Solving the Employee Retention Credit Partial Suspension Puzzle

Okay, something you should know if you employ workers. You may have a backdoor method for qualifying for the employee retention credit. The partial suspension rule.

Unfortunately, this method of qualifying for credits is murky. At least for small businesses that operate in a single location. But you want to look at the rule. Learn it. And then see if it applies to your situation.

If you can’t otherwise get employee retention credits? The partial suspension eligibility method provides a backdoor way for some firms who wouldn’t otherwise qualify to get credits.

Quick Review of the Easy Eligible Employer Rules

But first a quick review of what employee retentions are and how they usually work…

Employers who experience a greater than fifty reduction in gross receipts in some quarter of 2020 or a greater than twenty reduction in gross receipts in some quarter in 2021, get an employee retention credit.  (The comparisons typically look at the same quarter of 2019.)

For 2020, that credit equals fifty percent of the qualified wages paid. But not more than $5,000 per employee for the calendar year.

For 2021, that credit equals seventy percent of the qualified wages paid. But not more than $7,000 for a quarter.

Note: The 2021 credit—potentially $28,000 per employee—is huge. Take notice of that.

If a federal, state or local government order fully suspends operations, that order also qualifies an employer for employee retention credits.

For example, if a government order causes a restaurant to close from May 15 through August 15, the wages paid for that interval plug into the employee retention credit formula. The employer does not, in other words, need to compare quarterly gross receipts.

But then there’s also one other route to qualifying for employee retention credits: partial suspension. And here the waters get muddy in many settings.

Partial Suspension Rule

Let’s start by quoting official language that describes how the partial suspension rules work. IRS Notice 2021-20 says this about which employers have eligibility to claim employee retention credits:

Section 2301(c)(2)(A) of the CARES Act defines the term “eligible employer” as any employer carrying on a trade or business during calendar year 2020, and, with respect to any calendar quarter, for which (1) the operation of the trade or business carried on during calendar year 2020 is fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19.

Note: The same rule applies for 2021. But you need to read IRS Notice 2021-23 to get the official instruction for that.

IRS Notice 2021-20 Question 11:

On page 27 of that IRS Notice 2021-20, the IRS then asks and answers the key question about when a business is “partially suspended” in what I’ll call a blurry-picture situation.

Here’s the actual question asked which you want to look at and consider:

If a governmental order requires non-essential businesses to suspend operations but allows essential businesses to continue operations, is an essential business considered to have a full or partial suspension of operations due to a governmental order?

 IRS Notice 2021-20 Answer 11:

And here’s the official answer to this question:

An employer that operates an essential business is not considered to have a full or partial suspension of operations if the governmental order allows all of the employer’s operations to remain open. However, an employer that operates an essential business may be considered to have a partial suspension of operations if, under the facts and circumstances, more than a nominal portion of its business operations are suspended by a governmental order.

For example, an employer that maintains both essential and non-essential business operations, each of which are more than nominal portions of the business operations, may be considered to have a partial suspension of its operations if a governmental order restricts the operations of the non-essential portion of the business, even if the essential portion of the business is unaffected. In addition, an essential business that is permitted to continue its operations may, nonetheless, be considered to have a partial suspension of its operations if a governmental order requires the business to close for a period of time during normal working hours.

The notice then elaborates. A “more than nominal” portion of an employer’s business operations would have generated ten percent or more of the firm’s gross receipts in the same quarter of 2019. Or it would have amounted to ten percent or more of the firm’s hours of service in the same quarter of 2019. (This information appears in the “Question 12” discussion.)

If a employer operates in multiple locations and government orders close one of those locations, that closure counts, plain and simple, as a partial suspension. (This information appears in the “Question 20” discussion.)

Finally, the notice adds a little twist and complexity to all of this. A reduction in consumer demand doesn’t matter for purposes of determining partial suspension. (This information appears in the “Question 13” discussion.)

You may want to read the roughly 15 pages of discussion about what counts and what doesn’t count if it matters to your clients. Or for your own firm’s employee retention credits. But let me spotlight some of the issues that I think may help you determine whether you qualify or might qualify for partial suspension for less than obvious situations.

Nominal Matters

A first obvious observation. You probably need to be able to show a reduction of ten percent or more in gross receipts or hours in order to take the position that an employer’s operations have been partially suspended.

In other words, any reduction in gross receipts or hours of service less than ten percent probably fails to support the position that a non-nominal chunk of the business stopped due to a government order.

Consumer Demand

And then something else. The bit about not looking at consumer demand connects to this, I think.

For example, the available data I’ve looked at and talked about elsewhere at this blog suggests that reduced consumer demand and government orders work hand in hand to push down business revenues. (Er, if you’ve read any of my complaints about the media exaggerating infection, hospitalization and fatality rates, you know I beat that drum because I worry it damages your business.)

But if we maybe think about this? Maybe you and I want to see considerably more than a ten percent reduction in gross receipts or hours worked so we’re also formally recognizing some dampening in consumer demand?

In other words, you need some ten-percent-or-greater chunk of the business to have been suspended, obviously, to just meet the “more than nominal” operations threshold. That’s maybe the first ten percent.

And then don’t we probably need some chunk of additional reduction in revenue or hours to reflect the drop in consumer demand?

The Twenty Percent Test May Be Relevant

Another percentage to anchor your analysis and thinking? Twenty percent. And here’s why I say this.

For 2020, the gross receipts eligibility test qualifies an employer for employee retention credits when the gross receipts drop to less than fifty percent of the same quarter in 2019. But the employer maintains its eligibility for the credits as long as the gross receipts stay at least twenty percent off as compared to 2019.

That twenty percent value pops up again for 2021. For that year, the gross receipts eligibility test qualifies an employer for employee retention credits when gross receipts drop by more than twenty percent as compared to 2019.

Again, we’re just talking here. Trying to bring this partial suspension rule into sharper focus… but I propose this: If a twenty percent decline in gross receipts often works as the hard number that maintains or creates eligibility for credits based on gross receipts? That reduction in revenues may really suggest a firm suffers from non-essential operations or activities closing.

Fixtures and Equipment and Comparability

One final thing to mention here. The IRS Notice mentions (Question 14) the issue of whether a firm can continue operations comparable to those prior to closure due to a government order.

The Notice discussion then gives a couple of examples. One example describes a software development firm. It reconfigures its operations to run comparably even after a local government order closes its offices. That firm, the IRS concludes, fails to qualify as partially suspended.

Another example in that same discussion describes a physical therapy facility. This firm also reconfigures operations. But reconfigured, it can’t provide the full range of therapies. Why? The facility provides equipment and tools that the physical therapists often need in hand to treat patients. That firm, the IRS concludes, qualifies as partially suspended.

The takeaway here? Maybe two things. First, if a business operation uses physical assets located in the closed offices, that suggests a partial suspension occurs when the offices close. Second, if a service must sometimes be provided in the presence of a customer or patient, that suggests a partial suspension occurs when the offices close.

Summing Up Partial Suspension Rule

Putting everything mentioned above together?

Here are my current impressions. I think separating essential not-suspended business operations from non-essential suspended businesses gets tricky. Especially for single-location and really small businesses. Accordingly, I think these small businesses want to see some overall reduction in revenues or hours significantly greater than ten percent. To me, that seems in line with non-nominal operations stopping due to a government order.

I don’t think however, that you need to go much above that ten percent reduction threshold for blurry-picture situations. Maybe a fifteen percent reduction signals a firm suffers from partially suspended operations? Or maybe twenty percent sends that signal? At least the way I’m thinking.

Finally, as just a matter of common sense? In any blurry-picture situation, I think a firm arguing for partial suspension wants to be able to point to equipment or fixtures required for the services but that could not be used due to an office closing. Or a firm wants to be able to point to in-office, face-to-face services that could not occur due to a government order closing the offices used for such meetings.

But I’d welcome your comments…

Need More Information or ERC Training for Staff?

If you realize some of your staff need more training about how the employee retention credits work, no problem.

We’ve got economical $14.95 paperback book that represents a great way for staff, managers and partners to learn how employee retention credits work: Maximizing Employee Retention Credits.

We’ve also got a number of related articles and blog posts about the employee retention credit and many may be useful for folks still getting up to speed.