Stimulus for the Good Guys: The Employee Retention Credit

September 29, 2020 – With all the optics issues plaguing the Paycheck Protection Plan (PPP), the CARES Act Employee Retention Credit (ERC) is a great option for companies seeking stimulus support in exchange for keeping workers employed despite a Covid-19 downturn.

The PPP Debate is Still Raging

Even though the PPP funding window has been closed for several months, the debate around how these taxpayer funds are used and which types of companies were supposed to qualify in the first place continues. Just ask the folks in Miami that allegedly used PPP funds to buy a Lamborghini, among other things. The Department of Labor states under the CARES Act that companies can use PPP funds for either general corporate purposes or wages. To that end, if certain conditions are met, the loan may be forgiven. As its name represents, the PPP is intended to protect paychecks. Unfortunately, due to contentious behavior by some corporations and individuals, PPP optics have become a hot-button issue for two key reasons. 

First: PPP eligibility. Specific limitations around ownership aggregation make the rules particularly challenging for businesses, including private equity firms and their portfolios. While Congress was well intentioned, it drafted a $2 trillion stimulus plan in a matter of days. The usual wordsmithing and iterative interpretation were left for later. In the meantime, the fast pace in which the applications were created, and the funds disbursed, opened the door for bad actors like our Lamborghini driving friends to submit questionable applications yet still receive funds. 

Second: PPP forgiveness. Banks have only recently opened up the PPP forgiveness application process, so most companies have not yet applied for forgiveness. How and when to apply for forgiveness is still not clear. To make matters more complicated, loans under a certain dollar threshold may be forgiven with a simple affidavit. To that point, will ‘Paycheck Protection’ actually live up to its name? PPP at its best may have helped certain companies continue to pay employees, but the extent of which will probably never be known.

The Real Paycheck Protection is the CARES Act ERC

The most important distinction is that the ERC is NOT a loan. Unlike the PPP, the ERC is a Payroll Tax Credit, calculated because of a well-defined employee-centric corporate action. ERC eligibility and qualified wages are based on either a Covid related government shutdown order or a material business decline. If under certain specific criteria, the answer is ‘yes,’ the credit is earned based upon wages and benefits paid to employees, despite those employees being partially or fully idle. For example, consider how movie theaters were closed because of a state or other Covid-19 related order. Those theaters that continued to pay wages and health benefits to their workers, despite the mandated closure, could be eligible to receive a payroll tax credit of up to $5,000 per employee. 

Rewarding the Employee-First Approach

Many companies’ first reaction to Covid-19 was to reduce headcount. Factors such as business uncertainty, stakeholder responsibility and access to capital reserves all contributed to that tough decision. Some companies chose to ignore the risks and continued to pay workers some or all their wages and health benefits. These “good guys” helped Federal and State governments, as the employees remained on private payrolls and did not transition into the strained unemployment system. Additionally, employees and their families were offered some level of comfort, during some difficult times.

The companies that continued to pay employees can look to the ERC for help. ERC is well suited for management teams that put the interests of rank-and-file employees above the interests of executives and shareholders. 

Limitation on credit for executive compensation

The per employee credit cap acts as a guardrail so that wages paid to highly compensated individuals do not materially increase the aggregate credit potential. In other words, paying a handful of high-wage earners do not get you the same bang for buck as paying the masses. Companies that are eligible for the largest credit amounts generally have this trait in common:  They continued to pay a broad cross-section of the employee base over many weeks during a Covid-19 downturn.

Putting employees ahead of shareholders

Paying employees for not working is generally not ideal for maintaining shareholder value. Operating margins decrease, cash is depleted, and lines of credit get tapped. Shareholders generally bear the consequences of these outcomes. The ERC helps, but it only helps partially because of the per employee wage cap. Additionally, management teams that continued to pay employees at the expense of shareholders risked their own livelihood. Regardless, many companies and their respective teams took this gutsy employee-centric approach despite the personal consequences.

As of the publish date, the new stimulus legislation packages as proposed by both the Republicans and the Democrats contain an expansion of the ERC. Perhaps Congress understands the power of this proposal to drive worker-centric corporate practices to both drive down unemployment as well as provide comfort to workers during uncertain times.

We have not yet heard a story about a company using ERC funds to buy a Lamborghini. Unfortunately for folks that are thinking about it, the fact that ERC is directly tied to wages already paid makes that scenario unlikely. We hope that the ERC continues to be the very uneventful tax credit for which it was intended: a direct tax benefit to companies that looked out for their employees.

Learn more about the Employee Retention Credit (ERC).

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