As we mentioned in our last blog, small business owners can see major benefits from the Employee Retention Credit with a little expert guidance. Unfortunately, many taxpayers have seen endless promotions from “ERC mills” proclaiming promises like “Get $26,000 per employee through the Employee Retention Credit!” Unfortunately, these mills provide very few details on how to ensure you actually qualify for the tax credit—but this is where reputable tax professionals can step in and offer real value!
After making sure your client’s business counts as an eligible employer, the next step is to determine if it can satisfy one of three tests:
- A significant decline in gross receipts,
- A full or partial suspension of business operations, or
- A recovery startup business (applicable only for the third and fourth quarters of 2021)
Understanding the nuances of these three tests can be tricky. Fortunately, training as a Certified Tax Planner provides access to ongoing education and the support of a community of tax professionals to help boost your knowledge on this fairly new credit. To start, read the below for an overview of these three ERC qualifying tests.
Test #1: Significant Decline in Gross Receipts
This test simply requires an accurate account of a company’s yearly income. Remember that gross receipts include all of a company’s sales. This amount is not reduced by the cost of goods sold or any gains from disposing of assets or selling of assets that are not part of the primary trade or business. For example, if the taxpayer decides to sell off investments to increase cash flow in their business, that would not count towards the total gross receipts. Any sales tax collected will not count either.
The “significant decline” is evaluated by comparing any three-month period to the same time period in the previous year. Even if a business sees their income go up by the end of that year, it may still qualify if it meets the gross receipts tests for one or more quarters that year.
The highest bar is set for 2020. To claim a significant decline in gross receipts for any quarter in 2020, the business must have less than 50% of the amount earned during that same quarter in 2019. So if a company had $100 in gross receipts for the second quarter of 2019, but it only had $49 for the second quarter of 2020, that company would qualify for the ERC under this rule.
The rules are different for 2021. If the business’ gross receipts in 2021 are less than 80% of their receipts during the same quarter in 2020, it will qualify.
The three ERC tests function independently of one another, so if a business meets the qualifying criteria listed here, it would not need to pass the two other tests.
Test #2: Full or Partial Suspension of Business Operations
This second test tends to be more ambiguous. There are two elements in play here:
- Your business must be impacted by an applicable government order in your region.
- The government order must correspond to a full or partial suspension of your business operations.
The first element requires that the government order be specific to the taxpayer’s state, county, or other local government authority. Business owners cannot simply claim that the number of customers who came to their storefront was reduced because a neighboring state had a shutdown. The mayors and county supervisors in that area must have had a governmental order in place. Examples include a mandate for non-essential businesses to close, a shelter in place order, a curfew order, or a health department order mandating changes that prevented the business from operating.
One important note is that the order does not need to have been fully enforced. In some regions, law enforcement patrolled neighborhoods to make sure residents stayed at home for the duration of the lockdown. In other regions, the governmental order was mandated, but there may not have been enough structure and accountability in place to ensure the rules were being followed. As long as the order was officially in place, this checkbox can be marked.
Keep in mind that public statements by politicians are not the same as governmental orders, such as a state representative going on television and urging residents to stay at home.
If this is the test that your client’s business is most likely to qualify under, you will need to find documented proof of the order in their area. Check county websites, health department websites, or the homepage of the local government authority. You can use tools like the Wayback Machine to recover a copy of the website as it looked on the dates of the lockdown.
Secondly, you need to establish a clear cause-and-effect between the governmental order and the suspension of the business. Voluntary suspensions do not count, nor do suspensions because of employee absences. Supply chain disruptions also do not count if they were not directly caused by a U.S. governmental order (orders by foreign governments will not count) or if there was a suitable replacement available for the company’s supplies.
Test #3: Recovery Startup Business
This test only applies for the third or fourth quarter of 2021. If the business began after February 15, 2020, it may qualify as a recovery startup business. For the purpose of this rule, a business has “begun” when it has started performing the activities for which it was organized. So a business that had formed in January 2020 but did not start functioning as a business until later that year may qualify under this test.
The second factor is the company’s average annual gross receipts. For the three-year period ending in the year before the calendar quarter for which you are claiming the credit, the business’ average annual gross receipts cannot exceed $1 million.
Summary
Businesses that first began during the COVID-19 lockdown, that were required by law to shut down their business operations, or that saw a significant decline in sales could qualify for the Employee Retention Credit. With all the flashy advertisements from those ERC mills, taxpayers have been understandably confused about how to determine if they truly qualify. This is what makes the advice of a trained tax professional immensely valuable when it comes to the ERC.
Build up your knowledge of the Employee Retention Credit requirements by signing up to become a Certified Tax Planner today.
