Maximizing the Employee Retention Credit – Determining Qualified Wages
October 20, 2020
If you aren’t familiar with the Employee Retention Credit (“ERC”), then you’ve come to the right place. We’re breaking this credit down step-by-step through a series of articles, so if you need some background, check out our previous two installments to get an overview of the credit and understand employer eligibility.
Some quick basics before we dive into determining qualified wages: the ERC is a fully refundable tax credit for companies experiencing severe business disruptions due to COVID-19. Employers can receive up to $5,000 per full-time employee in credits. With your third-quarter filing due on October 31, 2020, now is a good time to assess your company’s eligibility. You might also have a refund opportunity related to previous quarterly Form 941 filings!
Know that your business will NOT be eligible if you:
- Received a Paycheck Protection Program (“PPP”) loan;
- Did not repay a PPP loan in a timely fashion; or,
- Operate as a self-employed individual with no employees.
If your business does not meet one of these exclusions and meets the definition of an Eligible Employer, the next step in the analysis is to determine the “Qualified Wages” that will form the basis of your potential ERC claim.
This article will focus on defining qualified wages so you can understand what’s included and how it affects your claim. If you are a business owner that thinks the ERC may be helpful and you still aren’t sure if you qualify, take Aprio’s quick ERC survey to find out if you are eligible.
Determining Qualified Wages
The legislation defines Qualified Wages as the wages and compensation paid to employees by an Eligible Employer after March 12, 2020, and before January 1, 2021, including qualified health plan expenses. Qualified wages are subject to a maximum cap of $10,000 per employee for all calendar quarters.
Qualified Wages do NOT include:
- The related payroll taxes and withholdings – including the employee’s or employer’s shares of Social Security taxes, the employee’s and employer’s shares of Medicare taxes, and the federal income taxes required to be withheld;
- Severance payments made to a former employee following termination of employment –(Although payments to active employees can be considered qualified wages, severance payments are payments for the past employment relationship and thus do not qualify.)
- Wages included in the calculation of other payroll tax credits – such as qualified sick or family leave wages under the Families First Coronavirus Response Act as well as wages included in the Work Opportunity Tax Credit and the credit for paid family medical leave.
The actual calculation of your business’s qualified wages will depend on whether your business meets the ERC’s definition of a “large employer” or a “small employer.”
- A large employer – is a business that averaged more than 100 full-time employees in 2019
- A small employer – is a business that averaged 100 or fewer full-time employees in 2019
There are many nuances to defining your average number of employees, so we recommend working with a knowledgeable advisor throughout the process of calculating your credit to maximize your benefit.
Since the rules and calculations are different depending upon whether your business is a large employer or a small employer, the remainder of the article will address the Qualified Wages determinations for each type of employer. Let’s start with a small employer.
“Small Employer” Calculations
If your business is an eligible Small Employer, your Qualified Wages include all of the wages paid to any employee during the eligible time period, up to $10,000 per employee.
Your Qualified Wages also include health plan expenses paid to all employees (regardless of whether they were working or receiving regular wages), excluding any amounts that your employees paid for with after-tax contributions. Additionally, Qualified Wages for a Small Employer may include wages paid to employees under a pre-existing paid-time-off (PTO) vacation, sick and other leave policies.
Consider this example:
- A Small Employer lays off or furloughs all of its employees. It does not pay wages to its employees for the time they are laid off or furloughed and not working, but it continues the employees’ health care coverage. In this instance, the health plan expenses would also be treated as Qualified Wages.
“Large Employer” Calculations
If your business is a Large Employer, your Qualified Wages include only the wages paid to employees for the time that they were not providing services, up to $10,000 per employee.
For example, if your hourly employee works 25 hours per week instead of his or her normal 40 but continues to receive full pay for 40 hours, wages for the 15 hours when the employee is not providing services are Qualified Wages.
The employment status of the affected employees can impact your calculation. Determining the time that they are not providing services for salaried employees is generally more difficult than for hourly employees. You may have to develop a method for determining and substantiating the paid hours that were not worked. For example, you may consider requiring salaried employees to track and report hours that were not worked or requiring the employees’ supervisors to estimate and document the hours not worked, but both approaches could raise employee relations concerns.
Large Employers also have different considerations when it comes to determining whether Health Plan Expenses or Paid Time Off are Qualified Wages:
Paid Time Off
A Large Employer may not treat amounts paid to employees for paid time off (PTO) for vacations, holidays, sick days and other days off as Qualified Wages. However, if you provide employees an additional period of PTO that employees must use during a furlough period, that PTO may be treated as Qualified Wages because the PTO was not earned for services previously provided.
Health Plan Expenses
Like Small Employers, Large Employers may include health plan expenses as Qualified Wages, but only to the extent the expenses are allocable to the time the employees are not providing services. So, health plan expenses paid to employees that have been furloughed without pay may be included, but any health care expenses allocable to the time the employee was providing services must be excluded.
Consider these examples:
- The employees of a Large Employer receive 60% of their wages for 50% of their normal hours. The employer continues to cover 100% of the employees’ health plan expenses. Qualified Wages in this scenario would include: the 10% of the wages that it pays employees for time they are not providing services, plus 50% of the health plan expenses, because the health plan expenses are allocable to the time the employees were not providing services.
- A Large Employer lays off or furloughs its employees and does not pay wages to the employees, but does continue to cover 100 percent of the employees’ health plan expenses. In this instance, the business may include health plan expenses as Qualified Wages.
Next Steps: Claiming the ERC
Claiming the ERC as an Eligible Employer with Qualified Wages requires several steps, but you don’t have to navigate it alone. Aprio’s experts have vast experience with calculating and claiming payroll tax credits and have been on the forefront of helping clients navigate the adverse financial impacts of the Coronavirus pandemic.
About the Author
John is a tax partner at Aprio with more than 20 years of experience in corporate tax strategic planning, compliance and accounting for income taxes under ASC 740. John collaborates with Aprio’s tax and accounting professionals to identify and implement tax credits and incentives for companies of all sizes and in various industries, including manufacturing, technology and insurance.