How to determine if a Recovery Startup Business qualifies for the Employee Retention Credit
By Andrew Seifert, JD, tax consultant, Wipfli LLP
February 16, 2022
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provided for an Employee Retention Credit (ERTC) for eligible employers that pay qualified wages to some or all employees after March 12, 2020, and before Jan. 1, 2021.
[1] Subsequent legislation modified and extended the credit to last through Dec. 31, 2021.
[2] One of the modifications made was to create Recovery Startup Businesses (RSBs), which is another way businesses can qualify for the ERTC.
Most recently, the Infrastructure Investment and Jobs Act limited the availability of the ERTC in the fourth quarter of 2021 to only taxpayers that are RSBs.
[3] Consequently, taxpayers that may have experienced a full or partial suspension of operations or a decline in gross receipts in the fourth quarter of 2021 are not eligible for the ERTC for wages paid after Sept. 30, 2021.
[4]
The limitation of the fourth quarter for claiming ERTC makes it even more important that taxpayers determine whether they qualify as an RSB. In order to qualify as an RSB, there is a separate set of criteria from the regular ERTC rules that a business must meet.
For a business to qualify as an RSB, an employer must meet the following requirements:
- It began carrying on a trade or business after Feb. 15, 2020.[5]
- Its average annual gross receipts for the three-tax-year period ending with the tax year that precedes the calendar quarter for which the ERTC is determined do not exceed $1,000,000. [6]
- It is not otherwise an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.[7] (As discussed later in section Not Otherwise Eligible, this requirement is obsolete for fourth quarter of 2021.)
In the case of an eligible employer which is an RSB, the amount of the credit allowed for any calendar quarter shall not exceed $50,000.
[8] The credit for RSBs may be claimed for wages paid after June 30, 2021 and before Jan. 1, 2022.
[9]
Carrying on a trade or business
The determination of when an employer “began carrying on a trade or business” is made in the same manner as IRC Section 162.
[10] In general, a taxpayer has not begun carrying on a trade or business until the business has begun to function as a going concern and performed the activities for which it was organized.
[11] An activity is recognized as a trade or business, and the expenses are deductible under IRC Section 162, if there is some regular activity directed toward making a profit. When a taxpayer is only in the initial or preparatory stages, before beginning to undertake profit-making activity, that taxpayer cannot deduct expenses incurred and has not begun carrying on a trade or business.
[12]
By measuring when an employer “began carrying on a trade or business” through applying the rules of IRC Section 162, the date that an entity was formed and when that entity “began carrying on a trade or business” could be different dates. An entity performing startup activities has not “began carrying on a trade or business” until they have conducted a regular activity toward making a profit.
Average annual gross receipts
A taxpayer uses the rules found under IRC Section 448(c)(3) to determine an entity’s average annual gross receipts.
[13] To qualify as an RSB, the taxpayer’s average annual gross receipts for the three-tax-year period ending with the tax year that precedes the calendar quarter for which the ERTC is determined must not exceed $1,000,000.
[14]
Gross receipts for any taxable year of less than 12 months shall be annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period.
[15] Since RSBs must have begun carrying on a trade or business after Feb. 15, 2020, RSBs will not have gross receipts for a three-tax-year period. In fact, RSBs with calendar year-ends will not even have one full tax-year because the three-tax-year period ending with the tax year (2020) that precedes the calendar quarter (Q3 and Q4, 2021) for which the ERTC is determined would be limited to Feb. 16, 2020–Dec. 31, 2020.
For example, after beginning to carry on a trade or business on July 1, 2020, an entity had gross receipts through Dec. 31, 2020 of $475,000. Applying this short taxable year rule to the gross receipts in this scenario results in the following calculation: ($475,000*12 months)/6 months = $950,000.
Not otherwise eligible
A taxpayer cannot be an RSB if they are already an ERTC eligible employer due to a full or partial suspension of operations or a decline in gross receipts. This requirement effectively limits a taxpayer from claiming the ERTC twice on the same wages.
This requirement is not an issue for RSBs in the fourth quarter of 2021. The Infrastructure Investment and Jobs Act eliminated the ability for taxpayers to qualify for the ERTC in the fourth quarter of 2021 through both full or partial suspension of operations and a decline in gross receipts. The only way a taxpayer can qualify for the ERTC in the fourth quarter of 2021 is through qualification as an RSB.
Taxpayers must be aware of the
Not Otherwise Eligible rule for the third quarter of 2021. It is still possible to qualify under the government suspension or decline in gross receipts rules. If a taxpayer meets the qualifications for ERTC in the third quarter due to a government suspension or decline in gross receipts they will not qualify as an RSB; however, they may still qualify as an RSB for the fourth quarter of 2021.
Conclusion
It is recommended that a taxpayer who began carrying on a trade or business after Feb. 15, 2020 examine their gross receipts to see if they meet the requirements to be considered an RSB. The credit available for those who qualify as an RSB can be significant.
Andrew Seifert, JD, is a member of the national tax office of Wipfli LLP, where he assists clients with complex tax issues, transactional advising and overall business consulting. An MNCPA member, Andrew frequently presents on tax-related matters. You may reach him at aseifert@wipfli.com or 651-766-2856.
[1] CARES Act Pub. L. No. 116-136, 134 Stat. 281 (2020).
[2] Consolidated Appropriations Act (CAA), 2021, Pub. L. No. 116-260, 134 Stat. 1182 (2020) and American Rescue Plan Act of 2021 (ARPA), 2 Public Law 117-2, 135 Stat. 4 (2021).
[3] Infrastructure Investment and Jobs Act, 2021, Pub. L. No. 118-58.
[5] IRC Section 3134(c)(5)(A).
[6] IRC Section 3134(c)(5)(B).
[7] IRC Section 3145(c)(2)(A)(ii)(III).
[8] IRC Section 3134(b)(1)(B).
[10] IRC Section 3134(c)(5)(A).
[11] Richmond Television Corp. v. U.S., 345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other grounds per curiam, 382 U.S. 68 (1965), on remand, 354 F.2d 410 (4th Cir. 1965), overruled on other grounds;
NCNB Corporation v. United States, 684 F.2d 285 (4th Cir. 1982); see also Rev. Rul. 81- 150, 1981-1 C.B. 119.
[12] Koons v. Commissioner, 35 TC 1092 (1955).
[13] IRC Section 3134(c)(5)(B).
[15] IRC Section 448(c)(3)(B).
