According to a study of the pandemic’s impact on small businesses from the Proceedings of the National Academy of Sciences (PNAS), more than 41% of companies reported needing to close due to COVID-19 (Alexander W. Bartik, Marianne Bertrand, Zoe Cullen, Edward L. Glaeser, Michael Luca, and Christopher Stanton, “The Impact of COVID-19 on Small Business Outcomes and Expectations,” Proceedings of the National Academy of Sciences, July 28, 2020, https://doi.org/10.1073/pnas.2006991117). Another report found that, at its peak, the pandemic resulted in more than 23 million jobs lost (CEW Georgetown, “Tracking COVID-19 Unemployment and Job Losses—CEW Georgetown”).
As a result of this devastation, Congress stepped in to provide critical relief to American businesses that were forced to shut down, turn away projects, and lay off employees. From the Paycheck Protection Program (PPP) to Economic Injury Disaster Loans (EIDL), taxpayers were—and in some cases, still are—entitled to several opportunities for financial relief.
Specifically, the Coronavirus Aid, Relief, and Economic Security (CARES) Act allocated approximately $349 billion in relief for small businesses. This act created the opportunity for eligible employers to claim a refundable tax credit known as the Employee Retention Credit (ERC) if wages were paid to some or all employees between March 12, 2020, and January 1, 2021 (IRS 2021). Later, through the American Rescue Plan Act of 2021 (ARPA), eligibility for the ERC was extended through January 1, 2022.
Who Still Qualifies?
Unfortunately, many of the financial relief tools intended to help American businesses work through the era of COVID-19 are no longer available. The Paycheck Protection Program ended in May 2021, while the Shuttered Venue Operators Grant (SVOG) is no longer accepting applications and the Restaurant Revitalization Fund (RRF) has closed. Although such programs could require further reporting in future, these aren’t viable options for businesses that still need access to capital in order to keep their doors open.
Absent the reopening of these programs based on an extreme uptick in COVID-19 cases, it seems the most viable remaining option is the ERC. CPAs should look at businesses that experienced a revenue drop for tax years 2020 or 2021, compared with 2019, to vet qualification. CPA firms should consider discussing ERC eligibility with any client that had to change how their business operated as a result of COVID-19, including the makeup of their warehouse, inclusion of sanitation stations, altered work hours, and other modifications. These traits signal the need for a deeper dive.
Depending on the year at issue, employers can claim the ERC against certain employment taxes equal to 50% or 70% of qualifying wages (up to $10,000) per employee, per quarter. The employer’s business, however, must have experienced a full or partial suspension of operations or a significant decline in gross receipts during the eligibility period. For the partial shutdown, the litmus test is whether the business had more than a nominal impact on some aspect of its operations.
In terms of clarifications, guidance has been limited. In March 2021, the IRS released Notice 2021-20, which offered a definition for “more than a nominal portion of its business operations” as either:
- the gross receipts from that portion of the business operations is not less than 10 percent of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or
- the hours of service performed by employees in that portion of the business is not less than 10 percent of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).
The guidance also provided an example of a business that had experienced more than a nominal impact on some aspect of its operations. In the scenario, a restaurant was forced to close its onsite dining due to a government order classifying all restaurants for sit-down service (IRS Notice 2021-20).
It is clear based on this standard that businesses will need to be able to provide some type of breakdown of their operations to establish how the impact should be defined as “more than nominal.”
Beyond this guidance, in August 2021 the IRS also issued Notice 2021-49, which included details of the credit’s extension, and also expanded the definition of eligible employers to include “recovery startup businesses,” while modifying the definition of qualified wages for “severely financially distressed employers” (U.S. Internal Revenue Service Notice 2021-49).
Navigating Reviews and Intricacies
The IRS has already begun working with the Department of Justice’s COVID-19 Fraud Task Force, and will also likely loan personnel to other government agencies, including the SBA, in the government’s attempt to eliminate fraud related to COVID-19. Despite the SBA’s announcement that it would likely “spot check” loans of less than $2 million, taxpayers and CPAs alike need to be acutely aware of the risks of claiming any sort of COVID-19 relief without proper documentation (Blank Rome LLP, DeLancey Jr., and Short, “Paycheck Protection Program Audits Are upon Us—Borrowers Prepare!” JD Supra, April 20, 2021).
President Biden has also pushed to bolster the IRS’s enforcement capabilities through a suggested $80 billion in additional funding over the next decade; if passed, this would allow the agency to dig deeper into its analysis of claimed funds and credits related to COVID-19 (The Editorial Board, “Biden’s Dream of an IRS Strike Team,” Wall Street Journal, September 3, 2021, https://on.wsj.com/3b3T3Jo).
Whether determining eligibility to claim ERCs, PPP loans, EIDL loans, or any other COVID-19 relief, intricacies abound. For example, although qualifying wages cannot generally be used for both PPP loan forgiveness and ERC qualification, wages not included in payroll costs associated with a PPP loan, or wages that exceed the minimum amount for PPP forgiveness, can be used to claim the ERC.
What is certain is that businesses that want to make the most out of the currently available COVID-19 relief tools should apply for them swiftly.
Furthermore, the IRS recently released Revenue Procedure 2021-33, detailing the ability of employers to exclude certain PPP loan amounts, as well as shuttered venue and restaurant revitalization grants from “gross receipts” when calculating ERC eligibility (https://www.irs.gov/pub/irs-drop/rp-21-33.pdf). A lack of initial guidance to clarify eligibility for these relief tools, combined with the urgency felt by thousands of U.S. businesses due to a lack of accessible capital, has created a scenario primed for potential issues and errors.
Sticking to Best Practices
Despite any gray areas that loom over these relief tools, it is vitally important, regardless of which COVID-19 loan or credit is being claimed, for a taxpayer to have properly documented all necessary elements that went into their calculation of eligible amounts.
In the authors’ experience, specifically related to ERC claims, we have found that many payroll providers are allowing clients to “self-certify,” or conduct an automated qualification, based upon the gross receipts test. Neither of these methods ensure the proper documentation or thorough review of other qualifications such as a “partial shutdown.” Additional due diligence is required.
If businesses claimed the ERC through their payroll provider, they need to verify that the payroll provider is not over-claiming the credit. The authors have unfortunately seen examples of payroll providers claiming 70% of all wages for the credit instead of only those wages that qualify—a mistake that will likely come back to haunt them.
Furthermore, CPAs should look back to periods in which their clients claimed PPP loans during the CARES Act era, particularly the tail end of Q1 2020 and the entirety of Q2 2020, in order to re-evaluate whether the taxpayer was eligible for ERC. To that end, working with a trusted advisor to navigate the interplay with PPP if the client received forgiveness will be crucial.
In the end, taxpayers and their CPAs should be ready and willing to provide records in the case of an audit, including documentation establishing how an employer determined whether it was a “large employer,” records that illustrate a significant decline in gross receipts, government orders that might apply, and detailed credit calculations. Other documents—including copies of Forms 7200, as well as related tax returns—should also be kept by taxpayers and their advisors.
Regarding PPP, CPA firms should ensure that their clients have filed for loan forgiveness, and prepare adequate records to ensure the taxpayer will be able to adequately explain to the SBA how the loan funds were ultimately spent.
According to the SBA, the administration will consider a variety of factors when reviewing PPP loans claimed, including—but not limited to—eligibility, the loan amount, and the use of the proceeds granted. Taxpayers must maintain PPP documentation records for at least six years after the date the loan is either forgiven or repaid.
Despite numerous uncertainties—including the fate of the ERC with the passage of the bipartisan infrastructure bill—what is certain is that businesses that want to make the most out of the currently available COVID-19 relief tools should apply for them swiftly. CPAs have an incredible opportunity to guide these businesses through the intricacies of the process and help them see future success.
Authors’ Addendum: With the passage of the Infrastructure Investment and Jobs Act on November 15, President Biden has simultaneously ushered in a new era of opportunity and uncertainty for businesses, especially for small businesses hit hard by COVID-19 (Jacob Pramuk, “Biden Signs $1 Trillion Bipartisan Infrastructure Bill into Law,” CNBC, November 15, 2021. https://cnb.cx/3e3QgBc). While the Infrastructure Act offers a wealth of positive provisions for struggling businesses, such as providing federal funding for state infrastructure projects that can be bid out to smaller construction companies and extending broadband internet to much of rural America, the act also limits the eligibility for the Employee Retention Credit by a full calendar quarter, leaving many businesses that were looking to claim the credit in a worse financial position heading into 2022 (Diana Ransom, “How the $1 Trillion Infrastructure Deal Benefits Small Business. ,” Inc.Com., Nov. 6, 2021, https://bit.ly/3F4PAHS).
Because the Employee Retention Credit will be sunsetting early, it is imperative that CPAs help their clients and employers secure all remaining funding for which they are eligible before the provision is gone for good. Businesses should still review eligibility for the credit while remaining cognizant of the fact that the fourth quarter of 2021 is no longer part of the eligibility time frame.
Thankfully, other than the timeframe for eligibility, the qualifications for claiming the credit were unaltered by the enactment of the Infrastructure Act. One of the reasons the ERC was so effective was that the credit could be paired with the Paycheck Protection Program, offering small businesses an entirely separate avenue through which they could access COVID-19-specific relief and maintain staff. As the US faces economic uncertainty and a scattershot pandemic recovery headed into 2022, CPAs who help businesses claim the ERC for as much of 2021 as they are able will provide them a better footing for recovery and steady growth into 2022.