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.

Unfortunately, this method of qualifying for credits is murky. At least for small businesses that operate in a single location. But you want to look at the rule. Learn it. And then see if it applies to your situation.

If you can’t otherwise get employee retention credits? The partial suspension eligibility method provides a backdoor way for some firms who wouldn’t otherwise qualify to get credits.

Quick Review of the Easy Eligible Employer Rules

But first a quick review of what employee retentions are and how they usually work…

Employers who experience a greater than fifty reduction in gross receipts in some quarter of 2020 or a greater than twenty reduction in gross receipts in some quarter in 2021, get an employee retention credit.  (The comparisons typically look at the same quarter of 2019.)

For 2020, that credit equals fifty percent of the qualified wages paid. But not more than $5,000 per employee for the calendar year.

For 2021, that credit equals seventy percent of the qualified wages paid. But not more than $7,000 for a quarter.

Note: The 2021 credit—potentially $28,000 per employee—is huge. Take notice of that.

If a federal, state or local government order fully suspends operations, that order also qualifies an employer for employee retention credits.

For example, if a government order causes a restaurant to close from May 15 through August 15, the wages paid for that interval plug into the employee retention credit formula. The employer does not, in other words, need to compare quarterly gross receipts.

But then there’s also one other route to qualifying for employee retention credits: partial suspension. And here the waters get muddy in many settings.

Partial Suspension Rule

Let’s start by quoting official language that describes how the partial suspension rules work. IRS Notice 2021-20 says this about which employers have eligibility to claim employee retention credits:

Section 2301(c)(2)(A) of the CARES Act defines the term “eligible employer” as any employer carrying on a trade or business during calendar year 2020, and, with respect to any calendar quarter, for which (1) the operation of the trade or business carried on during calendar year 2020 is fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19.

Note: The same rule applies for 2021. But you need to read IRS Notice 2021-23 to get the official instruction for that.

IRS Notice 2021-20 Question 11:

On page 27 of that IRS Notice 2021-20, the IRS then asks and answers the key question about when a business is “partially suspended” in what I’ll call a blurry-picture situation.

Here’s the actual question asked which you want to look at and consider:

If a governmental order requires non-essential businesses to suspend operations but allows essential businesses to continue operations, is an essential business considered to have a full or partial suspension of operations due to a governmental order?

 IRS Notice 2021-20 Answer 11:

And here’s the official answer to this question:

An employer that operates an essential business is not considered to have a full or partial suspension of operations if the governmental order allows all of the employer’s operations to remain open. However, an employer that operates an essential business may be considered to have a partial suspension of operations if, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a governmental order.

For example, an employer that maintains both essential and non-essential business operations, each of which are more than nominal portions of the business operations, may be considered to have a partial suspension of its operations if a governmental order restricts the operations of the non-essential portion of the business, even if the essential portion of the business is unaffected. In addition, an essential business that is permitted to continue its operations may, nonetheless, be considered to have a partial suspension of its operations if a governmental order requires the business to close for a period of time during normal working hours.

The notice then elaborates. A “more than nominal” portion of an employer’s business operations would have generated ten percent or more of the firm’s gross receipts in the same quarter of 2019. Or it would have amounted to ten percent or more of the firm’s hours of service in the same quarter of 2019. (This information appears in the “Question 12” discussion.)

If a employer operates in multiple locations and government orders close one of those locations, that closure counts, plain and simple, as a partial suspension. (This information appears in the “Question 20” discussion.)

Finally, the notice adds a little twist and complexity to all of this. A reduction in consumer demand doesn’t matter for purposes of determining partial suspension. (This information appears in the “Question 13” discussion.)

You may want to read the roughly 15 pages of discussion about what counts and what doesn’t count if it matters to your clients. Or for your own firm’s employee retention credits. But let me spotlight some of the issues that I think may help you determine whether you qualify or might qualify for partial suspension for less than obvious situations.

Nominal Matters

A first obvious observation. You probably need to be able to show a reduction of ten percent or more in gross receipts or hours in order to take the position that an employer’s operations have been partially suspended.

In other words, any reduction in gross receipts or hours of service less than ten percent probably fails to support the position that a non-nominal chunk of the business stopped due to a government order.

Consumer Demand

And then something else. The bit about not looking at consumer demand connects to this, I think.

For example, the available data I’ve looked at and talked about elsewhere at this blog suggests that reduced consumer demand and government orders work hand in hand to push down business revenues. (Er, if you’ve read any of my complaints about the media exaggerating infection, hospitalization and fatality rates, you know I beat that drum because I worry it damages your business.)

But if we maybe think about this? Maybe you and I want to see considerably more than a ten percent reduction in gross receipts or hours worked so we’re also formally recognizing some dampening in consumer demand?

In other words, you need some ten-percent-or-greater chunk of the business to have been suspended, obviously, to just meet the “more than nominal” operations threshold. That’s maybe the first ten percent.

And then don’t we probably need some chunk of additional reduction in revenue or hours to reflect the drop in consumer demand?

The Twenty Percent Test May Be Relevant

Another percentage to anchor your analysis and thinking? Twenty percent. And here’s why I say this.

For 2020, the gross receipts eligibility test qualifies an employer for employee retention credits when the gross receipts drop to less than fifty percent of the same quarter in 2019. But the employer maintains its eligibility for the credits as long as the gross receipts stay at least twenty percent off as compared to 2019.

That twenty percent value pops up again for 2021. For that year, the gross receipts eligibility test qualifies an employer for employee retention credits when gross receipts drop by more than twenty percent as compared to 2019.

Again, we’re just talking here. Trying to bring this partial suspension rule into sharper focus… but I propose this: If a twenty percent decline in gross receipts often works as the hard number that maintains or creates eligibility for credits based on gross receipts? That reduction in revenues may really suggest a firm suffers from non-essential operations or activities closing.

Fixtures and Equipment and Comparability

One final thing to mention here. The IRS Notice mentions (Question 14) the issue of whether a firm can continue operations comparable to those prior to closure due to a government order.

The Notice discussion then gives a couple of examples. One example describes a software development firm. It reconfigures its operations to run comparably even after a local government order closes its offices. That firm, the IRS concludes, fails to qualify as partially suspended.

Another example in that same discussion describes a physical therapy facility. This firm also reconfigures operations. But reconfigured, it can’t provide the full range of therapies. Why? The facility provides equipment and tools that the physical therapists often need in hand to treat patients. That firm, the IRS concludes, qualifies as partially suspended.

The takeaway here? Maybe two things. First, if a business operation uses physical assets located in the closed offices, that suggests a partial suspension occurs when the offices close. Second, if a service must sometimes be provided in the presence of a customer or patient, that suggests a partial suspension occurs when the offices close.

Summing Up Partial Suspension Rule

Putting everything mentioned above together?

Here are my current impressions. I think separating essential not-suspended business operations from non-essential suspended businesses gets tricky. Especially for single-location and really small businesses. Accordingly, I think these small businesses want to see some overall reduction in revenues or hours significantly greater than ten percent. To me, that seems in line with non-nominal operations stopping due to a government order.

I don’t think however, that you need to go much above that ten percent reduction threshold for blurry-picture situations. Maybe a fifteen percent reduction signals a firm suffers from partially suspended operations? Or maybe twenty percent sends that signal? At least the way I’m thinking.

Finally, as just a matter of common sense? In any blurry-picture situation, I think a firm arguing for partial suspension wants to be able to point to equipment or fixtures required for the services but that could not be used due to an office closing. Or a firm wants to be able to point to in-office, face-to-face services that could not occur due to a government order closing the offices used for such meetings.

But I’d welcome your comments…

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 Solving the Employee Retention Credit Partial Suspension Puzzle 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.

As of March 3, 2021, a new sole proprietor PPP formula exists.

While most Paycheck Protection Program borrowers calculate their PPP loan amount using their average monthly payroll or net profit, the smallest businesses can look at a different number: Their gross income.

This change makes a huge difference to the smallest small businesses. And business owners and their advisors probably want to get up to speed. Fast.

Reviewing the Old PPP Formula and Rules

Let’s keep this simple.

The PPP program gives small business owners money.

Technically, yes, the program loans small businesses money. But as long as the firm uses the money to pay owner compensation, employee payroll, and a handful of other operating expenses?

Yeah, good enough. The borrower doesn’t repay the loan.

Example 1: You operate a sole proprietorship and borrow $10,000. You use that money to pay yourself a draw. You don’t need to repay the loan.

The original PPP loan formula looked at the average monthly payroll a firm paid. To calculate the loan, the borrower multiplied the average monthly payroll by 2.5.

Example 2: A small business spends $4,000 a month on payroll. The PPP loan equals 2.5 times $4,000, or $10,000.

For small proprietors, originally, the PPP loan formula also counted sole proprietor profits as payroll for the owner.

Example 3: A sole proprietorship earns its owner net profit equal to $2,000 a month on average. The PPP loan equals 2.5 times $2,000, or $5,000.

A predictable tweak: If a small sole proprietorship pays employees, the formula combines the employee payroll and the owner profits.

Example 4: Say a small business spends $4,000 a month on payroll and earns its sole proprietor $2,000 a month on average. The PPP loan formula calculates the eligible average monthly payroll as $6,000. And the formula returns $15,000 as the PPP loan amount.

You can still calculate the PPP loan amount using the above formulas. But Schedule C sole proprietors get another better option…

The New Sole Proprietor PPP Formula

Rather than look net profit, a sole proprietor can calculate her or his owner payroll by looking at gross income. And this is big. Really big. The little table below shows the change:

The old PPP loan formula looked that $12,000 bottom-line profit, calculated a $1,000 per month profit, and returned a $2,500 PPP loan amount.

The new sole proprietor PPP loan formula looks at the $60,000 of gross income, calculates a $5000 per month profit and returns a $12,500 PPP loan amount. At a minimum.

Note: If you have a copy of your last tax return handy, look at what Schedule C Line 7 shows. That value represents your annual gross income. You can, by the way, look at either your 2019 gross income or your 2020 gross income.

No Double-counting of Employee Payroll Costs

A sole proprietor with W-2 employees calculates the PPP loan amount slightly different. And in a slightly more complicated manner.

A sole proprietor with employees gets PPP money for employee payroll costs. If that $48,000 of operating expenses shown in the table above includes, say, $24,00o for employee payroll? The owner gets PPP money for that too.

But the business doesn’t get to double count employee payroll.

Example 5: Say a sole proprietorship earns $60,000 of gross income as shown in that earlier table. Further assume the business spends $48,000 on operating expenses but uses $24,000 of this money for employee payroll. The PPP loan formula, therefore, adjusts the $60,000 of gross income down to $36,000. But the annual payroll in this case equals $60,000 (the $36,000 of adjusted gross income plus the $24,000 of employee payroll.) The average monthly payroll equals $5,000 because $60,000 divided by 12 months equals $5,000. The PPP loan equals $12,500–so the same value but calculated through a more circuitous route.

But the PPP loan formula adjusts the gross income amount for a reason. And that reason? The Paycheck Protection Program only funds employee payroll costs up to $8333 a month. Further, only wages paid to domestic employees working in the US count. The PPP loan application makes borrowers break out the payroll costs to show this.

Example 6: Say that sole proprietorship described in Example 5 pays $24,000 in payroll but that only $12,000 counts as payroll for PPP purposes. Maybe $6,000 goes to a foreign employee–so it shouldn’t count. Maybe another $6,000 represents payroll in excess of the per-employee $8333 monthly limit. In this case, the PPP loan formula works like this. First, it subtracts $24,000 from the $60,000 of gross income to get $36,000 of owner compensation and proprietor expenses. Then the formula calculates the annual payroll as equal to $48,000 (the $36,000 of adjusted gross income plus the $12,000 of eligible employee payroll.) The average monthly payroll equals $4,000 because $48,000 divided by 12 months equals $4,000. The PPP loan equals $10,000, or 2.5 times $4,000.

Financial Grace for Folks with Bad Financial Histories

Now, an awkward subject…

If some bad financial history previously prevented you from applying? Take another look at applying.

The new rule specifically “removes the eligibility restriction that prevents businesses with owners who have non-financial fraud felony convictions in the last year from obtaining PPP loans, and removes the eligibility restriction that prevents businesses with owners who are delinquent or in default on their Federal student loans from obtaining PPP loans.”

Those quotes come right out of the rule’s opening paragraphs.

Important Other PPP Loan Details

The PPP program ends on March 31, 2021. You want to act fast.

If you already borrowed PPP money using the original formula, you cannot redo the loan. You get stuck with the original PPP loan formula. (Sorry.)

If you use the new PPP loan formula based on gross income and gross income exceeds $150,000, you must justify your need for the loan by certifying your firm faces “economic uncertainty.” (More discussion of this issue here, here and here: Covid-19 and Economic Uncertainty.)

If a sole proprietor employs no W-2 employees, the maximum first draw PPP loan equals $20,833. (To receive that loan amount, the sole proprietor needs to generate at least $100,000 in gross income in either 2019 or 2020.)

You provide a copy of your tax return’s Schedule C with your loan application.

You need to supply documentation proving you earned income such as a “IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed.”

Further, and here I quote from the new rule again, “You must provide a 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.” (Only people in business on that date qualify for PPP loans.)

Second draw PPP loans, something we’ve discussed in more detail here, can also use the gross income to calculate PPP loan amounts. A second draw PPP loan works almost identically to a first draw loan. The one difference to be aware of? A second draw PPP loan borrower with a NAICS code starting with 72 gets 3.5 months of their average payroll cost for the owner rather than 2.5 months.

Note: The NAICS code that starts with 72 identifies accommodation and food service businesses.

Other PPP Loan Resources

The new PPP loan application forms, available here, first draw and second draw, step you through the math.

Accountants, attorneys and bankers probably should read the new Interim Final Rule, available here.

The post The New Sole Proprietor PPP Formula appeared first on Evergreen Small Business.

As you maybe know, the popular Paycheck Protection Program requires borrowers to certify they face uneconomic uncertainty due to the Covid-19 pandemic in order to get a PPP loan.

But as a new round of PPP lending ramps up, small business owners ought to reexamine the issue of economic uncertainty. The landscape looks much different today than it did back when all this started. And that change may play into whether a firm qualifies for a PPP loan. Maybe even a second draw PPP loan. Further, the changing landscape should factor into every firm’s business planning.

In particular, six issues stand out. Especially for folks who maybe haven’t had the chance to keep up with the Covid-19 research and the steady drip-drip-drip of pandemic-related data.

Widespread Infection in the United States

For example, a first important point for most small business owners to consider. The number of infections, according to reliable sources, greatly exceeds the number of confirmed cases.

Usually, you and I see or hear reports about confirmed cases. But the CDC estimates the actual number of infections runs four to five times the number of confirmed cases.

The CDC estimates that roughly 83 million Americans had been infected with Covid-19, for example, by December 31, 2020. (This information appears here, Estimated Covid-19 Burden. And I’ve copied and pasted a picture below.)

At the time I’m writing this in late January, confirmed cases run about 25,000,000 in the United States. Applying that same ratio of four or five infections for every confirmed case, then, we’re talking 100,000,000 to 125,000,000 infections.

The population of the United States equals about 330,000,000. So roughly a third of us have already been infected.

And the actionable insight here? Surely small business owners, in thinking about Covid-19 economic uncertainty, want to consider the strong possibility that a giant chunk of the population (including customers and employees) has already been infected. And also consider that that chunk grows larger every day…

Note: In the first version of this blog post, I referenced another document, CDC planning scenarios, which uses a higher ratio of infections to cases. The Estimated Covid-19 Burden document, however, appears to be the more up-to-date source.

Herd Immunity Closer Than Many Guess

A related point to mention, again in the context of economic uncertainty and your small business.

The herd immunity threshold we’ve all heard so much about? We may be closer to that than people guess. Especially when you consider both the immunity we receive from infections and from vaccinations, which I’ll talk about in a minute.

The CDC planning scenarios document just mentioned, for example, provides the R factors, or R values, that allow public health officials to estimate how many people someone infected with Covid-19 infects. The best guess scenario gives an R factor of 2.5. Which is the same thing as saying on average someone infected with Covid-19 infects 2.5 other people.

The other planning scenarios use R factors of 2 and 4.

And what’s interesting—at least to a small business owner thinking about economic uncertainty—is these R factors let you and I estimate roughly the herd immunity threshold using this simple formula:

1-1/R

You can use this formula, for example, to estimate herd immunity thresholds for the CDC planning scenarios’ R factors, as shown in the table below:

But scientists argue about the actual herd immunity threshold.  The real world shows more complexity and fluidity than this simple formula reflects.

As noted in earlier blog posts,  one peer-reviewed study says Covid-19 herd immunity may run around 43%. (Article here: The disease-induced herd immunity level for Covid-19 is substantially lower than the classical herd immunity level.)

Another study (not yet peer-reviewed but widely discussed) estimates that herd immunity thresholds might run more like 10 to 20 percent (Article here: Individual variation in susceptibility or exposure to SARS-CoV-2 lowers the herd immunity threshold.)

Scientists seem to agree you can use the simple herd immunity formula to determine herd immunity thresholds from vaccinations. They don’t agree that same simple formula works for infections-based herd immunity.

In any case, the point you and I can take away, in terms of economic uncertainty. The end of this pandemic may not yet be visible… but it may be just over the horizon. Certainly well within the time frame we “business plan” for.

A Sidebar about Natural Herd Immunity

One tangential note about natural herd immunity: Depending on how closely you’ve followed the Covid-19 news, you may recall policy makers, scientists and physicians arguing that herd immunity from infection wouldn’t work. (See here, for example: Herd Immunity is a Dangerous Strategy.)

If you reread or revisit those commentaries now, however, you see that those folks were often really saying herd immunity wouldn’t work except with catastrophically high fatalities.

The terrible reality here? We’ve had catastrophically high fatalities.

About 400,000 family members, friends and neighbors—often those most vulnerable in our communities—have died.

Over the next few weeks, predictions say, we tragically will lose another mind-numbingly large number of people.

Understand I’m not suggesting we rely on natural herd immunity going forward as a strategy. (I don’t know that anyone suggested that.)

Rather,  the high community spread of the last few months has plausibly resulted in, tragically, the very scenario people worried about. Further, when one combines natural immunity with vaccinations, yeah, we’re close enough to herd immunity to incorporate its effect into our business plans.

Infection Fatality Rates and Age-related Risk Gradient

In the beginning, the first reports of infection fatality rates appeared apocalyptic.

People who closely follow such things may remember that early World Health Organization reports implicitly suggested a 3 percent to 4 percent infection fatality rate.

You can still read media accounts that seem to suggest this. (The error the writer usually makes when reporting this? He or she compares deaths to confirmed cases, thereby ignoring the infections that aren’t ever laboratory confirmed.)

But here’s what the CDC estimates for infection fatality rates. This table comes from that CDC planning scenarios document I’ve referenced a couple of times already.

Make sure you understand how those decimal values work.

If you look at the current-best-estimate scenario, for example, you’ll see that the infection fatality rate equals 0.00003 for people in the age group 0 to 19. That 0.003 percent infection fatality rate means Covid-19 fatalities for that age group run roughly 1 out of every 33,333 people who catch the virus.

In comparison, if you look again at that scenario, you’ll also see that the infection fatality rate equals 0.054 for people in the age group 70 and older. That 5.4 percent infection fatality rate means Covid-19 fatalities for that age group run roughly 1 out of every 19 people who catch the virus.

You can make calculations for other age groups, too. But I think an actionable insight falls out of the variability in infection fatality rates.

That insight? The steep increase in risk related to age may be a factor in how much economic uncertainty a small business faces.

The case for closing schools and childcare facilities, for example, surely weakens as policy makers and parents grow to understand the extremely low risk for children. And that may be good news and lessen uncertainty for some business owners.

And then obviously, small businesses serving older customers or employing older workers face extremely high risk—which small business owners want to recognize and plan for. Surely that higher risk creates higher economic uncertainty.

Vaccination Counts Snowballing

As I write this, Covid-19 vaccinations in the U.S. probably total about 22 million Americans. And the daily vaccinations run about 800,000 to 900,000 a day.

The incoming Biden administration plans to bump the rate to 1,000,000 a day for its first 100 days.

This volume of vaccinations should dramatically reduce economic uncertainty over the next few months.

The vaccinations appear to provide remarkable protection. Better than 90 percent, for example, in the cases of the first two vaccines available, Pfizer and Moderna. And as a planning matter, that protection exists a few days after the second dose.

By the way? Be sure to combine the effectiveness of vaccines with the age-related risk. When you do that, you can see that as communities vaccinate those most vulnerable, fatalities and hospitalizations should shrink massively. And those positive changes should help communities restart and economies rebound. (As I write this, the CDC reports that nearly 2.6 million vaccination doses have been administrated in long-term nursing homes–a feat that may save one or two hundred thousand lives.)

Finally, when you think about herd immuity thresholds, remember to combine the 100 million plus people who’ve been infected with the 100 million people who will soon get vaccinated. Both infection and vaccination can produce immunity.

Supply Chain Risks

Two final comments about Covid-19’s impact on small businesses.

First, note that the pandemic’s lockdowns, restrictions and reductions in consumer demand have destroyed millions of small businesses.

The tracktherecovery.org website estimates that nearly one in three small businesses has closed (see chart below).  That’s six, seven, maybe even eight million small businesses.

If your firm relies on small businesses as suppliers or customers, therefore, think through how these small business closures affect your operations.

You may have lost, or may soon lose, customers or vendors. Or your supply chain partners may have lost them.

You may need to identify these broken links and work to repair or replace them.

A related thought, too. Even if your supply chain miraculously emerged unscathed, probably you want to think about either shortages in services and goods or price increases.

A crazy example here to show you how I think we ought to think: If your firm or organization usually sponsors a fall holiday party? I think you not only make plans now to have the party. I think you make a reservation and pay a nonrefundable deposit to lock in your event.

Re-inflating Balance Sheets

And then another related comment—also sparked by the data available from the Track the Recovery website. On average small businesses saw their revenues shrink by nearly a third over the months of the pandemic (see chart below). And I think you need to consider this angle when you think about economic uncertainty.

Those revenue shortfalls probably mean you made less money. Maybe even lost money. You know that. But the other more hidden damage here: The revenue reductions probably shrunk your balance sheet.

If you started the pandemic with, say, $100,000 of working capital, your shrinking balance sheet may now show only, say, $25,000 of working capital.

And the challenge is, your now smaller balance sheet won’t support you ramping up your sales to your old levels until you re-inflate your balance sheet. Which creates uncertainty of course. And also amounts to a financial puzzle many small firms will have to solve.

Final Words on Covid-19 Economic Uncertainty

The upshot of all this? At least in terms of thinking about economic uncertainty and your small business plan and PPP loans?

The economic environment your firm faces might look very different in the coming weeks and months.

Much, maybe even most, of the news counts as good. Which is weird to point out given the destruction and distress of the last year. And that good news reduces the economic uncertainty.

But some of the news is still pretty terrible. And lots of folks need our support and help.

All of the above creates a requirement to carefully plan for the changes that surely arrive in the coming months.

Other Resources

As an example of how sentiment has changed over the last few months, see the blog post we published late last spring about the economic uncertainty safe harbor: PPP Certification and the New Safe Harbor.

We’ve got blog posts that supply more information on second draw PPP loans, PPP loan increase amounts, and calculating whether a firm qualifies for a PPP loan.

For more detail about Covid-19’s impact on small businesses—and sorry it’s a long gritty post—you can check this out: Post-Pandemic Covid-19 Small Business Planning.

The post Covid-19 Economic Uncertainty Update appeared first on Evergreen Small Business.

Editor’s Note: Daniel Chodan, a tax partner with the Trout CPA firm in Pennsylvania, wrote the article that appears below. If you follow Dan on Twitter because of his contributions to #taxtwitter–and you should–you’ll recognize that this post elaborates on a fascinating insight he recently shared there regarding the PPP affiliation rules… 

Expanded business relief programs have created new opportunities and pitfalls for groups of related businesses. Both the Paycheck Protection Program (PPP) and the Employee Retention Credit (ERC) require certain related businesses to be grouped together to determine eligibility which creates unique scenarios when a recent or upcoming businesses acquisition is involved.

A Caution to Start

Owners of multiple businesses should be cautious and seek professional advice in these areas. The rules for combining businesses are complex and their application to current relief programs is likely to evolve. The rules are also inconsistent between the major programs as the PPP follows the SBA’s affiliation rules and the ERC follows the IRS’s controlled group rules.

PPP Affiliation Rules

Businesses are grouped for the first draw of PPP eligibility for the purpose of employing no more than 500 employees. For the second draw of PPP, businesses are grouped for eligibility purposes of employing no more than 300 employees and for determination of a quarterly decline in gross receipts of at least 25 percent

So how could affiliation affect a group of businesses? Consider an affiliated group example of a medical office and retail store owned by the same person. The medical office was an essential business and had consistent gross receipts in 2020 compared to 2019; however, the retail store was subject to a shutdown order and saw a dramatic decline in gross receipts in the second quarter of 2020. When the gross receipts are combined for the affiliated group, the group shows a decline in total gross receipts of more than 25 percent for the second quarter of 2020 which qualifies both businesses for the second draw of PPP loans.

How then could an acquisition affect a group of businesses? Consider the previous example but assume instead that the retail store was only acquired in September 2020. The acquisition took place after the second quarter of significant gross receipts drop, but the PPP combination of gross receipts for the business group applies for the entire period of measurement, not just the period after the acquisition. So both businesses again qualify for the second draw of PPP loans due to a combined decline in gross receipts of more than 25%.

It is unclear at this time how an acquisition in 2021 would be treated as current SBA rules only address affiliates acquired during 2020.

Employee Retention Credit Controlled Groups

Businesses are grouped for the ERC for the purpose of determining

1. If there has been a quarterly decline in gross receipts greater than 50 percent
2. Whether operations are fully or partially suspended, and
3. Calculating the total number of employees (FTEs) to determine eligible wages.

So how could controlled group status affect a group of businesses? The ERC groups gross receipts of multiple businesses to determine if a decline in gross receipts occurred of more than 50 percent for 2020 eligibility and 20 percent for 2021 eligibility. The previous example of a medical office and retail store owned for all of 2020 would be treated similarly for ERC. Both businesses would be ERC eligible if the decline in gross receipts for the second quarter of 2020 exceeded 50 percent.

How then could an acquisition affect a group of businesses? Similar to the PPP example, a business acquired in 2020 must combine gross receipts for an ERC controlled group. However, a key difference is that the ERC only combines gross receipts for the calendar quarters which the business was owned and operated. So the previous example of the retail store acquired in September 2020 will not qualify the controlled group for ERC as the retail store’s second quarter gross receipts are not grouped (although it would be qualified under the PPP rules).

Another key qualification difference between PPP and ERC is eligibility based upon whether operations are fully or partially suspended due to COVID government orders. All members of an aggregated group are treated as a single employer for ERC, and if one member of the group is subject to suspension by governmental order then all members of the group are considered to have their operations partially suspended. So in the previous example of the retail store acquired in September 2020, assume the retail store is subject to a government order restricting its activity to only online sales and curbside pickup while the physical storefront is not allowed to admit customers. The retail store is subject to a partial suspension of operations which means the entire controlled group is eligible for ERC during the period of suspension.

Presumably, acquisitions in 2021 would be treated similarly for the ERC as the program was expanded to cover the first two quarters of 2021. However, there has not yet been updated IRS guidance on the ERC since the Consolidated Appropriations Act expanded the program in late December.

A Closing Caveat

This blog post is general in nature and is not intended to be, nor should it be, treated as tax or legal advice. As of 1/18/2021, the IRS has not issued critically important guidance related to the Consolidated Appropriations Act; so this is based on interpretations of the law itself, existing IRS FAQs, and current SBA rules. The Act may provide significant opportunities for your company. However, the interplay between the Act, the CARES Act, and various Internal Revenue Code sections is nuanced and complicated so professional advice may be needed.

Other Resources

The newest Interim Final Rules for PPP loans appear here: first draw PPP loans and second draw PPP loans.

The statute the SBA uses for determining whether two entities count as affiliates appear here.

Dan Chodan’s biographical and contact information appears here.

The post ERC and PPP Affiliation Rules May Make Acquisitions More Attractive appeared first on Evergreen Small Business.

This blog post describes the mechanics of calculating these revenue reductions. And don’t worry. I’ll make this short as possible.

The General Rule

The general rule about how large a revenue reduction you need to qualify for a second draw PPP loan? You need to have a quarter in 2020 when your revenues fell by at least 25 percent as compared to the same quarter in 2019.

Example: Your business generated $100,000 of revenue each quarter in 2019. If in any quarter in 2020, your revenue equaled $75,000 or less? You qualify.

What Counts as Revenue

The first big question then? What exactly counts as revenue. The new Interim Final Rule provides this definition:

all revenue in whatever form received or accrued (in accordance with the entity’s accounting method) from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.

The rule further elaborates:

Generally, receipts are considered “total income” (or in the case of a sole proprietorship, independent contractor, or self-employed individual “gross income”) plus “cost of goods sold,” and excludes net capital gains or losses as these terms are defined and reported on IRS tax return forms.

Finally, the rule explains what doesn’t count:

Gross receipts do not include the following: taxes collected for and remitted to a taxing authority if included in gross or total income (such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees); proceeds from transactions between a concern and its domestic or foreign affiliates; and amounts collected for another by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder or customs broker. All other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from gross receipts

The quoted definitions get gritty. But that’s good. You and I can work with gritty. We want the details.

Calculating Quarterly Revenues with QuickBooks Desktop

Your accounting system, assuming you’re using something like QuickBooks Desktop or QuickBooks Online should make it relatively easy to calculate quarterly revenues. Also changes in quarterly revenues.

In QuickBooks Desktop, for example, you first produce a profit and loss statement by choosing the Reports⇒Company & Financial⇒Profit & Loss Standard command. That tells QuickBooks to generate a financial statement that shows income and expenses.

To tell QuickBooks to calculate the quarterly percentage change, click the Customize Report button at the top of the report window to open the Modify Report dialog box, check the Previous Period and % Change boxes, and then click OK to close the Modify Report dialog box.

Finally, to compare quarterly revenues—including calculating the percentage change–use the Dates From and To boxes to look at revenues and percentage changes for each quarter.

Tip: Click the Refresh button to get an updated version of the profit and loss statement.

You need the % Change in total income to show up as -25% or larger than -25%. Note that little hyphen barely visible. You need a minus 25% change or worse.

Calculating Quarterly Revenues with QuickBooks Online

The steps for calculating quarterly revenue amounts and changes in QuickBooks Online work similarly.

First, you want to produce a profit and loss statement by choosing Reports⇒Standard⇒Profit & Loss. That tells QuickBooks to generate a financial statement that shows income and expenses.

Next, indicate you want to compare quarterly revenues by using the Report Period boxes to look at revenues for each quarter.

Finally, to tell QuickBooks to calculate the quarterly percentage change, drop down the Compare Another Period box and check the Previous Year and % Change boxes.

Once you click Run Report, QuickBooks generates a new report. You need the % Change in total income to show up as -25% or larger than -25%.

Accounting Method Options

One final remark. It appears borrowers may use either cash basis accounting or accrual basis accounting to calculate revenues and make calculations. As already quoted once but now quoted again (boldfacing added this time), the interim final rule says this:

gross receipts to include all revenue in whatever form received or accrued (in accordance with the entity’s accounting method)

I think we can read that to say either cash or accrual—whichever the entity uses for its accounting method.

Note: Accounting programs including QuickBooks Desktop and QuickBooks Online let users easily flip between cash and accrual basis accounting. Both versions of QuickBooks, for example, include Cash and Accrual radio buttons you can use to switch accounting methods.

Finally, just because someone will wonder: Surely, you need to make apples to apples comparisons. You compare accrual revenues to accrual revenues. Or compare cash revenues to cash revenues. You don’t mix and match.

The Simple Qualification Formula Based on Annual Revenues

Comparing quarterly revenues requires a decent accounting system. Probably a system based on accounting software. Probably a system the owner or bookkeeper keeps up-to-date. That may be a bridge too far in some small business settings…

Accordingly, the rules also let you look at annual revenues if a firm operates all of 2019 and 2020.

For example, say your business earned $100,000 each quarter in 2019. Quarterly revenues of $100,000 equal annual revenues of $400,000. Because 4 times $100,000 equals $400,000.

If your 2020 revenues equal $300,000? Or less? You qualify.

Note: The reason this simplifying rule works? If your annual revenues fell by 25 percent or more, at least one quarter’s revenues fell by 25 percent.

If you use the simplified annual approach, you can probably just use your tax returns once the 2020 tax return is done.

But this caution: Using the annual approach makes qualifying more difficult. Returning to the example where a firm generates exactly $100,000 each quarter in revenues, a firm qualifies for a second draw if in some quarter, revenues drop by $25,000. To qualify based on annual revenues, the firm needs its annual revenues to drop by $100,000.

Other Resources

The actual 42-page IFR appears here: https://home.treasury.gov/system/files/136/PPP-IFR-Second-Draw-Loans.pdf

Our earlier discussion of how Second Draw Loans work.

The second draw PPP loan application form.

The post Calculating Revenue Reductions for Second Draw PPP Loans appeared first on Evergreen Small Business.

The good news here? You may be able to avoid the trap. But the bad news? You may need to take steps in the next few days.

Accordingly, let me explain how this PPP tax trap works. And then let me point out the two gambits you may have for sidestepping trouble.

Finally, a clarification: I’m not sure if this PPP tax trap is something real or just theoretical. But, gosh, for some borrowers, the dollars could be big.

So, let’s be careful…

PPP Tax Rules: A Quick Review

The new PPP tax laws say the PPP loan money isn’t taxable. The same laws say PPP borrowers can take a tax deduction for the spending. And the laws also say the PPP borrowers get basis for the forgiveness.

In a perfect world, this combination of favorable tax laws should mean you avoid any federal income taxes on the PPP money.

But a PPP tax trap exists in theory. Accordingly, if you can, you probably want to take steps to sidestep the trap.

A Simple Example of the PPP Tax Trap

A simple example shows how the PPP tax trap blindsides the unwary.

Say a business got a $1,000,000 PPP loan. Assume the business broke even for the year. (Taxable income, in other words, equals zero for the year.)

Assume the $1,000,000 of PPP money still sits there, in the partnership or corporation bank account.

And a final critical assumption: Say the business owner has $100,000 of basis in the business. That’s the dollar amount the owner has invested in the firm either through original capital contributions or reinvested profits.

The PPP tax trap here? If the PPP borrower distributes the PPP money to its owner before the PPP loan gets forgiven, the owner lacks the basis to get the distribution tax free.

With $100,000 of basis in her or his ownership interest, if the business pays out the $1,000,000 of leftover PPP money to the owner, the business owner pays long-term capital gains taxes on a $900,000 distribution in excess of her or his basis.

The tax rate runs either 15 or 20 percent on this gain. So, the tax equals $135,000 to $180,000.

Avoiding the PPP Tax Trap: Method #1

A first way to avoid the tax trap? Delay taking the distribution until the year of forgiveness.

In an example like that provided earlier, the business can just leave the leftover PPP money in the bank account until the year of forgiveness.

After the PPP lender grants forgiveness, the PPP borrower gets basis. And that’ll mean a tax-free distribution.

So that’s one way to sidestep trouble.

Note: If you return a “PPP” distribution to the business before the year ends, that should also fix the excess distribution problem.

Avoiding the PPP Tax Trap: Method #2:

The second way to avoid the tax trap? A PPP borrower may be able to treat funds paid out to a shareholder as a shareholder loan. This accounting method then shows the payments as a shareholder receivable instead of a distribution.

Accounting for a disbursement of PPP funds as a shareholder receivable complicates your bookkeeping.

You’ll want a formal shareholder receivable “note payable” with standard terms and conditions.

Probably you’ll want to ask your accountant for detailed advice and help on this. Maybe your attorney too.

But delaying the distribution until both official forgiveness occurs and until the IRS specifies how the tax accounting works? That seems like something many PPP borrowers will want to consider if they lack basis.

Other Resources You May Find Helpful

A quick discussion of the two other important tweaks to the PPP loans: second draw loans and PPP original loan amount increases.

Tony Nitti’s nice, detailed discussion of this whole basis problem: Congress Agreed to Make PPP Expenses Deduction. Note that basis may also delay when you get deductions for PPP spending–though that seems like less of a problem to me.

Finally, a brief overview of how PPP tax accounting works at our CPA firm’s website.

The post The PPP Tax Trap appeared first on Evergreen Small Business.

We just need Congress to pass and the President to sign the Continuing Small Business Recovery and Paycheck Protection Program Act (which is part of the Consolidated Appropriations Act, 2021.)

A few days after the bill becomes law, you may be able to get additional PPP money if your original loan amount was less than you were entitled to. This blog post talks about this possibility… and how to make sure you don’t inadvertently miss the bus.

PPP Second Draw Loans Different

A quick clarification, however. I’m not talking here about a second draw loan that some small businesses get.

We talk about second draw PPP loans in another blog post: PPP Second Draw Loans. Read that if your small business has been especially hard hit.

Those second draw loans also become a possibility when Congress passes the Continuing Small Business Recovery and Paycheck Protection Program Act. But second draw loans are something different. And something most small businesses won’t be eligible for.

PPP Loan Amount Increases

What we’re talking about here are increases in your PPP loan amount. For example, say you borrowed $20,000. But also say you should have been able to borrow $30,000. In a situation like this, you may be able to get a $10,000 increase.

How common are these shortfalls? Pretty common, I think.

With many of the earliest PPP loans, borrowers received the wrong loan amount. In a number of these cases, banks inadvertently shortchanged borrowers—often due to misunderstanding SBA rules. Probably most of the time, borrowers rushing to apply missed some payroll costs. Finally, in a handful of cases, the SBA rules simply changed as the process unfolded.

The Continuing Small Business Recovery and Paycheck Protection Program Act partially addresses these problems by saying that a borrower may return to its lender for an increase in the PPP loan amount if the increase stems from changes to the interim final rules.

Section 312 Creates PPP Loan Amount Increases

Section 312 of the new law creates this opportunity. Here’s the exact language, which probably only accountants, attorneys and banks care about:

(c) INTERIM FINAL RULES.—Notwithstanding the interim final rule issued by the Administration entitled ‘‘Business Loan Program Temporary Changes; Paycheck
11 Protection Program—Loan Increases’’ (85 Fed. Reg. 29842 (May 19, 2020)), an eligible recipient of an included covered loan that is eligible for an increased covered loan amount as a result of any interim final rule that allows for covered loan increases may submit a request for an increase in the included covered loan amount even if—(1) the initial covered loan amount has been fully disbursed…

Example PPP Loan Amount Increases

The tricky part of all this? Identifying where the rules may have changed. Accountants, attorneys and bankers will want to see how the SBA responds to this new feature of the PPP. But here’s a partial list of rule changes that may allow a PPP borrower to return to a lender with a request for more money.

Partner Self-employment Income

Some of first PPP loan applications didn’t include partner self-employment income as a payroll cost. Both borrowers and bankers easily made that mistake to due to a lack of clarity in the actual statute.

To deal with this confusion, thankfully, the SBA rather quickly clarified that partners in partnership could get a PPP loan based on their payroll costs in its interim final rule providing additional eligibility criteria.

Most partnerships hopefully already know about this rule change. In early May, the SBA flagged the issue and gave a green light to banks and partnerships to apply for and process an increase in the PPP loan amount.

Fishing Boat Owners and 1099 Crew members

The first interim final rule said that a borrower can’t count 1099 contractors as employees. That same rule pointed out these folks should get their own PPP loans based on their own Schedule C self-employment earnings.

In an interim final rule on eligible payroll costs published on June 16, 2020, however, the SBA updated this rule and said that fishing boat operators who pay crew members as 1099 contractors can count that as payroll cost. This rule means that these PPP borrowers if they did their PPP loan amount calculations incorrectly should be able to get an additional amount from their PPP borrower.

Group Insurance Other than Health Insurance

The new Continuing Small Business Recovery and Paycheck Protection Program Act itself should create additional payroll cost for some small businesses.

Section 105 of the new law would add group insurance to the payroll costs that count for both PPP loan amounts and forgiveness. So, in addition to group health insurance, benefits such as group life insurance and group disability insurance should count.

Farmers and Ranchers PPP Loan Amount Increases

One final additional payroll cost to mention that appears in the new Act. For farmers and ranchers reporting their business profits on a Schedule F (or any equivalent successor schedule), the payroll cost formula uses the gross income as the farmer’s or rancher’s “owner compensation replacement” payroll.

Just because this change surely confuses people, two quick examples from our Maximizing PPP Loan Forgiveness e-book…

Example 1. Skelton reports her profit on a Schedule C and shows $300,000 in revenue, $200,000 in costs of goods sold, and $40,000 of other business expenses. In this case, the Schedule C gross income equals $100,000 ($300,000 – $200,000 = $100,000 ) and the net profit equals $60,000 ($300,000 -$200,000 – $40,000 = $60,000) . This business owner plugs that $60,000 of net profit into the PPP formulas.

Compare this situation to that of a farmer or rancher.

Example 2. Smith farms and ranches. Like Skelton, he shows $300,000 in revenue, $200,000 in costs of goods sold and $40,000 of other business expenses. In this case, the Schedule F gross income again equals $100,000 ($300,000 – $200,000 = $100,000) and net profit again equals $60,000 ($300,000 – $200,000 – $40,000 = $60,000 ). But this business owner plugs $100,000 into the PPP formulas as the owner compensation replacement.

You see how big the difference is… and why for a farmer or rancher, a PPP loan amount increase opportunity needs to be monitored. Closely.

PPP Loan Amount Increases Due to Other Errors

One final tantalizing possibility to mention.

The SBA may issue a rule that says if you bungled your original payroll costs number—the number that determined your PPP loan amount—that you can fix that.

The law doesn’t say you get to do that. Or at least not to me. But the SBA has shown a lot of grace to small businesses in their rule-making. And I would not be surprised if they let people who goofed fix their error.

Next Steps

If you think you might be eligible for a PPP loan amount increase? Here’s what I think you do.

First, figure out what the increase amount should be. That’s step one.

Second, talk to your bank. See if they can give you any sense of how quickly they’ll response once Congress passes and the President signs the new PPP legislation.

Third, finally, watch the Small Business Administration’s website for any rules that explain how you request an increase in the loan amount.

Some Other Resources

Here are some additional resources you might find useful:

Ideas for planning for a post-pandemic economy
Tax accounting for sole proprietors and partnerships
How you should have handled your PPP loan (in case you get a second chance at this!…)

The post PPP Loan Amount Increases appeared first on Evergreen Small Business.

Accordingly, I want to provide small business owners who need that help with additional detailed information above and beyond what’s available in most news reports. Folks will want to move quickly to get in line for a second loan.

And, unfortunately, the PPP second draw loan rules are complicated and tricky…

Note: This blog post was originally published in August 2020 and then updated on December 21, 2020.

Who is Eligible for PPP Second Draw Loan

A first thing to know: Only a subset of PPP first round borrowers qualify for a second draw loan.

First, for example, a second-draw-loan borrower generally needs to fall beneath specified size thresholds:

• 300 or fewer employees
• Less than the revenue threshold specified in section 121.201 of Title 13, Code of Federal Regulations (sometimes as low as $1,000,000 but often quite a bit more) or a size that falls under the alternative size standard established under Section 632(a)(5), which is a tangible net worth of the applicant of not more than $15,000,000 or average net income for federal tax purposes of not more than $5,000,000 excluding carry-over losses.
• private and not public.

Second, a firm needs to not fall into a typically ineligible-for-an-SBA-loan category from the lengthy bulleted list that appears here. But this note: If your firm falls into one of the “typically ineligible” categories but the PPP laws or rules have already allowed you to get a first PPP loan, you may be eligible for a second draw loan.

And then a handful of other excluded firm categories exist, too:

• An entity organized for research or for engaging in advocacy in areas such as public policy or political strategy or that otherwise describes itself as a think tank in any public documents;
• Any business concern or entity primarily engaged in political or lobbying activities;
• Any entities affiliated with entities in the People’s Republic of China, the Special Administrative Region of Hong Kong, or that retains as a member of the board of directors a person who is a resident of the People’s Republic of China.

This idea: If you have an attorney, accountant or banker you work with, get their help to determine if you qualify for a second draw loan. And maybe do that ASAP since probably this second wave of borrowing will burn through the remaining PPP money fast.

Note: To provide second draw loans, the SBA will use the leftover money from the original PPP loans and then an additional $150 billion. But that will go really fast, I’m betting.

Qualifying for a Second Draw Loan

A borrower that’s small enough and then not otherwise ineligible due to its operating activities or connections to China must meet another requirement. Its revenues must have dramatically declined.

The simplest situation occurs when a firm’s gross receipts during a quarter of 2020 shrink by 25 percent or more as compared to the same quarter’s gross receipts during 2019.

Example 1. Martha runs a preschool. In 2019, the preschool generated $100,000 in gross receipts each quarter. Gross receipts fell due to the COVID-19 pandemic in 2020, however. In quarter 1, revenues equaled $75,000, for example. And then in quarter 2, revenues equaled $25,000. Martha can qualify for a second draw loan based on the drop in revenue in quarter 1 of 2020. That drop equals 25 percent. And she needs a drop at least that large. Martha can also qualify for a second draw loan based on the drop in revenue in quarter 2 of 2020. That drop in revenue equals 75 percent.

If an entity operated in neither the first or second quarters in 2019 but did operate during the third and fourth quarter, the entity qualifies for a second draw loan if gross receipts for one of the quarters of 2020 drops by 25 percent or more as compared to the gross receipts for the third or fourth quarter of 2019.

Example 2. Martha’s friend, Abigail, started a preschool in the fall of 2019 based, frankly, on the success she saw Martha enjoying. The timing could not have been worst. The third quarter revenue was slow due to the start-up—roughly $25,000. The fourth quarter, enrollment exploded and she recorded $100,000 of gross receipts. In 2020, however, she recorded receipts of $80,000 for the first quarter and $60,000 for the second quarter. Abigail qualifies for a second draw loan based on the 40 percent reduction in revenues that shows up when comparing the second quarter of 2020 to the fourth quarter of 2019.

The second draw loan statute provides a similar grace to someone who started a business in the fourth quarter of 2019. If an entity didn’t operate the first, second or third quarter of 2019 but did operate the fourth quarter and if gross receipts in one quarter of 2020 shrink by 25 percent or more as compared to the fourth quarter of 2019, the firm qualifies for a second draw loan.

Example 3. Abigail’s daughter-in-law Louisa starts a preschool during the fourth quarter of 2019 and booked $40,000 of gross receipts for that quarter. For the first quarter of 2020, she booked $35,000 of gross receipts which isn’t enough of a drop to get her a second draw loan. For the second quarter, however, she booked $20,000 of gross receipts. The drop in revenue from the fourth quarter of 2019 to the second quarter of 2020—the $40,000 to $20,000 drop equals 50 percent—allows Louisa to qualify for a second draw loan.

Finally, if an entity began operations only in 2020 but was in operation on February 15, 2020 and gross receipts for the second quarter of 2020 fall by at least 25 percent of the gross receipts for the first quarter of 2020, the entity qualifies.

Accounting Method for Gross Receipts

The statute leaves unanswered a key question: How a borrower does the accounting used to determine gross receipts.

A quick first guess might be that a borrower simply uses the same accounting method as it does for its tax returns. So, either tax accrual basis or tax cash basis accounting.

One other factor to consider, however, is the borrower-friendly way the SBA has arranged the PPP loan terms. Given that for purposes of determining forgivable payroll and nonpayroll costs the SBA allows a borrower to use both cash basis and accrual basis accounting, a borrower may find the SBA allows them to use any reasonable accounting method that shows the required reductions in gross receipts.

This technical detail, then, bears close monitoring by accountants, attorneys and bankers.

PPP Second Draw Loan Amount Formulas

The second draw loan statute uses almost the same basic PPP loan amount formula as used for the initial PPP loans. But some subtle differences exist.

Default Second Draw Loans

The default, most common second draw loan formula works nearly identical to most borrowers’ original PPP loans. That formula says a second draw loan equals either 2.5 times the average monthly payroll during the 1-year period before the date on which the loan is made. Or the 2.5 times the average monthly payroll during calendar year 2019.

The only real difference? The second draw loan formula limits the loan amount to no more than $2,000,000.

Example 4. Dolley operates a women clothing store and qualifies for a second draw loan based on the $10,000 a month of payroll costs she paid or incurred 2019. The second draw loan amount equals $25,000. That amount matches her original PPP loan amount, which also equaled $25,000 and was also calculated as 2.5 times the $10,000 average monthly payroll in 2019.

Note: The original PPP loan amount formula limited the loan amount to no more than $10,000,000. Note, however, that this $10,000,000 limit will be reduced as part of the Continuing Small Business Recovery and Paycheck Protection Program Act.

Seasonal Employer Second Draw Loans

The second draw loan formula works differently for a seasonal employer.

For a seasonal employer, the second draw loan formula first calculates the average monthly payroll paid or incurred for a 12-week period (quoting the statute) beginning on February 15, 2019 or March 1, 2019, and ending June 30, 2019, or for a consecutive 12-week period between May 1, 2019 and September 15, 2019.

The formula then multiplies this average monthly amount for this 12-week period by 2.5, compares this product to $2,000,000, and sets the second draw loan amount to the lesser of the product or $2,000,000.

Example 5. James and Elizabeth own a wildly popular bar and restaurant in a seasonal tourist destination. They qualify as a seasonal employer and averaged $1,000,000 in monthly payroll costs over the 12-week period the seasonal employer second draw loan formula looks at. Their second draw loan amount however equals $1,000,000. Though 2.5 times $1,000,000 equals $2,500,000, the formula limits their loan to no more than $2,000,000.

New Employer Second Draw Loans

The second draw loan program provides a special formula for new entities.

The statute defines a new entity as an entity that did not exist in the 1-year period before February 15, 2020. And for these folks, the formula calculates the average monthly payroll costs for the months in 2020 the entity operated, multiplies that average monthly amount by 2.5 to get a tentative loan amount, and then again limits the loan to no more than $2,000,000.

Example 6. Stockly Donelson, a new law firm, started operations on March 1, 2020 and averaged $20,000 a month in payroll over the six months before it applied for a second draw loan. It qualifies for a second draw loan equal to $50,000.

Aggregate PPP Loan Limits

The second draw loan rules limit aggregate borrowing by an entity and its affiliates in three ways.

First, the rules say that a borrower receiving multiple second draw loans because it operates multiple locations (like a restaurant chain or a motel operator) can receive no more than $2,000,000 in total.

Second, the rules say that borrowers who have received a PPP loan may not receive another SBA loan that pushes their aggregate borrowing over $10 million.

Third, the rules say that within any 90-day interval or time, a borrower and its affiliates may not receive more than $10,000,000 of guaranteed loans.

Public Disclosures of Second Draw Loans

Probably a borrower won’t know whether the SBA will disclose borrowers receiving second-draw loans when applying. But borrowers and their professional advisors want to consider this wrinkle.

Publicly alerting competitors, employees, supplies and other stakeholders that a firm’s revenues have declined by 25 percent or more may cause significant damage in some situations. And the SBA’s current approach is to provide detailed information about all borrowers who take PPP loans.

Second Draw Loan Forgiveness

Second draw loan forgiveness works like first draw loan forgiveness. A borrower potentially receives forgiveness equal to the sum of its payroll costs, mortgage interest, rent, utility payments, operations expenditures, property damage costs, supplier costs, and worker protection expenditures incurred before January 1, 2021.

Note: The “Continuing Small Business Recovery and Paycheck Protection Program Act” adds four new categories of forgivable spending: operations costs, property damage, supplier costs and worker protection expenditures.

As with first draw loans, at least 60 percent of the forgiveness must stem from spending on payroll costs.

Example 7. Stockly Donelson, the law firm mentioned in the preceding example, received a $50,000 original-version PPP loan and then a $50,000 PPP second draw loan. The firm may receive forgiveness for both loans. To receive full forgiveness, and assuming it will use the 24-week covered period, it needs to spend at least $60,000 on payroll and related costs and any remaining PPP loan money on mortgage interest, rent, utilities, operations expenditures, property damage costs, supplier costs, and worker protection expenditures.

Smallest Firms Targeted with Second Draw Loans

Understandably, perhaps, the statutory language that creates the second draw loan also tweaks the lending process to level the playing field for small borrowers and lenders.

The new loan sets aside $25 billion in funding for entities employing 10 or fewer employees, for example.

Also, it sets aside $10 billion in funding to be made by community financial institutions; insured depository institutions with consolidated assets of less than $10 billion; credit unions with consolidated assets of less than $10 billion; and farm credit system institutions with assets of less than $10 billion.

Finally, it directs the SBA to prioritize under-served communities and issue guidance addressing barriers to access to capital for under-served communities.

Other Resources

The second draw PPP loan application form appears here.

The new PPP statutes change the tax accounting. Here’s a blog post at our CPA firm website that explains: How Taxes Work for PPP Loans.

If a borrower does get another PPP loan, probably it makes sense to look at this blog post: How You Should Have Done Your PPP Loan. In retrospect, many borrowers should have handled their original PPP loans differently.

The full Covid 19 relieft bill appears here: Continuing Small Business Recovery and Paycheck Protection Program Act.

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