Many businesses that were negatively impacted by the pandemic qualified for the Employee Retention Credit (ERC). The ERC was enacted through the CARES Act to encourage businesses to keep employees on their payroll. To be eligible, businesses had a decline in gross receipts and had a full or partial suspension of operations. Like the Payroll Protection Program (PPP), the ERC program led to questions about accounting and reporting.
The ERC is a credit to offset payroll taxes, and not an income tax credit, so must be as such. The ERC is claimed on Form 941 for the quarter that the qualified wages are paid. If the calculated tax credit is more than the amount of the employer’s share of payroll taxes owed for a given quarter, the excess is refunded. Any credit claimed through the ERC program will result in a reduction of wage expense claimed to the extent of the credit amount (Section 280C). If an employer chooses to amend any 941’s after their income tax return has been filed, then the income tax return will also need to be amended to reflect the credit.
There are three different accounting treatments for the ERC. Entities should account for ERCs using one of these standards after considering which standard would provide the most transparency to the users of their financial statements.
1. International Accounting Standards (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance.
- Most public companies are using this method and offsetting wages with the credit.
- ERCs, unlike PPP loans, are structured as a refundable credit and not a loan.
- If an entity accounted for their PPP loans under IAS 20, there is a presumption that they will utilize the same guidance to account for their ERCs.
- Under IAS 20, a business entity recognizes ERCs on a systematic basis over the periods in which the entity recognizes the payroll expenses for which the grant (i.e., tax credit) is intended to compensate the employer when there is reasonable assurance (i.e., it is probable) that the entity will comply with any conditions attached to the grant and the grant (i.e., tax credit) will be received.
- IAS 20 permits presentation as a credit in the income statement (either separately or under a general heading, such as “other income”) or as a reduction of the related expense (with appropriate disclosure in the footnotes regarding key features of the grant). This guidance is not available to not- for-profit entities.
2. Revenue Recognition (ASC 958-605)
- This method should be used by all non-for-profit entities.
- If the entity receives ERCs as an advance, it will record a liability for the cash received until such time that the conditions to earn the credit are substantially met.
- When conditions are met:
- A not-for-profit entity is required to record the income as revenue.
- A for-profit entity may record the amount as grant revenue or other income.
- 958-605 does not permit an entity to net the grant against qualifying costs.
- The evaluation of whether all conditions are substantially met will require the use of judgment. Uncertainty regarding whether an entity qualifies for the credit would generally indicate that the conditions were not substantially met at period end. Since the accounting model under Subtopic 958-605 requires that substantially all conditions are met to recognize the grant into income, entities will need to consider whether preparing and submitting the filing is a “more than administrative task” that would defer recognition until such time that the filing with the Internal Revenue Service is made.
- Under 958-605, the entity would present the amount of an employment tax refund receivable or an unearned refund advance as a current asset or liability.
- Though some or all qualifying expenses may have occurred in 2020, it may not be appropriate to record them as 2020 income under ASC 958-605, based on other barriers that may not have been overcome until 2021.
- In 2021, the Consolidated Appropriations Act, expanded, retroactively to March 12th, 2020, the Employee Retention Credit (ERC) to include those otherwise eligible employers who also received Paycheck Protection Program (PPP) loans. If the entity qualified for the 2020 ERC due to Consolidated Appropriations Act, the income cannot be recorded until 2021.
- Under ASC 450, entities would treat the ERCs (whether received in cash or as an offset to current or future payroll taxes) as if they were gain contingencies.
- Under ASC 450-30, entities would not consider the probability of complying with the terms of the ERC program but, rather, would defer any recognition in the income statement until all uncertainties are resolved and the income is “realized” or “realizable”.
- The AICPA discourages this method due to it providing less specificity on disclosure, measurement, and recognition requirements as compared to other methods.