One of the popular taxpayer relief provisions passed to help businesses affected by the COVID shutdowns is the employee retention credit (ERC). The ERC allows companies to claim a refundable payroll tax credit for wages or qualified health plan expenses paid by any eligible employer. The eligibility criteria for ERC are any company that meets the following tests:
1. Operations were suspended or shutdown through government mandate
2. Experienced a 50% reduction in revenue from a quarter in 2020 compared to the same quarter in 2019
3. Experienced a 20% reduction in income from a quarter in 2021 compared to the same quarter in 2019
Businesses that meet any of these criteria can claim a payroll tax credit of up 70% of the first $10,000 paid to an employee per quarter in 2021 ($7,000 credit per employee per quarter). To reach the $10,000 limit, employers can allocate:
1. Wages paid to the employee
2. Health plan expenses paid for by the employer
3. Health plan expenses paid for by the employee only through pre-tax salary reduction
Impact on R&D Credits
Since the inception of the ERC, the IRS and Congress have issued a bevy in rule changes. The latest governing iteration, the Consolidated Appropriations Act (CAA), contains language that excludes wages claimed as part of the ERC from wages that would be calculated for various other credits, including the R&D Tax Credit and the Work Opportunity Tax Credit. Thus, taxpayers seeking to maximize the use of both the R&D Credit and ERC need to be thoughtful in which expenses are allocated towards the ERC calculation.
To avoid a reduction in qualified research wages as calculated under the R&D tax credit, businesses can take the following steps when making ERC claims:
1. Allocate as much of the ERC claim to qualified health plan expenses as possible
2. Claim ERC credits on wages paid to employees not heavily involved in the R&D process (e.g., support staff, marketing, admin)
ATS does not foresee that these regulations will have a significant adverse impact on R&D Credits in 2021. The duplicate wage exclusions would only substantially impact companies with a high allocation of wage percentages associated with qualified research. For example, companies with a majority of employees with 80%-100% wages allocated to R&D may see a reduction in qualified research expenses (QRE) equal to $7,000 per employee per quarter, whereas employees with 25%-50% wages allocated to QRE would most likely not be affected.
As with all COVID-related relief programs, the rules and regulations on ERC are constantly changing. However, businesses and advisors preparing ERC claims should take a strategic approach when allocating expenses toward the credit. This way, companies can make the most out of all tax incentives available. For more information or questions on how to maximize your tax position, please contact ATS directly.