Tax Strategy Tuesday:  Startup Business Employee Retention Credit

The year ends in a just a few days. So, a last minute tax strategy: If you can start a business before the year ends, you should be able to employ the recovery startup business employee retention credit tax strategy.

That tax strategy—and yes you still have time barely—gives you a tax credit that equals as much as $50,000 for the fourth quarter of 2021.

And just to make this point crystal clear. Yes. The federal government may give you $50,000. Cash. All you need to do? Start a trade or business before the year ends.

Tip: We discuss a tax strategies every Tuesday here at the Evergreen Small Business blog. Click here to see the full list: Tax Strategy Tuesday.

Employee Startup Business Employee Retention Credit in Nutshell

The rules for the recovery startup business employee retention credit work simply.

A small business employer needs to begin carrying a trade or business sometime after February 15, 2020 and before December 31, 2021.

The recovery startup business employee retention credit equals 70 percent of the wages and health insurance paid to any non-family-member employee but not more than $7,000 per employee for a quarter.

And then the rules limit you to $50,000 a quarter.

Example: You own a construction company and then start a sideline consulting gig during the quarter. The construction company employs five workers who each make $12,000 a quarter. The consulting gig employs a part-time employee who makes $5,000 a quarter. Assuming none of these employees is family? The recovery startup business employee retention credit equals $38,500: 70 percent of the first $10,000 paid to each of the five construction company employees plus 70 percent of the $5,000 paid to the consulting business’s part-time worker.

The Two Tricks that Make Tax Strategy Work

Two tricks make the recovery startup business employee retention credit super-attractive as a tax strategy.

First? All you need to do is begin carrying on a trade or business. (If you’re already in one business, that means beginning to carry on a new or a different trade or business.)

This caution: A trade or business needs to something you do in pursuit of profits. So, a real business. Not a hobby. Not a faux business. And you need to engage in the trade or business with regularity and continuity. (We’ve pointed out elsewhere that buying a rental property and placing that property into service qualifies under the rules.)

And then the second trick that makes this tax strategy really attractive: An employer aggregates all its trades or businesses. An entrepreneur who owns and operates a construction company and a rental property, for example, aggregates those two ventures into a single employer. Which produces a really interesting result…

Example: A construction company owned by a single entrepreneur employs workers. She buys a rental property after February 15, 2020 and that rental property qualifies as a trade or business. That new rental then counts as beginning to carry on a trade or business. And then the wages paid by the construction company create up to $50,000 of employee retention credits.

Possible Tax Savings from Startup Business Credit Tax Strategy

Because the tax strategy we’re talking about here is a credit, the tax savings equal the credit.

A $25,000 credit means you get $25,000 of tax savings. A $50,000 credit means you get $50,000 of savings.

To claim the employee retention credit, an employer uses the quarterly 941 federal payroll tax return. Essentially, you (or your accountant) uses the employee retention credit to reduce the payroll tax deposits required. Or if you’ve already made the payroll tax deposits, you use the employee retention credit to get a refund of overpaid deposits.

Turbocharging the Startup Business Employee Retention Credit Strategy

Just to point again to something mentioned earlier. You can claim a recovery startup business credit if you started a new trade or business after February 15, 2020 and before December 31, 2021.

Someone who starts a business after February 15 2020 and before September 30, 2021 gets the credit for the third and fourth quarters of 2021. Someone who starts a business during the fourth quarter of 2021, gets the credit only for the fourth quarter.

Accordingly, you want to think about whether or not you’ve already started a trade or business and so already triggered eligibility.

Example: In the summer of 2020, you bought a rental property. If you’re attempting to maximize profits and engaging in that rental trade or business with regularity and continuity? Bingo. You already qualify. You should have added an employee retention credit to your third quarter 941 filed in 2021. And then you should add an employee retention credit to your fourth quarter 941 you’ll file in early 2022.

If you haven’t yet started a new trade or business, you need to find something else—something real of course—to start as soon as you can.

Limits to Strategy

Only small business employers qualify for recovery startup business employee retention credits.

The definition of “small business?” An employer that averages $1,000,000 or less in gross receipts over the three previous tax years. Usually that means the 2018, 2019 and 2020 calendar years. Note that some special rules apply if an employer didn’t operate in those years.

Also the strategy only works for two quarters: The third quarter of 2021 and the fourth quarter of 2021.

Note: The other flavors of the employee retention credit terminated at the end of the third quarter of 2021. Only the recovery startup business employee retention credit program works in the fourth quarter 2021.

Also this important bit: For any employee retention credit, only wages and health insurance paid to non-family-members count.

How This Tax Strategy Can Blow Up

Taxpayers and their advisors want to carefully assess whether some new activity rises to the level of a separate trade or business.

We’ve got a discussion that digs into this issue in our book, Maximizing Employee Retention Credits, but the general rules say you apply the Section 162, need to have separate or separable books and financial records, and want to have begun carrying that identifiable new activity by December 31, 2021.

The Startup Business Credit Strategy Works Best for These Taxpayers

The startup business employee retention credit works best, in a sense, for qualifying small business owners who start a new trade or business or invest in rental  property but who already have employees in another existing business.

Other Information Sources

Section 3134 is the bit of law that creates the recovery startup busines employee retention credit (available here.) That statute provides useful detail. Further, the IRS published Notice 2021-49 and it gives detailed guidance on the recovery startup business employee retention credit (available here.)

For taxpayers and tax advisors who want to dig into the details of the recovery startup business credit, we’ve got a series of longer blog posts: Recovery Startup Business Employee Retention Credit, the $100,000 Real Estate Employee Retention Credit Windfall, and Nine Awkward Questions about the Startup Business Employee Retention Credit.

Finally, and as always, taxpayers want to discuss a strategy like this with their tax advisor. He or she knows the details of your specific situation. And this plug for our CPA firm: If you don’t have a tax advisor who can help, please consider contacting us: Nelson CPA.