The Taxpayer Certainty and Disaster Relief Act (TCDRA) of 2020, part of the Consolidated Appropriations Act, 2021 (CAA), included an important provision allowing taxpayers/employers who availed themselves of a First Draw Loan under the Paycheck Protection Program (PPP) enacted as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act to “retroactively” qualify also for the Employee Retention Credit (ERC). (view our webinar)
Prior to the enactment of the CAA, taxpayers/employers who took advantage of the PPP loan were disqualified from taking advantage of the ERC. Because of this restriction, most taxpayers/employers elected to take advantage of the PPP loan opportunity and forgo the ERC. (see related post) However, now that employers are eligible for both tax benefits, it is worthwhile to focus time and attention on the ERC, which can be applied retroactively for 2020.
Under the 2020 ERC program, qualifying taxpayers/employers were able to obtain a tax “credit” for payroll paid of 50% of eligible wages, up to a total of $10,000 for calendar year 2020. Thus, the maximum credit available under the ERC is $5,000 per employee for 2020.
Payroll Cannot Count for Both Forgivable PPP Loan Funds and the ERC
A significant limitation in securing the greatest economic benefit under the ERC is payroll. The rules for the ERC provide that “any” payroll utilized by a taxpayer/employer in requesting forgiveness of the PPP loan cannot be considered a second time in securing the ERC.
As PPP loan borrowers are aware, to secure forgiveness of the loan, at least 60% of the funds borrowed must have been spent on covered payroll, while 40% was allowed to be spent on “other covered expenses.” Because the original eight-week covered period was expanded to 24 weeks, those taxpayers who had borrowed the maximum loan amount at 10 weeks of payroll [2.5 times average monthly payroll] had more than twice the anticipated period of time to spend the proceeds on covered payroll. As a result, the eligible payroll incurred by many taxpayers/employers/borrowers during the 24-week covered period was sufficient to meet not only the required 60% of the loan, but could be used to offset the entire PPP loan proceeds when requesting forgiveness.
Prior to passage of the TCDRA, there were no issues with requesting forgiveness by demonstrating that amounts greater than 60% of the total loan were used on qualifying payroll when seeking forgiveness. In fact, such an approach generally made filing for forgiveness an easier undertaking with reduced administrative burden as less data had to be confirmed (for the “other” covered expenses.) However, now that payroll costs can also qualify for the ERC, using an excess of 60% in requesting loan forgiveness reduces the amount of payroll that can be considered in claiming the ERC.
Issues for Borrowers Who Submitted PPP Loan Forgiveness Applications
Where such an approach was taken as an expediency in requesting forgiveness before the changes made by the CAA, it is probably safe to say that those borrowers doing so would have taken a different course had they suspected that those payroll costs may later be eligible for the ERC. Borrowers who applied for forgiveness prior to the enactment of the TCDRA were not aware that there would be an option to claim the ERC or that such a claim would be conditioned on not having used such wages to obtain forgiveness of a PPP loan.
We at GYF, as well as numerous other professional organizations and commentators, have noted this unintentional effect on the computation of the allowable 2020 ERC. To address this issue, the American Society of Certified Public Accountants, (AICPA) recently sent a comment letter to the Internal Revenue Service (IRS) recommending how best to deal with the issue of claiming the 2020 version of the ERC when payroll costs have been already been reported on a PPP loan forgiveness application.
Per the AICPA letter:
The CARES Act provided employers with the option to benefit from one of two mutually exclusive incentives, a Paycheck Protection Program (PPP) loan or an employee retention credit (ERC), designed to allow employers to retain employees during the pandemic. Section 206 of the TCDRA allows employers who received a PPP loan to retroactively claim the ERC for wages paid after March 12, 2020, but not for the wages used to obtain PPP loan forgiveness.
…It is unclear how the reporting of wages as payroll costs on a previously filed PPP loan forgiveness application affects an employer’s ability to claim the ERC for wages that were included on a loan forgiveness application but did not affect the amount of loan forgiveness.
An applicant could reasonably have concluded that, with a 24-week covered period over which to spend funds that were based on 2.5 months of average 2019 payroll, that they could simply report wages on the application form. Similarly, a borrower might have reported all wages and related expenses on the forgiveness application form, assuming that this would allow full forgiveness even if the bank or SBA decided a portion of their expenses did not qualify for forgiveness.
The AICPA analysis notes that borrowers had no idea listing excess wages on the application would end up having a potentially negative impact on qualification for this tax credit, since they were not at all eligible for this credit under the law in place when they applied for forgiveness. The letter notes:
To be eligible for PPP loan forgiveness, an employer must incur or pay payroll, rent, utilities and interest amounts during the covered period or alternative covered period. On loan forgiveness applications, many employers reported only payroll costs (and not rent, utilities, and interest), because the payroll costs generally exceeded the loan amounts. Because employers did not have the option to claim the ERC at the time many loan forgiveness applications were filed, they were not concerned about reporting wages in excess of those needed for loan forgiveness.
Now that the rules are changed, are those borrowers simply out of luck? The AICPA letter recommends that the IRS adopt guidance to avoid that result.
The AICPA recommends that the IRS and Treasury provide guidance stating that the filing of a PPP loan forgiveness application does not constitute an election to forgo the ERC with respect to the amount of wages reported on the application exceeding the amount of wages necessary for loan forgiveness.
The AICPA letter also points out that the IRS had allowed those who were qualified to claim the ERC to opt out and then later change their mind, but that this guidance does not address the PPP issue.
Qualified wages for ERC purposes are amounts paid by an eligible employer up to $10,000 per employee, unless the employer elects out of the provision. IRS ERC FAQ #93 states that an eligible employer can elect not to apply the ERC for any calendar quarter by not claiming the credit on the employer’s employment tax return. IRS ERC FAQ # 94 states that the election can be changed by amending a quarterly payroll tax filing and that the employer can claim a credit for a subsequent quarter even though no credit was claimed in the previous quarter. The FAQs do not address the election process when payroll costs have been reported on a PPP loan forgiveness application.
Examples to Illustrate the Concerns and Recommendations
The AICPA letter includes two separate examples of applying the organization’s recommendation to specific facts.
In this straight-forward case, the borrower simply reported more wages on the forgiveness application than were required to obtain forgiveness, likely because there appeared to be no reason not to do so.
Employer X received a $1,000,000 PPP loan. On its PPP loan forgiveness application Employer X reported $1,500,000 of payroll costs for the covered period April 15, 2020 to September 29, 2020. The entire loan was forgiven.
Employer X should be permitted to claim the ERC for qualified wages paid from March 13, 2020 through December 31, 2020, including qualified wages related to the $500,000 of wages reported on the loan forgiveness application in excess of the $1,000,000 of wages necessary for forgiveness, without jeopardizing the validity of the PPP loan forgiveness application.
This case is more complex. In addition to reporting more payroll costs than would have been necessary to obtain forgiveness, the borrower also failed to include other, non-payroll costs that would have reduced the amount of payroll costs necessary for forgiveness.
Employer X received a $1,000,000 PPP loan. On its PPP loan forgiveness application, Employer X reported $1,500,000 of payroll costs for the covered period April 15, 2020 to September 29, 2020. In addition, Employer X incurred $100,000 of rent expenses during the covered period that were not reported on the loan forgiveness application as they were not necessary for loan forgiveness. The entire loan was forgiven.
Employer X should be permitted to claim the ERC for qualified wages paid March 13, 2020 through December 31, 2020, including up to $600,000 ($1,500,000 of wages included on the loan forgiveness application + $100,000 of rent expenses not reported on the application – $1,000,000 loan) of payroll costs reported on the loan forgiveness application, without jeopardizing the validity of the PPP loan forgiveness application.
The resolution posited by the AICPA takes a common-sense approach to the issue and is logical. There is no way at this time, however, to discern the expected response or timing from the IRS. If you have already filed your PPP Loan Forgiveness Application, and find yourself in this situation, please feel free to contact Bob Grossman, Don Johnston or Mike Weber at 412-338-9300 to discuss the options that may be available to you at this time.
If you have NOT yet filed an application for PPP loan forgiveness, we strongly recommend that you contact GYF and take steps to minimize the total amount of covered payroll used in your request. We currently believe, if it is possible and your company meets the requirements to qualify for the retroactive 2020 ERC, that it is best for you set forth your covered payroll in the application at the lowest level possible while still meeting the 60% threshold.
Grossman Yanak & Ford LLP will continue to monitor this issue as well as all other developments relating to the PPP loan program and the ERC.