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Employee-owned companies can take advantage of the Employee Retention Credit

By Jim Donovan, CPA, Eide Bailly and Tonya Rule, CPA, Eide Bailly

January 14, 2022

Many employee stock ownership plans (ESOPs) have the misconception they can’t take advantage of the Employee Retention Credit (ERC) that was enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act because a majority are tax exempt S Corporations. However, the ERC is an employment tax credit, not an income tax credit, making many ESOPs eligible so long as they meet other qualifications.
 
The ERC has evolved since its inception, and the IRS has issued several rounds of guidance to help clarify the rules about how organizations can claim the credit. Here’s what your ESOP needs to know about qualifying for the ERC.

What is the Employee Retention Credit?

The ERC is a refundable tax credit of up to $5,000 per employee for 2020. For 2021, the ERC can be up to $7,000 per employee per quarter through Sept. 30. The ERC is available to employers, including nonprofit organizations, that have been fully or partially suspended by a government order or had a significant decline in gross receipts.
 
Here’s a breakdown of the ERC rules across 2020 and 2021.
 
  2020 2021 — Q1 & Q2 2021 Q3 2021 — Q4* 
Time period March 13, 2020, to Dec. 31, 2020 Jan. 1, 2021, to June 30, 2021 (credit computed for each quarter) July 1, 2021, to Sept. 30, 2021 Oct. 1, 2021, to Dec. 31, 2021
Credit rate 50% 70% 70% 70%
Qualified wages Can qualify up to $10,000 per employee Can qualify up to $10,000 per employee Can qualify up to $10,000 per employee Can qualify up to $10,000 per employee
Maximum credit per employee $5,000 aggregate $7,000 per quarter $7,000 per quarter $7,000 per quarter and capped at $50,000
Eligible small employer Less than or equal to 100 full-time employees Less than or equal to 500 full-time employees Less than or equal to 500 full-time employees Less than or equal to 500 full-time employees
Eligibility requirements: Decline in gross receipts Gross receipts decline of greater than 50% in any quarter in 2020 versus 2019 Gross receipts decline of greater than 20% in any quarter in 2021 versus 2019 Gross receipts decline of greater than 20% in any quarter in 2021 versus 2020 or eligible recovery startup business* Eligible recovery startup business*
Alternate quarter provision for gross receipts Not applicable Look back to the preceding quarter to meet qualification criteria Look back to the preceding quarter to meet qualification criteria Not applicable
*Recovery startup business Not Applicable Not applicable New category of qualified business that started Feb. 15, 2020, or later and limited to $50,000 in credit in Q3 New category of qualified business that started Feb. 15, 2020, or later and limited to $50,000 in credit in Q4
Severely financially distressed employer Not Applicable Not applicable Gross receipts down over 90% in Q3 vs. 2019 and eligible small employer rules ignored Not applicable
Overlapping provisions — don’t double dip! PPP, FFCRA, WOTC, FMLA PPP, FFCRA, WOTC, FMLA, R&D, Indian Employment, Veterans, Empowerment Zone PPP, FFCRA, WOTC, FMLA, R&D, Indian Employment, Veterans, Empowerment Zone, SVO Grants, Restaurant Revitalization Grants PPP, FFCRA, WOTC, FMLA, R&D, Indian Employment, Veterans, Empowerment Zone, SVO Grants, Restaurant Revitalization Grants
 
*The recent infrastructure bill (The American Jobs Plan) signed into law included a provision that sunset the Employee Retention Credit on Sept. 31, 2021. It was originally set to expire on Dec. 31, 2021. Only recovery startup businesses can now take the ERC for the fourth quarter in 2021.

Recent clarifications and changes

Timing of the deduction disallowance
A recent IRS notice reinforces that the wage deduction disallowance is tied to the year in which the qualified wages were paid or incurred. Unfortunately, that may mean eligible employers who claimed the 2020 credit after filing their 2020 tax return claiming a full deduction for wages paid will need to amend their 2020 tax return to back out the wage deduction by the amount of the ERC claimed for 2020.
 
Full-time employees versus FTEs
Full-time employees, not full-time equivalents, are the basis for determining whether an eligible employer qualifies as an eligible small employer. Additionally, the status is based on an employer’s full-time employee count for the 2019 calendar year for both the 2020 and 2021 ERC. Second, an employee’s full-time status is irrelevant when determining qualified wages.
 
Qualified wages and tips
Cash tips of more than $20 in a month are includable as qualified wages for the ERC. An eligible employer can claim both the ERC and the FICA tips tax credit pursuant to IRC Section 45B on the same wages.
 
Related individuals
Clarification on the inclusion of majority owner wages for the ERC states that a direct majority owner’s ownership is attributed to each of the owner’s family members.
 
Alternative quarter election
Eligibility for each quarter is determined independently. For the 2021 ERC, an eligible employer can use the current quarter or the alternative quarter to qualify using gross receipts.
 
Applicable employment taxes
For the third and fourth quarters of 2021, Notice 2021-49 outlines that the ERC will be taken against the employer’s share of Medicare tax first (but after other credits), with the remainder refundable. The ERC for earlier periods first offsets the employer’s portion of Social Security tax.
 
Recovery startup business
For the recovery startup business (RSB) qualification, the business is deemed to have started when it became a going concern performing activities for which it was formed. The aggregation and affiliation rules continue to apply under IRC Section 52(a) for controlled group of corporations; 52(b) for partnerships, proprietorships, etc. under common control; and 414(m) and 414(o) for affiliated service groups. Additionally, gross receipts for the group cannot exceed an average of $1 million for the three tax years preceding the quarter in which the ERC is claimed. Certain tax-exempt organizations can qualify for the ERC as an RSB.
 
Gross receipt eligibility
Generally, an employer is not penalized for participating in other relief provisions when determining gross receipts solely for purposes of the ERC. The ERC relies on IRC Sections 6033 and 448(c) for the definition of gross receipts for tax-exempt organizations and nontax-exempt organizations, respectively. PPP loan proceeds, shuttered venue grants and restaurant revitalization grants are included as gross receipts pursuant to the definitions in the code.
 
There is now a safe harbor for employers to exclude those amounts from gross receipts solely for ERC eligibility purposes if the exclusion is applied consistently across all relevant periods and consistently across all members of the aggregated group. Employers are required to retain records to substantiate their ERC.
 
Tonya Rule, CPA and Jim Donovan, CPA, are partners with Eide Bailly who specialize in the Employee Retention Credit. You may reach Tonya at trule@eidebailly.com and Jim at jdonavan@eidebailly.com.
 
The Minnesota Center for Employee Ownership serves as a free unbiased source for education and resources around all forms of employee ownership. With 52,000 business owners over the age of 55 in Minnesota exiting their business in the next 3–5 years, there is a crisis looming. What will happen to their legacy, employees, community?   Business owners will look to their advisers on how best to exit. Contact us for more information on how we can be a resource for you at www.mnceo.org or Sue Crockett, executive director at scrockett@mnceo.org.