The employee retention credit (ERC) provides a significant opportunity for employers to address some of the economic challenges resulting from the COVID-19 pandemic. Introduced as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in March 2020, it was significantly expanded by the Consolidated Appropriations Act, 2021 (CAA) in December 2020 with its scope further extended by the American Rescue Plan Act (ARPA) in March 2021. The ERC allows employers to receive a credit of as much as $5,000 per employee during 2020, and as much as $28,000 per employee during 2021. For employers meeting the eligibility tests in all quarters of 2020 and 2021, the ERC has the potential to provide a significant influx of cash.
Employers may qualify for the ERC if they’re either subject to a full or partial suspension of their business as a result of a governmental order or experience a significant decline in their gross receipts. This decline in gross receipts is determined by comparing receipts in a tested quarter of 2020 or 2021 with the corresponding quarter of 2019. If a small employer meets either of these tests, it may claim a credit based on the amount of wages and health benefits paid to all employees during a quarter of eligibility. Employers that aren’t small employers can claim the credit on wages and health insurance paid to employees who aren’t working. For 2020 credits, an employer is defined as a small employer if it had 100 or less full-time employees in 2019. For 2021 credits, the requirement is satisfied if the employer had 500 or less full-time employees in 2019. A more detailed discussion of these rules can be found here.
Many portfolio companies owned by private equity groups (PEGs) may have concluded that they’re ineligible for ERC credits, when in reality they’re eligible to claim lucrative benefits. Changes in tax law related to ERC credits and other factors have resulted in much misinformation about ERC credits, resulting in “myths” about how portfolio companies are ineligible for credits. In fact, those businesses may have significant opportunities available to them. Here are some of the more common questions about how the ERC applies to portfolio companies.
My portfolio company didn’t pursue a PPP loan under the Paycheck Protection Program (PPP) because it has access to significant liquidity through the investment fund owning the company. Doesn’t that mean that the portfolio company also can’t pursue the ERC?
No. Qualifying for the ERC is based on entirely different standards than the PPP. Many employers have cash reserves, or liquidity from their investors, to maintain operations without the PPP loan. However, if receipts decline or the business is subject to a governmentally ordered suspension, the employer remains eligible to claim the ERC.
My portfolio company did apply for the PPP loans. I thought that meant it was ineligible for the ERC.
The CARES Act initially precluded employers from claiming an ERC when also taking a PPP loan. However, the CAA retroactively changed the law such that employers can take advantage of both incentives. There are provisions in place to prevent claiming the ERC on the same payroll dollars that were funded with PPP loan proceeds that are ultimately forgiven; however, many employers will find that there’s still an opportunity to claim significant benefits from both programs.
My portfolio company’s gross receipts declined, but I know that the PEG owns other portfolio companies that performed very well during the pandemic. Would I still be eligible to claim the ERC?
Quite possibly. If multiple portfolio companies are sufficiently related to each other to be considered a “single employer,” the companies would be aggregated for purposes of determining whether there was a substantial decline in gross receipts. However, in a traditional private equity structure, there’s typically a sufficiently broad group of investors in the funds that aggregation across portfolio companies wouldn’t be common. The ERC refers to several different sections of the Internal Revenue Code to determine whether multiple related entities should be aggregated into a “single employer” for purposes of the ERC. Where entities don’t have a common corporate parent, or where there aren’t five or fewer individuals, trusts, or estates that own 80% or more of each of the related entities, the entities generally wouldn’t be considered a “single employer,” in which case, the test for whether a company had a significant decline in gross receipts would be applied entity by entity. Fortunately, these same aggregation rules are utilized for other employee benefit programs, so legal counsel for the PEG should be familiar with this evaluation.
My PEG owns a large number of portfolio companies. While each of them is relatively small, the combined number of employees across all exceeds 500. Are the portfolio companies subject to the more stringent rules that reduce the ERC credits that are available?
Not necessarily. Similar to above, if the ultimate ownership of the portfolio companies doesn’t require aggregating the portfolio companies into a “single employer,” each entity would separately count its employees and only apply the rules limiting the scope of their credit if, standing on their own, their full-time headcount in 2019 exceeded 100 (when calculating the 2020 ERC) or 500 (for the 2021 ERC).
What if I have multiple portfolio companies that do business with each other, or I have a management company that services my portfolio companies. Does that make a difference?
Possibly. If multiple portfolio companies are operating as parts of the same “trade or business,” it may be necessary to combine them when considering the tests under the ERC. In addition, when a management company derives more than 50% of its receipts from a particular related entity, it may be necessary to aggregate those entities with each other.
If I’m required to aggregate my portfolio companies, what does that mean for the suspension of business or decline in gross receipts tests?
When entities are aggregated as a single employer, the aggregation is for all purposes under ERC. This means that a full or partial suspension of any part of the aggregated businesses could qualify all of the aggregated entities. This also means that when comparing gross receipts during a testing period with the corresponding 2019 quarter that all entities would be considered together. In some instances, this could result in qualifying a larger number of employees for the credit; in others, where one aggregated entity suffered economically but another did particularly well, it’s possible to not qualify for the ERC as a consequence of aggregation. Careful consideration should be given as to whether aggregation is required and what the impacts of doing so are.
The rules seem to keep changing. How can I stay current with ERC developments that may impact my portfolio companies?
Our ERC team has resources to assist companies with ERC-related questions. In addition, the IRS maintains frequently asked questions about the credit.
What should I do now?
Portfolio companies should consider whether they’re eligible to claim employee retention credits. The ERC is generally claimed on quarterly payroll tax returns. These payroll tax returns may have already been filed for 2020. However, it may be possible to amend such returns as long as action is taken timely.
Do you have questions about the ERC? Give us a call.
