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Your PPP and ERC questions answeredBy: National Association of Tax Professionals
February 26, 2021

The past several months have been a whirlwind of activity! New tax law was enacted and, as exciting as change can be, it can also be frustrating when more questions than answers are provided.

In preparation for tax season, there were quite a few questions circling around by our members related to the Payroll Protection Program (PPP) and the employee retention credit (ERC). Here are a few our research team has received recently, as well as their answers. Additional information and IRS links were provided to aid in understanding.

ERC & 401(k)

The first question concerns the ERC and employer matching contributions to a qualified 401(k) plan. The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows for a refundable payroll tax credit for 50% of wages paid to employees by eligible employers to certain employees during the COVID-19 pandemic, specifically after March 12, 2020, and before Jan. 1, 2021.

On Dec. 27, 2021, the Consolidated Appropriations Act, 2021 (CAA,2021) extended and expanded the ERC until June 30, 2021. The CAA, 2021 increased the ERC rate from 50% to 70% of qualified wages (Sec. 207(a)(2)(b)). Member Paul called the NATP research services with a question about an employer’s matching contribution to a qualified 401(K) plan.

Q: Pero Inc. received an ERC and sponsors a 401(k) retirement plan. Does Pero need to make matching contributions based on wages its eligible employees earned, disregarding the ERC received?

A: Generally, compensation for retirement plan purposes is not reduced by employer credits, including the ERC. The recommendation would be for the preparer to obtain a copy of the 401(k) plan document and determine how the plan defines compensation if the preparer is responsible for determining the match. Otherwise, the preparer should have the client contact the plan administrator.

Compensation generally means wages, salaries, fees and other amounts received for personal services rendered in the course of employment with the employer maintaining the plan to the extent the amounts are includible in gross income [Reg. §1.415(c)-2(b)]. Employees must include qualified wages for purposes of the ERC in gross income.

For the ERC, Pero may treat as qualified wages the amount its employees contribute as pre-tax salary reduction contributions to the 401(k) plan. Pero may not treat as qualified wages its matching contributions to the 401(k) plan. See example 3, question 58, of the IRS’s FAQs about determining qualified wages.

ERC & PPP

Under the CARES Act, an employer is not eligible for the ERC unless the PPP loan was repaid by May 18, 2020. CAA, 2021 retroactively (effective March 12, 2020) states employers who receive a PPP loan may still qualify for the ERC for wages that are not paid with forgiven PPP proceeds (Sec. 206(c)). Borrowers can qualify for loan forgiveness if certain requirements are met during the 8 or 24-week period after disbursement.

Q: Mexish Inc., a restaurant, claimed the ERC and received a PPP loan. Mexish used wages during the 24-week period when requesting forgiveness of the PPP loan. The restaurant had over 100 employees. Are all the wages in the 24-week period now disqualified when claiming the ERC?

A: No. Only wages Mexish paid with forgiven PPP loan proceeds are excluded. In other words, Mexish, which received a PPP loan and sought loan forgiveness, can claim the ERC for qualified wages it paid that were not treated as payroll costs when obtaining forgiveness of the PPP loan.

Stated another way, payroll costs for PPP loan forgiveness do not includes wages used to claim the ERC. For purposes of the 2020 ERC, it is interesting to note, if Mexish increased the hourly rate paid to its employees during the pandemic to compensate for the increased hazards of working or to compensate for a reduction in hours its employee worked, the increase in hourly pay was not qualified wages for the ERC. (See question 53 of the IRS’s FAQs about ERC and increase in wages.)

ERC & decline in gross receipts

An employer that has a significant decline in gross receipts may be entitled to the ERC. Under the CARES Act, an employer is considered to have a significant decline in gross receipts beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50% of gross receipts from the same calendar quarter in 2019, and ending with the earlier of Jan. 1, 2021, or the first calendar quarter after the quarter for which gross receipts are greater than 80% of gross receipts for the same calendar quarter in 2019.

See question 39 for an example of how a significant decline in gross receipts is calculated for 2020.

For this purpose, gross receipts are gross receipts of the tax year, and generally include total sales (net of returns and allowances) and all amounts received for services. Any income from investments and incidental or outside sources is also included. (See question 40, what are gross receipts, for more information.)

The CAA, 2021 changes the gross receipt test. For 2021, an employer will satisfy the gross receipts test if quarterly gross receipts decline by more than 20% compared to the same quarter in 2019 (Sec. 207(d)(2)B)).

Q: Under the CARES Act, the significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter in which the employer’s 2020 quarterly gross receipts are greater than 80% of its gross receipts for the same calendar quarter in 2019, This means if an employer had a significant decline in quarter one of 2020, but not during quarter two or three of 2020, the employer is entitled to an ERC for quarter one and two of 2020. Assuming the significant decline in gross receipts occurs in the fourth quarter of 2020, does this mean the employer automatically qualifies for the ERC for the first quarter of 2021?

A: No, the CARES Act guidance does not apply to the first and second quarters of 2021. The significant decline in gross receipts ends the earlier of Jan. 1, 2021, or the first quarter following the quarter for which the employer’s 2020 gross receipts for the quarter are greater than 80% of its gross receipts for the same quarter during 2019. (See question 4, what is a significant decline in gross receipts.) The CAA, 2021 changed the test so an employer that had a more than 20% decline in gross receipts in 2021, compared to the same quarter in 2019, satisfies the test.

For the first quarter of 2021, the employer can satisfy the gross receipts test two ways:

  • First quarter 2021 gross receipts decrease by more than 20% when compared to the first quarter 2019 gross receipts, or
  • Fourth quarter 2020 gross receipts fell by more than 20% when compared to fourth quarter 2019 gross receipts

ERC & decline in gross receipts example 2

ShopYard wants to know if it meets the significant decline in gross receipts test for quarter one of 2021 when determining its ERC for the quarter. Once ShopYard knows its first quarter 2021 gross receipts, they can be compared to the gross receipts from the first quarter 2019. Alternatively, ShopYard can use the gross receipts from the fourth quarter 2020 and compare them to the gross receipts from the fourth quarter 2019. If either test shows a more than 20% decline in gross receipts, ShopYard is eligible for the ERC for the first quarter of 2021.

ERC & wages paid to relatives

The next question relates to whether wages paid to related individuals are qualified wages for the ERC.

Q: Can a sole proprietor claim the ERC for wages paid to their child?

A: No, a self-employed taxpayer cannot claim the ERC for wages paid to the child. Wages paid to the spouse may be considered qualified wages for the ERC. (See question 59 of the IRS’s FAQ sheet on ERC and related individuals.)

Wages paid to related individuals, as defined by §51(i)(1), are not taken into account for ERC purposes. A related individual is any employee who has any of the following relationships to their employer ,who is an individual:

  • A child or a descendant of a child
  • A brother, sister, stepbrother, or stepsister
  • The father or mother, or an ancestor of either
  • A stepfather or stepmother
  • A niece or nephew
  • An aunt or uncle
  • A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

If the eligible employer is a corporation, then a related individual is any person who bears a relationship described above with an individual owning, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.

If the eligible employer is an entity other than a corporation, then a related individual is any person who bears a relationship described above with an individual owning, directly or indirectly, more than 50% of the capital and profits interests in the entity.

ERC & tax consequences

The final question pertains to the income tax consequences of the ERC.

Q: BreakfastBar received the ERC. Does BreakfastBar include the ERC amount in its federal income?

A: No, BreakfastBar does not include the ERC amount in its federal income for tax purposes. With that said, BreakfastBar is not allowed an income tax deduction for wages that equal the ERC amount. If BreakfastBar paid an employee $10,000 in wages and received a $5,000 ERC, BreakfastBar’s wage expense is not $10,000; it needs to be reduced by the $5,000 ERC received.

It is unclear if BreakfastBar reduces its employer’s deduction for employment taxes. A Joint Committee of Taxation report from April 2020 states the ERC is taken into account for purposes of determining any amount allowable as a payroll deduction for federal income tax purposes. This would seem to suggest the Social Security taxes on the wages used for the credit are not deductible. If BreakfastBar was allowed a $5,000 credit, the Social Security taxes on the $5,000 wages would not be allowed as a deduction. Further guidance from the IRS is needed.

As a reminder, IRS FAQs cannot be relied upon as legal authority. They have been provided to aid in understanding of a concept.

For any specific client-related questions about the PPP or the ERC, our research team is available via phone, email or even chat! Professional level members receive one free research question per membership year and Premium level members receive five.

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You make the callBy: National Association of Tax Professionals
February 25, 2021

Question: Ethan, age 32, received a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reporting a $30,000 IRA distribution with Code 1 [early distribution, no known exception (in most cases, under age 59½)] in Box 7. Hailey, Ethan’s tax practitioner, questions Ethan about the distribution and learns the distribution is a coronavirus-related distribution. Hailey also confirms Ethan is a qualified individual. What form does Hailey prepare and file so Ethan’s distribution is not subject to the additional 10% tax?

Answer: Hailey will prepare and file Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts. The instructions to Form 5329 instruct preparers to enter exception number 12 – Other, on Line 2. This exception number is used to avoid the additional 10% tax. Hailey will also file Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments, since it’s used to report qualified distributions and recontributions.

The CARES Act allows qualified individuals to treat distributions up to $100,000 made from eligible retirement plans and IRAs between Jan. 1 and Dec. 30, 2020, as coronavirus-related distributions. A coronavirus-related distribution is not subject to the 10% additional tax that applies to distributions made before an individual reaches age 59½. A coronavirus-related distribution can be included in income in equal installments over a three-year period beginning with the year the distribution is received. An individual has three years to repay the distribution to a plan or IRA and undo the tax consequences of the distribution. The three-year period is automatic unless the taxpayer elects out and includes the entire amount in income in the year of distribution.

Form 8915-E has four parts. Part I determines the total amount of cumulative qualified distributions. Part II reports qualified disaster distributions from qualified retirement plans. The box on Line 9 is checked if the taxpayer is electing out of the three-year inclusion period. Part III reports qualified disaster distributions from traditional, SEP, SIMPLE and Roth IRAs. The box on Line 17 is checked if the taxpayer is electing out of the three-year inclusion period. Part IV reports qualified distributions to purchase or construct a principal residence that was repaid, in whole or in part, prior to June 25, 2021.

Bonus question: stimulus payments

Question: My client, Irene, will file married filing separately (MFS) for 2020 for the first time. She is separated from her husband, who received the stimulus payments for both of them in his separate bank account and would not give her what should have been hers. On the 2020 return, do I say she never received either stimulus payment? How will the IRS handle this?

Answer: No. Irene must report that she received half of both joint stimulus payments when calculating her recovery rebate credit. The fact that her husband kept the money is a separate legal issue.

The IRS has a list of frequently asked questions (FAQs) regarding the recovery rebate credit on its website. The FAQs, while helpful, may not be relied upon as legal authority.

IRS Recovery Rebate Credit — Topic D: Calculating the Credit, FAQ D12 says, “When joint Economic Impact Payments are issued to two spouses, each spouse must claim half the payment when calculating the Recovery Rebate Credit. Each spouse must enter half the payment on the Recovery Rebate Credit Worksheet.”

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IRS updates FAQs on paid sick leave credit and family leave creditBy: National Association of Tax Professionals
February 22, 2021

Eligible employers are allowed tax credits to cover certain costs of providing employees with paid sick leave and family and medical leave for reasons related to COVID-19.

Recent legislation extended and amended tax relief to certain small- and mid-sized employers that was provided for under the Families First Coronavirus Response Act (FFCRA).

The IRS recently updated its FAQs to cover how the COVID-related Tax Relief Act of 2020, enacted Dec. 27, 2020, extends the availability of the tax credits created by the FFCRA to eligible employers for paid sick and family leave provided through March 31, 2021, as well as other amendments to the credits.

The paid sick and family leave credits, which previously were available only until the end of 2020, have been extended for periods of leave taken through March 31, 2021.

The paid sick leave credit is designed to allow qualified businesses – those with fewer than 500 employees and who pay “qualified sick leave wages” – to receive a credit for wages or compensation paid to an employee who is unable to work (including telework) because of coronavirus quarantine or self-quarantine, or has coronavirus symptoms and is seeking a medical diagnosis. Eligible employers may claim a credit for paid sick leave provided to an employee for up to two weeks (up to 80 hours) at the employee’s regular rate of pay, or up to $511 per day and $5,110 total.

In addition, an eligible employer can receive the paid sick leave credit for employees who are unable to work due to caring for someone with coronavirus or caring for a child because the child’s school or place of care is closed, or the paid child care provider is unavailable due to the coronavirus. Eligible employers may claim the credit for paid sick leave provided to an employee for up to two weeks (up to 80 hours) at 2/3 the employee’s regular rate of pay, or up to $200 per day and $2,000 total.

Employers are also entitled to a paid family leave credit for paid family leave provided to an employee equal to 2/3 of the employee’s regular pay, up to $200 per day and $10,000 total. Up to 10 weeks of qualifying leave can be counted toward the family leave credit.

Eligible employers are entitled to immediately receive a credit in the full amount of the paid sick leave and family leave plus related health plan expenses and the employer’s share of Medicare tax on the leave provided through March 31, 2021. The refundable credit is applied against certain employment taxes on wages paid to all employees.

Eligible employers may claim the credits on their federal employment tax returns (e.g., Form 941, Employer’s Quarterly Federal Tax Return), however, they can benefit more quickly from the credits by reducing their federal employment tax deposits. If there are insufficient federal employment taxes to cover the amount of the credits, an eligible employer may request an advance payment of the credits from the IRS by submitting a Form 7200, Advance Payment of Employer Credits Due to COVID-19.

Similar credits are available to self-employed individuals. Guidance is also available for businesses with fewer than 50 employees where compliance would jeopardize the viability of the business as a going concern.

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You make the callBy: NATP Research
February 18, 2021

Question: Patrick, age 50, asked during his tax appointment if he could take a distribution from his IRA in 2021 and still receive the allowed COVID-19 relief provisions under the CARES Act. Will Patrick be subject to the early withdrawal penalty, better known as the 10% additional tax, under §72(t) if he receives the distribution in February 2021?

Answer: Yes, the 2021 IRA distribution to Patrick will be subject to the 10% additional tax (early withdrawal penalty) if no other exceptions apply. The CARES Act provides relief from the early withdrawal penalty for any coronavirus-related distribution of up to $100,000 made on or after Jan. 1, 2020, and before Dec. 31, 2020, to a qualified individual.

Bonus question: stimulus payments

Question: My client is 22 years old and graduated college in May 2020. His parents claimed him as a dependent for 2019 taxes, so he didn’t get a stimulus check in 2020. After graduating college, he became employed and provides more than 50% of his own support, so he is no longer a dependent on his parent’s return. Does this mean he will get a recovery rebate credit (RRC) for $1,200 and $600 on his 2020 tax return due to his change in dependency status?

Answer: Because he is not a dependent, the taxpayer will be eligible for the RRC of $1,200 and $600 when he files his 2020 individual tax return, providing he meets the income level requirements and has a Social Security number valid for employment. The RRC has the same requirements as the economic impact payment.

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IRS mission-critical functions continue during COVID-19By: National Association of Tax Professionals
February 17, 2021

The IRS is open and processing mail, tax returns, payments, refunds and correspondence. However, COVID-19 continues to cause delay in some services, such as:

  • Live phone support
  • Processing paper-filed tax returns
  • Answering mail from taxpayers
  • Reviewing tax returns, even for returns filed electronically

What to expect

Whether you’ve sent in a client’s individual or business tax return or are answering a letter, the IRS provides information on how long you may have to wait and what to do next based on the following actions taken:

  • Filed an individual tax return, business tax return or amended return
  • Received a bill or notice
  • Answered a letter or notice
  • Sent a missing form or document
  • Sent a check to the IRS
  • Requested paper tax forms
  • Requested a tax-exempt sector determination, ruling or closing agreement
  • Sent a third-party authorization or power of attorney form
  • Need to file a form with a digital signature
  • Received a failure to deposit penalty as an employer

Other services

COVID-19 operations and staffing limits have affected other IRS services. The IRS provides information on availability and processing times if you:

IRS enforcement and compliance operations

These IRS offices have resumed services:

  • U.S. residency certification
  • Compliance

To view the status of your action, visit the IRS website to check on your individualized needs. It is also recommended to check the site for updates.

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Additional Articles

You make the callFebruary 25, 2021
IRS updates FAQs on paid sick leave credit and family leave creditFebruary 22, 2021
You make the callFebruary 18, 2021
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