag in the third and fourth quarters to $40,000. The firm qualifies as partially suspended from March 15 through June based on local government directives. The firm qualifies due to substantial revenue declines for the third and fourth quarter. Accordingly, wages and group health expenses paid between March 15, 2020 and December 31, 2020 potentially produce an employee retention credit.

Bigger Employee Retention Credit Tip #3: Acquiring to Aggregate

One other powerful tax planning opportunity bears mentioning. As noted earlier, the rules for employee retention credits require employers to aggregate businesses. An entrepreneur who owns, for example, two or three (or more) separate businesses aggregates those businesses into a single employer for the purposes of the employer retention credit.

Example 8: An entrepreneur owns a restaurant, an online ecommerce website, and a consultancy. All three businesses generated a $100,000 quarter of revenues in 2019. The employee retention credit formula combines these three businesses. If the aggregated firm experienced a full or partial suspension in any one of the three businesses through the entire second quarter, the entire consolidated operation potentially qualifies for employee retention credits for the second quarter. For example, if local public health officials directed the restaurant to close from April 1 through June 30, but the other two businesses continued to chug along? The entire three-business aggregation counts as partially suspended from April 1 through June 30. That “partially suspended” status means all three businesses qualify potentially for employee retention credits.

And then here’s the planning opportunity related to aggregation. If a business acquires a firm, it can aggregate that firm’s data from before the acquisition date if the acquirer possesses the information needed to calculate the formulas. A couple of examples show how this technique might work.

Example 9: A consultant operates a firm that generates $100,000 a quarter in 2019 but due to Covid-19 only $80,000 a quarter in 2020. Because no government restriction fully or partially suspends the consultancy operation, the consultancy fails to qualify for employee retention credits due to government restrictions. Further with a twenty-percent reduction in revenues, the firm fails to qualify for employee retention credits due to a significant decline in revenues.

However, if the consultant acquires another business, that may result in qualification for employee retention credits.

Example 10:  The consultant from example 9 acquires a restaurant on April 1, 2021. If that restaurant enjoyed $100,000 a quarter of revenues in 2019 but only books $70,000 a quarter of revenue in 2020 and 2021, then the consultant’s aggregated businesses qualify for the employee retention credit for the quarter that starts on April 1, 2021. For that quarter, the combined revenues, $80,000 for the consultancy and $70,000 for the restaurant, equal seventy-five percent of the aggregated 2019 revenues. Seventy-five percent falls under that eighty-percent threshold therefore qualifying the aggregated businesses for employee retention credits in the second quarter.

Show Me the Money

A quick comment in case you’re new to this employee retention credit topic. You get the refund created by the employee retention credit using the quarterly 941 payroll tax form.

If you should have claimed a credit on some past 941 forms from 2020? Or on the first or second quarter 941 for 2021? You need to go back and amend those. Or maybe better yet, have your tax accountant do the calculations and prepare the form. (If you didn’t know to include the credit in the first place, maybe you ought to have the accountant take care of this for you.)

Note: Our CPA firm will amend 941 forms for small businesses if you use a outside payroll service (like ADP, Paychex, or Gusto) and if you have an accounting system that supplies quarterly revenue data (so like QuickBooks Online, Xero Accounting, or QuickBooks Desktop). Use our CPA firm’s contact form to reach out.

If you can claim a credit on your original second, third or fourth quarter 941, you just calculate the amount and enter it on the 941 form. (You do need to have workpapers which backup and explain your calculations.) Further, if you know for a fact you’re getting a credit, you can and should reduce your payroll tax deposits immediately so you don’t have to wait a month or two or three for the refund.)

Closing Comments

Three quick comments in closing. First, you may unfortunately find you’re too late to boost your employee retention credits by more thoughtfully preparing the PPP loan forgiveness application. Don’t beat yourself up for that. Initially you could not qualify for employee retention credits if you also borrowed PPP money. So probably you or your accountant prioritized getting the PPP loan money. And then prioritized getting that loan forgiven. All that made sense. You want to remember all that if you inadvertently missed that opportunity.

And a second comment: As mentioned earlier, time is running out your ability to maximize your credits. If you want to use aggregation, for example, you need to finish an acquisition as soon as possible. Further, with regard to the PPP loan forgiveness, you probably need to apply soon for forgiveness if you haven’t already. The bottom-line in all this? You probably need to move fast to maximize employee retention credits.

A third comment which may be helpful to some readers trying to make sense of this crazy, new tidal wave of free money supplied by the federal government. Accept the free money element of this. Don’t try to make sense of what may not, once the dust settles, make much sense. The Congressional rationale here? Well, the Covid-19 pandemic restrictions coupled with reductions in consumer demand destroyed millions of small businesses. As I write this in July 2021, one source is reporting that nearly fifty percent of small businesses open in January of 2020 have now closed. And so what Congress did with programs like the Paycheck Protection Program and employee retention credits is shower small businesses with money to keep people on the payroll.

Need More Information or ERC Training for Staff?

If you realize some of your staff need more training about how the employee retention credits work, no problem.

We’ve got economical $14.95 paperback book that represents a great way for staff, managers and partners to learn how employee retention credits work: Maximizing Employee Retention Credits.

We’ve also got a number of related articles and blog posts about the employee retention credit and many may be useful for folks still getting up to speed.

The post Three Tips for Bigger Employee Retention Credits appeared first on Evergreen Small Business.

Editor’s Note: The employee retention credit (ERC) potentially provides big tax benefits to employers beat up by the pandemic. But the credit is wickedly complex.

In this guest blog post, nationally known expert Daniel Chodan, a tax partner with the Trout CPA firm in Pennsylvania, explains how the credit works for owner wages. Take it away, Dan!

The Employee Retention Credit (ERC) is a tremendous program for businesses with employees. Refunds can be up to $5,000 per employee in 2020 and up to $28,000 per employee in 2021.

Unfortunately, the ERC is mired in complex rules. Most employers will need to work with a professional to claim ERC as eligibility can be nuanced, reporting a claim is convoluted, and the interplay with other relief programs is intricate (particularly for the Paycheck Protection Program).

The Owner Wages Question

Here is one common question, for example: Can a greater-than-50% owner claim the employer retention credit on their own wages?

We would hope a simple enough question would have a simple answer, but it does not. The underlying IRS code and its practical implications confuses business owners and professionals alike.

I will explain the rules here to show how a greater-than-50% owner’s wages are ineligible for the ERC.

Related Parties Do Not Qualify for ERC

The CARES Act (which creates the employee retention credit) and later IRS guidance states “rules similar to Sec. 51(i)(1) apply” for the credit, which causes certain related individuals’ wages to be ineligible.

Relationships disqualified include the following:

• A child or a descendant of a child;
• A brother, sister, stepbrother, or stepsister;
• The father or mother, or an ancestor of either;
• A stepfather or stepmother;
• A niece or nephew;
• An aunt or uncle; and
• A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

Each of the relationships listed is disqualified for ERC if the person is related to a greater-than-50% owner. The confusion begins with this list. Owners and spouses themselves are not listed as disqualified relationships. This has led some to believe owner and spouse wages are allowed for ERC benefits, but further reading will show why they are not.

Attribution Rules Expand the List

The definition of a greater-than-50% owner under Sec. 51(i)(1) is the key issue. The IRS’s ERC FAQ No. 59 indicates it is an individual owning “directly or indirectly” greater-than-50% of the value of stock in a corporation or of the capital and profits interests in the entity.

The term “directly or indirectly” under Sec. 51(i)(1) is defined as being determined with the application of Sec. 267(c). The attribution rules of Sec. 267(c) include entity-to-member attribution, family attribution, partner-to-partner attribution, and limits on reattribution. While all of these rules do apply to the determination of a greater-than-50% owner for ERC, let’s just focus on the family attribution rules for today.

Family attribution of ownership under Sec. 267(c) occurs between the direct owner and the owner’s brothers and sisters (whether by whole or half blood), spouse, ancestors, and lineal descendants. This attribution of ownership occurs regardless of whether the family member owns any portion of the business under Regs. Sec. 1.267(c)-1. As a result, family attribution rules create many indirect owners of a business because they are related to the direct owners of a business. Family attribution also may cause an owner with only a small portion of direct ownership to have a larger portion of both direct and indirect ownership.

What This All Means to Employers

We got a bit technical there, but that is unavoidable to cover this issue. So what does it all mean? It means nothing is easy with ERC.

We might expect to only have a single greater-than-50% owner in a small business, but once the family attribution rules are applied, we will have many greater-than-50% owners.

We then must apply the list of disqualified relationships to each greater-than-50% owner to determine all of the disqualified related party wages. This pattern of attribution of ownership followed by disqualification is ultimately how a greater-than-50% owner’s wages become disqualified.

Let’s look at some examples to see how these rules work practically.

Example 1: S Corporation Owned by Father, Employing Father and Son

As a first example, consider a S corporation owned 100% by a father with the only employees being the father and his son.

The son’s wages are clearly disqualified for ERC as he is a disqualified relationship to a greater-than-50% owner (the father).

The father’s wages are not as clear because owners themselves are not listed as disqualified relationships. However, when we apply the family attribution of ownership rules, we determine there is more than one owner. The father’s 100% ownership attributes to his son, leaving both the father and the son as 100% owners directly and indirectly.

Because the father now has a disqualified relationship to a greater-than-50% owner, the father’s wages are also ineligible for ERC. The same result would occur whether or not the son was employed by the S corporation or had any direct ownership himself.

Example 2: S Corporation Owned by Two Brothers

Another common example is an S corporation owned 50%/50% by two brothers with the only employees being the two brothers.

Since there is no greater-than-50% owner, it may at first seem there are no related-party wages disqualified for ERC. However, when we apply the family attribution of ownership rules, the ownership of each brother attributes to the other and leaves both as 100% owners directly and indirectly.

Because each brother now has a disqualified relationship to a greater-than-50% owner, the wages of both owners are ineligible for ERC.

Example 3: S Corporation Owned by Two Cousins

A final example is an S corporation owned 50%/50% by two cousins with the only employees being the two cousins.

The cousins’ ownership does not attribute to each other by the family attribution rules. So each cousin is only a 50% owner directly and indirectly. However, the cousins’ ownership does attribute to ancestors, including their shared grandmother. The grandmother is considered a 100% owner of the S corporation because she is attributed the ownership of both of her grandchildren (the cousins).

Because each cousin now has a disqualified relationship to a greater-than-50% owner, the wages of both owners are ineligible for ERC.

Where Related Parties Rules Leave Employers

We must achieve full understanding of the direct ownership of a business, the related individuals employed by the business, and the owner family tree(s) for ownership attribution purposes.

The first step is determining who the direct and indirect owners of the business are according to family attribution rules.

The second step is applying the list disqualified relationships as they relate to any direct and indirect greater-than-50% owners.

Further attribution complexities arise when owners are also partners in another enterprise, when multiple layers of ownership exist, or when reattribution is limited, but these topics are beyond the scope of this article.

Often in the end, unfortunately, family attribution of ownership produces unfavorable results by generally disqualifying more wages for ERC. It is always possible that Congress could change the law or the IRS could provide new guidance – but until that happens we are unfortunately stuck with the rules as they are. Advisers and taxpayers should take a close look at these rules before claiming ERC.

About the Author

Daniel Chodan also wrote a guest blog post about the interplay of the Employee Retention Credit and PPP Affiliation Rules available here: ERC and PPP Affiliation Rules May Make Acquisitions More Attractive.

More biographical and contact information appears here.

Need More Information or ERC Training for Staff?

If you realize some of your staff need more training about how the employee retention credits work, no problem.

We’ve got economical $14.95 paperback book that represents a great way for staff, managers and partners to learn how employee retention credits work: Maximizing Employee Retention Credits.

We’ve also got a number of related articles and blog posts about the employee retention credit and many may be useful for folks still getting up to speed.

The post Owner Wages and Employee Retention Credit  appeared first on Evergreen Small Business.