For the last few weeks, we’ve been blogging on Tuesdays about tax strategies entrepreneurs and active investors can use. This week, however, a break from that series. I want to discuss the 16 ways employers have of qualifying for employee retention credits.
The reason? These employee retention credits add up fast. Pretty easily as much $5,000 per employee for 2020. If everything clicks just right, as much as $28,000 per employee for 2021.
In fact, crunch the numbers and complete the paperwork? For even small employers, we’re making refund claims that average $50,000 to $150,000. Which can be a gamechanger if your small business got beat up by the pandemic.
A Handful of Notes Before We Start
This post won’t describe how the credit formula calculations work.
We’ve discussed that bit of the puzzle in earlier blog posts in detail over the last couple of years. We’ve also got that book that appears next to this paragraph.
Accordingly, in this blog post, we focus on identifying when you want to go to the work of grinding through the formulas and their calculations.
I’m going to assume you qualify as a small employer. A small employer employed 100 or fewer full-time employees in 2020 and 500 or fewer full-time employees in 2021. That assumption simplifies the following discussion.
Finally, we’ll return next week to our regular Tax Strategy Tuesday series.
And now let’s get started…
More Than Fifty Percent Decline in Quarterly Gross Receipts in 2020
If your firm’s or organization’s gross receipts declined by more than fifty percent in some quarter of 2020? Yes. You qualify.
Furthermore, once an employer qualifies for credits based on a more than fifty percent decline, its eligibility continues through the quarter that 2020 gross receipts rise to more than 80 percent of 2019 gross receipts.
Example: Say your firm suffered a decline in gross receipts for the second quarter of 2020. Gross receipts which usually run a $100,000 a quarter dropped to $49,000. Fortunately, the next quarter, gross receipts bounced back to the usual $100,000 a quarter. In this situation, your firm qualifies for employee retention credits for the second quarter and then again for the subsequent third quarter.
One other example, too…
Example: Say that through 2019 your firm enjoyed steady quarterly gross receipts of $100,000. But then in the first quarter of 2020, gross receipts dropped to $49,000. That gives you eligibility for the first quarter. If gross receipts then ran $80,000 for the second quarter and the third quarter of 2020 and but then improved to $150,000 for the fourth quarter? You potentially qualify for employee retention credits on wages paid in all four quarters of 2020.
A few things to keep in mind… First, for 2020 employee retention credits, you can’t get more than $5,000 for an employee for the year. Second, you get the credit only for wages you paid out of company funds. Not for wages paid using paycheck protection program loans. And not for wages paid using other tax credits. Third, finally, while you can get employee retention credits for a fifty percent decline in the first quarter’s receipts, only wages paid after March 12, 2020 plug into the credit formula.
More than Twenty Percent Decline in Gross Receipts for Quarter 4 of 2020
If your firm’s or organization’s gross receipts in quarter 4 of 2020 declined by more than twenty percent as compared to quarter 4 of 2019? You qualify for employee retention credits for quarter 1 of 2021.
Note that in 2021, employee retention credits equal as much as $7,000 an employee for each quarter.
Example: In 2019, your firm generated $1,000,000 in gross receipts in the fourth quarter. In 2020, your firm generated $795,000 of gross receipts in the fourth quarter. That “more than twenty percent” decline qualifies your firm for employee retention credits for the first quarter of 2021.
More than Twenty Percent Decline in Gross Receipts for Quarter 1, 2 or 3 of 2021
If your firm’s or organization’s gross receipts in the first, second or third quarter of 2021 declined by more than twenty percent, you qualify for employee retention credits for either one or two quarters. You’ll qualify for the quarter with the decline. And if the quarter is the first or second quarter, you’ll also qualify for the subsequent quarter.
Example: For the first quarter of 2019, your gross receipts equaled $100,000. Due to Covid-19, for the first quarter of 2021, your gross receipts equaled $79,500. That 20.5 percent decline qualifies your firm for employee retention credits for the first quarter—and for the second quarter.
Let me give you another example, too, to highlight how a decline in the previous quarter creates eligibility.
Example: Say that a firm enjoyed steady quarterly gross receipts of $100,000 through 2019 and the first three quarters of 2020. And then say for the fourth quarter, it saw quarterly gross receipts decline to $79,500. Gross receipts then recovered to $100,000 for the first quarter of 2021. But then again dropped back to $79,500 for the second quarter of 2021. In this case, the firm qualifies for employee retention credits for all three quarters of 2021. It qualifies in quarter 1 of 2021 because the previous quarter’s gross receipts declined by more than 20 percent. It qualifies in quarter 2 of 2021 because gross receipts for that specific quarter declined by more than 20 percent. Finally, it qualifies for quarter 3 of 2021 because the previous quarter’s gross receipts—so quarter 2–declined by more than 20 percent.
Use a “Wrong” Quarter for 2020 Credits if Your Business Started in 2019
Qualifying for employee retention credits based on a decline in gross receipts usually compares quarterly gross receipts in 2019 to those same quarters in 2020 and 2021.
To determine whether the Covid-19 pandemic pushed down gross receipts in the second quarter of 2020 or 2021, for example, the formulas look back at the second quarter gross receipts of 2019.
That begs a question, though. What if a business starts part-way through 2019 and therefore a business owner doesn’t have a quarter from 2019 to use for comparison? Congress and the IRS provide a work-around.
First, they say for 2020 employee retention credits you use the first, probably partial quarter the firm operated in 2019 for the comparison.
Example: You started a new business in the third quarter of 2019. Accordingly, no first quarter or second quarter gross receipts value exists for comparisons between 2019 and 2020. To determine if quarterly gross receipts for the first or second quarter of 2020 declined by more than 50 percent, however, you can compare those quarters’ gross receipts to the 2019 third quarter gross receipts value.
The IRS also tells employers to use a reasonable method for converting a partial quarter’s gross receipts to a full quarter’s gross receipts.
Example: If an employer started a business halfway through the third quarter of 2019 and generates $100,000 of gross receipts for that half quarter? Probably a reasonable way to estimate a full quarter’s gross receipts is to double the $100,000.
Use 2020 Quarter if Not Operating in 2019 for 2021 Credits
And then things work slightly different for 2021 credits.
If an employer didn’t operate in some quarter in 2019 and so can’t compare 2021 quarterly receipts to 2019 quarterly receipts, it can compare the equivalent 2020 quarter to the 2021 quarter.
You Acquired a Hard-hit Business
An employer needs to aggregate the gross receipts of all the businesses it owns for purposes of determining whether gross receipts declined.
If you acquired a business in 2020 or 2021, furthermore, you must aggregate gross receipts starting from the point you acquire the new business.
But then this wrinkle: You can choose to aggregate the acquired business’s gross receipts from before the acquisition.
This option to aggregate pre-acquisition gross receipts may create a really interesting opportunity for some entrepreneurs. The following example illustrates this.
Example: You operate a food services firm that generated $1,000,000 a quarter of revenues in 2019, 2020 and 2021. On July 1, 2020, you bought a struggling restaurant. Through-out 2019, that restaurant generated $2,000,000 a quarter. Unfortunately, the restaurant’s gross receipts dropped 90 percent to $200,000 a quarter in mid-2020. The aggregated quarterly gross receipts of the employer after the acquisition therefore equal $1,200,000. Those numbers reflect a 60 percent decline. Accordingly, your acquisition qualifies your firm for employee retention credits for the last two quarters of 2020 and the first three quarters of 2021.
Note: A firm of the size imagined in the preceding example might have as many as forty or fifty employees. That would mean potentially a $200,000 or $250,000 employee retention credit for 2020. And as much as $280,000 to $350,000 a quarter for each of the first three quarters of 2021.
Government Order Fully Closes Your Business
If a federal, state or municipal government order fully closed your business due to Covid-19, wages you paid employees during the closure probably count for employee retention credits for 2020 and for the first three quarters of 2021.
Example: A government order banned patrons from visiting your firm from April 15, 2020 through November 15, 2020. Wages paid for the last half of the second quarter, all the wages paid during the third quarter, and wages paid for the first half of the fourth quarter potentially count for employee retention credit purposes.
Government Order Partially Closed Your Business
If a federal, state or municipal government order partially closed your business due to Covid-19, and that partial closure was more than just nominal, wages you paid during the partial closure probably count for employee retention credits in 2020 and for the first three quarters of 2021.
The IRS defines nominal, by the way, as ten percent or greater. Further, the IRS rule looks at either hours of service or gross receipts. So if a government order closed a part of the business that represents either ten percent or more of the hours worked… or closed a part of the business that represents ten percent or more of the gross receipts? Yeah, that counts as a partial closure.
As with a full closure, only wages paid during the partial closure count.
Example: A restaurant owner’s facilities include an inside dining room, a cocktail lounge, and outside patio area. Government orders close the inside dining room and cocktail lounge. These orders allow the outside patio area to continue operations. Further, the restaurant attempts to ramp-up a “take-out” service which government orders also allow. As long as the suspended parts of the business—the inside dining room and cocktail lounge–represent at least ten percent of the hours of service or at least ten percent of the gross receipts, all the restaurant’s wages probably count for employee retention credit purposes.
Government Order Closed Your Supplier
A government order that fully or partially suspends not your firm but a supplier you rely on can qualify you for employee retention credits, too.
The trick here? That government order that hits your supplier must trigger you either fully or partially suspending your operations.
Example: Your firm, a restaurant, isn’t subject to government orders which fully or partially suspend your operations. However, due to Covid-19 infections, local authorities close for May and June of 2020 the meatpacking plant you rely on for many of your supplies. That closure order, if it causes a full or partial closure of your restaurant, qualifies your firm for employee retention credits for May and June of 2020.
Government Order Reduces Hours of Operation
If a government order reduces the hours of operation from ten hours a day to eight hours a day, that twenty-five percent reduction in hours of service counts as a partial suspension. And the employer probably qualifies for employee retention credits during the interval when the reduced hours are mandated.
Government Orders Required Employees to Work Remotely
If a government order closes down a firm’s physical office location, and employees can successfully telework, that doesn’t count as a full or partial suspension.
However, if employees can’t really successfully telework, the closing of the physical office location counts as a partial suspension. (The key factor is whether the new remote-work approach works comparably to the old in-person approach.)
Further, if a transition to a remote work approach takes two-weeks or longer of transition time, the IRS says that creates a partial suspension.
Government Order Requires Social Distancing or Similar Modifications
If a government order requires social distancing or other modifications to a firm’s operations and those modifications have more than a nominal effect on a firm’s operation, that probably counts as a partial suspension.
Example: A government order requires restaurants to operate at fifty-percent capacity so as to allow social distancing. That modification order probably produces at least a ten percent reduction in hours of service or gross receipts and so counts as a more than nominal partial suspension.
Note: The IRS Notice that describes when modifications required by government orders possibly lead to partial suspensions (IRS Note 2021-20) identifies the sorts of changes that potentially qualify an employer as partially suspended: “limiting occupancy to provide for social distancing, requiring services to be performed only on an appointment basis (for businesses that previously offered walk-in service), changing the format of service (for example, restrictions on buffet or self-serve, but not prepackaged or carry-out), or requiring employees and customers to wear face coverings.”
Employer Expands a State or Local Order
If a firm operates in more than one location, it can decide to apply a government closure order that technically applies to only one location to all its locations. And if the effect of the closure order is more than nominal once the employer expands the government order to create a nationwide or firmwide policy? Yeah, that can count as a partial suspension.
Note: The IRS Notice that provides this guidance, IRS Notice 2020-21, comments that the expansion of the local government order should mesh with CDC recommendations and Department of Homeland Security guidelines.
Government Order Fully or Partially Closed One of Businesses You Operate
The employee retention credit formulas treat all the trades or businesses someone owns as a single employer. That means if someone owns, say, a winery, a software company, and rental property, these three trades or businesses get aggregated into a single employer
If a government order closes one of the trades or businesses—say the winery—and that partial closure counts as more than just nominal, wages paid by the employer in all three of the trades or businesses it operates probably count for employee retention credits.
Again, the IRS defines nominal as a ten percent or greater reduction in either hours of service or gross receipts. But for entrepreneurs operating multiple trades or businesses, therefore, a closure of any one of the ventures they operate possibly gives them employee retention credits on all their trades or businesses.
Another reminder. As with a full closure, only wages paid during the partial closure count.
Example: A business owner owns a winery (three employees), a consulting firm (15 employees), and an apartment building (one employee). Government orders close the winery for April, May, June, and July of 2020. That should count as a partial, more than nominal closure. Therefore, the employer probably qualifies for employee retention credits on wages paid in April, May, June and July of 2020 for the winery, the consulting firm, and the apartment building.
You Started a New Trade or Business After February 15, 2020
For the third and fourth quarter of 2021, an employer qualifies for a special flavor of employee retention credits—called recovery startup business employee retention credits—if it began carrying on any trade or business after February 15, 2020 and before 2021 ends.
To get recovery startup business credits for the third quarter of 2021, the employer needs to begin carrying on the trade or business before September 30, 2021. To get the credits for the fourth quarter of 2021, the employer needs to begin carrying on a trade or business before December 31, 2021.
Tax law limits a recovery startup business employee retention credit to not more than $50,000 in a quarter. And only small employers (averaging $1,000,000 or less in gross receipts for the three years prior to 2021) qualify. Furthermore, if in the third quarter of 2021, an employer qualifies for non-recovery-startup-business credits? So those based on a substantial decline in gross receipts or a full or partial suspension of operations? It should use those larger credits.
But if an individual who can’t otherwise qualify for employee retention credits starts a new trade or business? That act of starting a new business probably qualifies the employer for employee retention credits. And once again note that in this case the employer gets credits on the wages paid by all of the trades or businesses the employer aggregates.
Example: A small construction company averages less than $1,000,000 in annual gross receipts. The owner starts working as a rideshare driver on weekends to supplement his family’s income. That new sideline rideshare-driver business probably qualifies the business owner for employee retention credits on the wages paid by his construction company.
You Bought a Rental Property After February 15, 2020
One final way to qualify. Which is really a variant of the recovery startup business qualification method just described.
If a business owner bought a rental property after February 15, 2020 in pursuit of profits? And if she or he shows continuity and regularity in the rental trade or business? Bingo. That rental trade or business probably qualifies the employer for recovery startup business employee retention credits. (The aggregated gross receipts of the employer need to average $1,000,000 or less for 2018, 2019 and 2020.)
Example: The owner of a small professional services firm averaged less than $1,000,000 in revenues from 2018 through 2020. During the summer of 2020, he started a short-term rental trade or business. That qualifies the business owner for up to $50,000 of employee retention credits for wages paid in the professional services firm in the third and fourth quarter of 2021.
We published a longer blog here that explains all the details of using a rental property to qualify for employee retention credits: The $100,000 Real Estate Employee Retention Credit Windfall
Other Resources You Might Find Useful
Tax accountants probably want to read or maybe reread the employee retention credit IRS notices. They provide the rules discussed in this blog post related to qualifying for employee retention credits: IRS Notice 2021-20, IRS Notice 2021-23 and IRS Notice 2021-49.
If someone is helping clients with recovery startup business credits? This blog post may be a useful: Nine Awkward Questions about the Recovery Startup Business Employee Retention Credit
Nonprofit organizations may find this blog post helpful: Houses of Worship and Nonprofits Miss Boat on Employee Retention Credits
Finally, if you need help with employee retention credits, first talk with your tax accountant. Do keep in mind tax season gets pretty busy for accountants. And if you can’t get the help you need from her or him? Sure, you can contact our CPA firm. Please use this form, Nelson CPA.