When the COVID-19 pandemic hit the U.S. in spring 2020 and many businesses were required to close locations, some were hit harder than others. Restaurants, bars, and entertainment venues were impacted most seriously of all, because aside from delivery services, they couldn’t work remotely as professional services businesses could.
Congress enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act at the end of March 2020, with a variety of business and individual tax credits, loans, deductions and deferrals intended to ease the burden on these businesses and help them make it through the roughest months. One of the biggest tax provisions was the Employee Retention Credit (ERC), a refundable credit for businesses that incentivizes small businesses to keep their employees on their payroll, even if sales volume has fallen below what they would normally require to keep that staff.
In early 2021, as the pandemic continued but the promise of vaccines was starting to emerge, Congress extended the ERC for wages paid through the end of 2021, and increased the amount of the credit, expanded which employers are eligible, and made other changes.
Under the latest version of the ERC, employers can now claim tax credits for up to 70% of qualified wages paid (applied on wages of up to $10,000 per employee per quarter) for employees in 2021. This can result in a credit of up to $28,000 for the calendar year 2021. For wages paid in 2020, the previous version of the ERC allowed a credit of up to 50% on wages of up to $5,000 per employee. Prior tax credits can be claimed retroactively.
LLC Owners and Self-Employed Freelancers are Not Eligible for the ERC
Qualified wages include salaries and hourly pay, including qualified health care plans and employment taxes.
This means that self-employed workers (Schedule C and LLC) do not receive qualified wages. LLC owners are not considered employees and don’t receive wages because, as sole proprietors, they simply draw funds from the expected profits of the business. These are not paychecks, and no taxes or FICA are withheld.
While an LLC has some tax benefits for owners, this is a major drawback with regard to the Employee Retention Credit. If the LLC has other employees, the wages paid to those workers is eligible, but not the owner. So, if the LLC owner/self-employed individual is the only worker associated with the business, it can not claim the tax credit.
S-Corps and C-Corps Self-Employed Are Eligible
The owners (shareholders) of S-Corps and C-Corps can be eligible for the ERC because income earned by the business is reported and taxed on their individual income tax returns. To be eligible, shareholders must perform significant work for the business and be on the business’ payroll (subject to regular withholding).
Employers can qualify for the credit if they meet either of the following conditions:
1. Operations were partly or completely halted as a result of a COVID-19 shutdown order by a local or state government; or
2. Gross receipts declined by 50 percent or more compared to the same quarter in 2019; the qualifying period ends when sales recover to 80% or more of the same quarter in 2019.
3. Tribal governments and entities are eligible for the credit. However, state, federal, and local government entities, or private entities acting as a government entity, are not eligible.
4. Tax-exempt organizations are eligible if they meet either of the criteria in numbers 1 or 2 above.
And – The employer must have kept the employee/s on payroll during this period, if they are using those employee’s pay when calculating the ERC.
ERC & PPP Loans
Initially, the ERC was not available to employers that had received a PPP loan. However, with the March 2021 passage of the American Rescue Plan Act, some employers may be eligible for both, including retroactively into 2020. Employers cannot calculate an employee retention credit based on wages it has previously used to receive a PPP loan.
For employers who have received a PPP loan, if they included more payroll costs than necessary on the application, the payroll costs that were excluded, along with other eligible expenses, may be used as qualifying costs when determining their ERC.
As an example, if an employer with a $150,000 PPP loan actually reported $200,000 in payroll costs on their PPP application, there would be an excess of $50,000 in payroll costs that may be used as qualifying ERC expenses. With regard to calculating PPP loans, at least 60% of the entity’s qualified expenditures had to relate to qualified payroll. This often results in non-utilized qualified payroll and related expenses that can qualify for the ERC. IRS Notice 2021-20 provides more detail and several examples of the interaction between the ERC and PPP loans.
Advance Payment of Credit
Small businesses, defined as having less than 500 employees, can receive an advance payment of credits, with some limitations, using IRS Form 7200. Larger employers are not eligible for advance credit payments.
The Employee Retention Credit and other COVID-19 tax scenarios can be very complicated. A tax professional, such as a CPA, has the expertise to help freelancers take full advantage of current tax laws and develop strategies for future tax obligations.
Jonathan Medows is a New York City-based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He provides tax, accounting and business articles for freelancers on his website, http://www.cpaforfreelancers.com, which also features a blog and a free monthly newsletter.