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The Employee Retention Credit is Complicated: Here are Four Steps to See if Your Organization Should Look into it Anyway

By now, most tax-exempt employers have availed themselves of a variety of federal COVID relief funding opportunities. One funding source that may have been considered and ruled out early on is the Employee Retention Credit (ERC). There have been notable changes to the ERC program over the past 18 months, so if you haven’t looked at it in a while, it is worth reconsidering. Any employer might be eligible for the credit, but the degree to which the benefit of the ERC program makes the effort worthwhile can vary greatly based on your organization’s specific circumstances.

Here we break it down into four questions that every employer should consider to determine if the ERC is worth a closer look. Note that this approach ignores some of the technical details and is intended to give you a sense of whether it is worthwhile for your organization to further investigate those details.

1.

Q: Do you have affiliated entities that might subject you to the IRS’ aggregation rules?

If that sounds like a terribly technical and complicated question to start off with, it kind of is. But don’t let that stop you from looking into your organization’s ERC eligibility. Even if you do have affiliates that require aggregation, your aggregated group might still benefit from ERC. Aggregation essentially requires that organizations that are under common control are treated as a single employer for the purposes of ERC. Common control is often evidenced by control over a majority of an organization’s governing Board seats, but control can also occur by contractual relationships, common management, or other means. However, the IRS’ aggregation rules are not the same as GAAP consolidation rules or the SBA’s affiliation rules (applicable to PPP loans).

A: Regardless of whether your organization has related parties that sound like they might need to be aggregated, proceed to question 2. Realize that if you are part of an aggregated group, the remaining questions need to be answered for the entire aggregated group as though the members of the group are a single entity.

2.

Q: How many full-time employees did you have in calendar 2019?

Counting people for the purposes of ERC is not intuitive. A full-time employee is defined as an employee who worked 130 hours or more in a given calendar month or 30 hours or more in a given calendar week. For ERC purposes, you are directed to identify how many such employees you had in each calendar month of 2019 and then take the average of the 12 months of 2019. Employees who work less than 130 hours in any given month are not included in this calculation at all. This is a count of full-time employees, not full-time equivalents.

A: If your count of average 2019 full-time employees calculated this way is less than 100, you should proceed to question 3a/ 3b as you may be eligible for potentially notable ERC benefits for both 2020 and 2021. If the full-time employee count is between 100 and 500, ERC benefits could be significant for 2021 but probably less so for 2020. If this calculation yields a result of average 2019 employees of greater than 500, the potential benefits of ERC are limited.

Consider both 3a and 3b, but only one of them has to “work”

to make it worthwhile to move forward.

3a.

Q: Did you experience a reduction in gross receipts during the COVID era?

3b.

Q: Was your organization fully or partially shut-down due to COVID-related government orders?

Gross receipts is different than what you typically think of as “income” or “gross revenue.” For an initial evaluation of gross receipts, take your reported gross income, adjust out realized and unrealized gains and losses on investments or fixed assets sales, and add back the gross proceeds of investment or fixed asset sales.

For ERC purposes, this calculation should be done for each calendar quarter. Each quarter should be compared to the same quarter from 2019. So, for example, your gross receipts for Q2 2021 would be compared to the gross receipts from Q2 2019.

This idea of a shut-down does not mean a complete and total shut-down. A significant curtailment of your operation is enough, even if other parts of the operations continued to function somewhat like they did pre-COVID. As a rule of thumb, a partial shut-down is worth considering if it caused a portion of your operation that represented 10% or more of your total 2019 revenue to shut-down.

ERC eligibility due to government mandated shut-down covers the period during which the shut-down was in effect, so establishing the timeline for the start and end of the shut-down is critical.

A: If a 2021 quarter shows (or is likely to show) gross receipts that are no more than 80% of the 2019 quarter, or if a 2020 quarter shows gross receipts that are no more than 50% of the 2019 quarter, you should continue to question 4.

A: If operating/ programmatic activities that represented 10% or more of your total 2019 revenue were shut down due to government orders related to COVID, you should continue to question 4.

If either 3a or 3b or both are reasonable, move on to question 4.

4.

Q. Do you have payroll expenditures that have not been used to support the use of other funding sources?

ERC is claimed as a percentage of eligible payroll costs. Have you already “used” payroll expenditures to apply to HEERF funding, claim forgiveness on a PPP loan, other federal COVID relief funding, or to support claims under a non-COVID federal, state, or county funding contract? If so, do you have remaining payroll expenditures to utilize in support of an ERC claim?

A: If you have payroll remaining “unused” after other funding claims are satisfied, you should probably move forward with a closer look at ERC. In some cases, it might be worthwhile to move forward with a more detailed consideration of ERC even if much of your payroll expenditures are “spoken for” already.

Here we break it down into four questions that every employer should consider to determine if the ERC is worth a closer look. Note that this approach ignores some of the technical details and is intended to give you a sense of whether it is worthwhile for your organization to further investigate those details.

If you’ve made it this far, you should probably take a closer look at ERC. What does that mean? Here’s a summary of next steps:

  1. Firm up your eligibility documentation.
    • Document your relationships with affiliates in the context of the IRS’ aggregation rules.
    • Calculate gross receipts for each calendar quarter from 1/1/19 through the most recent quarter closed here in 2021, and identify quarters for which an eligible gross receipts reduction occurred.
    • Determine and document the period(s) of government mandated shut-down and how that shut-down supports ERC eligibility.
  2. Organize payroll data.
    • Accumulate payroll data for eligible time periods.
    • Consider payroll expenditures already utilized to support other funding sources.
    • Incorporate employer-paid health insurance where it adds value.
  3. Calculate the credit.
    • For 2020, the credit is calculated as 50% of the first $10,000 of compensation per employee for time periods between March 13, 2020 through December 31, 2020, during which the employer is eligible.
    • For 2021, the credit is calculated as 70% of the first $10,000 of compensation to each employee for each calendar quarter for which the employer is eligible.

This discussion is designed to be a summary, not a detailed do-it-yourself guide. There are a lot of details that might affect your ERC experience, and numerous strategy ideas that employers have incorporated to make the most of the ERC program. Your Bonadio CARES Team is here to guide you through it. We’ve helped hundreds of employers navigate through the ERC program. We’d love to talk to you about how this program can bring value to your organization.

The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.