The Employee Retention Credit – Introduction.
Congress acted quickly during the worldwide COVID-19 pandemic to provide hiring and other economic incentives to employers. One particularly helpful relief provision—the employee retention credit (“ERC”)—provided employers with potentially refundable credits for wages that they paid to their employees during certain periods of 2020 and 2021.
Regrettably, Congress’s swift action and subsequent tinkering with the rules and requirements of the ERC left many employers confused as to whether they qualified for the credit in any given calendar quarter. In an attempt to reduce this confusion, this article provides a primer on the ERC including certain applicable rules and eligibility requirements to claim the ERC.
Congress originally enacted the ERC relief provisions on March 27, 2020, as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Pub. L. No. 116-136 (the “CARES Act”). Congress later revised the ERC rules through enactment of: (1) The Taxpayer Certainty and Disaster Relief Act of 2020, Pub. L. No. 116-260 (the “Relief Act”) (enacted December 27, 2020); (2) the American Rescue Plan Act of 2021, Pub. L. No. 117-2 (the “Rescue Plan Act”) (enacted March 11, 2021); and (3) the Infrastructure Investment and Jobs Act, Pub. L. No. 117-58 (the “Infrastructure Act”) (enacted November 15, 2021). The IRS issued guidance on the ERC through FAQs and various Notices.
At its basics, eligible employers that qualify for the ERC are entitled to: (1) a refundable credit of up to $5,000 per employee for any qualified wages paid between March 15, 2020, and December 31, 2020; and (2) a refundable credit of up to $7,000 per employee per quarter (i.e., a maximum of $21,000 per employee) for qualified wages paid between January 1, 2021, and September 31, 2021. Special rules also apply to extend the ERC to certain “recovery startup businesses.”
Basic ERC Rules.
There are various rules and requirements to claim the ERC. These include: (1) attribution rules; (2) eligibility rules; and (3) rules related to recovery startup businesses. Each of these rules is taken in turn below.
Significantly, attribution rules apply to determine ERC eligibility. Generally, these attribution rules apply if members of a controlled group of corporations or trades or businesses under common control have attribution under I.R.C. §§ 52(a), (b), 414(m), or 414(o). For example, brother-sister companies generally have attribution.
To the extent the attribution rules apply, all employer businesses are treated as a single employer for purposes of: (1) determining whether the employer had a trade or business operation that was fully or partially suspended due to a COVID-19 government order; (2) determining whether the employer experienced a significant decline in gross receipts; (3) determining whether the employer averaged more than the requisite threshold of employees, which can otherwise limit the ERC; and (4) determining the maximum credit amount per employee. Thus, taxpayers who have common ownership in more than one business must be careful to ensure they properly apply the attribution rules to determine ERC eligibility and the credit amount for the ERC.
Threshold Eligibility Requirements.
An employer may be entitled to an ERC if the employer can show: (1) its business operations were fully or partially suspended due to a COVID-19 governmental order; or (2) its gross receipts in 2020 and/or 2021 decreased a sufficient amount relative to prior employment calendar quarters. These two requirements are discussed in inverse order below.
Significant Decrease in Gross Receipts.
The gross receipts test is different for 2020 and 2021. For qualified wages paid in 2020, the gross receipts test analyzes whether the employer had a significant decline in gross receipts in any quarter in 2020 relative to the corresponding quarter in 2019. A decline in gross receipts is significant enough to meet the ERC requirements if the decline in gross receipts in any quarter in 2020 is less than 50 percent of the gross receipts of a corresponding quarter in 2019. After this threshold requirement is met, the employer continues to qualify until gross receipts are greater than 80 percent of its gross receipts for the same calendar quarter in 2019.
For qualified wages paid in 2021, the gross receipts test is met to the extent that an employer has gross receipts in any calendar quarter in 2021 that are less than 80 percent of its gross receipts for the same quarter in 2019. Special rules apply to the extent the employer was not in existence in any calendar quarter of 2019.
Full or Partial Suspension of Business Operations.
The gross receipts test seeks to measure the economic impact of COVID-19 on the business. Notably, even if the employer does not meet the gross receipts test, the employer may nevertheless qualify for the ERC if it can show that its business operations were fully or partially suspended due to a COVID-19 governmental order. IRS guidance indicates that there must be a direct correlation with the governmental order and its impact on the business’s operations. Therefore, employers that seek to fall under this requirement must carefully analyze the governmental orders at issue and their impact on the business operations during the time the order was in effect.
Generally, government orders include: (1) orders from a city’s mayor stating that all non-essential businesses must close for a specified period; (2) a State’s emergency proclamation that residents must shelter in place for a specified period, other than residents who are employed by an essential business and who may travel to and work at the workplace location; (3) an order from a local official imposing a curfew on residents that impacts the operating hours of a trade or business for a specified period; and (4) an order from a local health department mandating a workplace closure for cleaning and disinfecting. Because states varied in their COVID-19 orders, employers need to carefully analyze whether the business was considered essential or non-essential based on the specific order at issue.
Recovery Startup Business.
The Rescue Plan Act added new section 3134 to the Internal Revenue Code of 1986, as amended. Under section 3134(b)(2), a recovery startup business was permitted an ERC for the third and fourth quarters of 2021, not to exceed $50,000 for any calendar quarter. Significantly, a recovery startup business may qualify for the ERC, regardless of whether they satisfy the gross receipts test or the full/partial suspension test above. But taxpayers should bear in mind that complex tax averaging and other rules (such as attribution) can impact whether the employer meets the requirements of a recovery startup business.
Without doubt, a large number of employers who otherwise qualified for the ERC missed claiming the credit on their employment tax return filings. However, such employers continue to have a limited window to file amended employment tax returns to claim the credit. Therefore, employers with questions regarding the ERC should immediately reach out to their tax professional to properly determine whether they meet the ERC eligibility requirements and, to the extent that they do, file amended employment tax returns to claim the ERC.