Originally when the employee retention credit (ERC) was just being implemented, it was difficult as well as overly complicated for small businesses to apply and have their qualifications accepted. However, recent changes have resulted in a significant shift in the application process. Now employee retention credits are available to businesses with under 500 employees based on the total wages paid to W-2 employees.
Navigating the world of ERCs can be a daunting task for business owners to determine if they qualify for the credit. In many cases, the language used can be confusing. As a tax preparer, you may want to partner with an ERC specialist to help your clients substantiate the pandemic’s impacts to fulfill the complicated task of qualifying for the credit. The technical jargon associated with IRS regulations can result in the false idea that the only way to prepare is if the firm has experienced a loss in revenue. This is simply not the case, as there are three ways to qualify based on the following criteria: revenue reduction, supply chain distributions, and partial or complete shutdown.
The first way to substantiate a business’s qualification is through the reduction of revenue. Out of the three qualifiers, loss of revenue is the one that most tax preparers are aware of. For 2020, a firm must have experienced a 50% reduction of gross sales in at least one quarter for quarters two, three and four of the year, as the COVID-19 pandemic began in the second quarter of 2020. When and if the revenue reduction in 2020 returned to 80% of the 2019 level, the qualification ends. Regarding the 2021 tax year, a business could qualify with a 20% reduction of gross sales for each quarter one, two and three, compared to the same quarter in 2019.
Supply chain disruptions that resulted from government-ordered shutdowns are another way a business can qualify. Businesses that rely on third-party sources, such as vendors and suppliers, for their companies to function can take this route to qualify. The qualification must have resulted from a government suspension order that impacted a business’s suppliers, resulting in the third party not being able to deliver crucial goods or components. An example of this would be a hotel that could not obtain certain products such as sheets, shampoo, towels or laundry soap during the pandemic. Another qualifying instance would be construction firms that could not receive windows or lumber due to the closures and delays at ports. These impacts qualify a company, regardless of revenue gain or loss.
The third option to qualify involves when a business has experienced a partial or full shutdown. This qualification is based on a “suspension test” to demonstrate that operations were partially or fully suspended due to a COVID-19 governmental order. For this option, it’s essential to know that a government restriction may have directly impacted operations, even if that shutdown order wasn’t given to the business directly. Trade shows were canceled due to government orders, making it impossible for all types of businesses to meet and obtain new customers. Another example would be a cleaning service that used to earn most of its revenue by disinfecting restaurants and office buildings, which was no longer possible during the mandated shutdowns. The cumulative effect of the full or partial suspensions needs to have had a more than nominal, meaning more than a 10% impact on the business’s bottom line when considering the gross receipts of that portion of your business in 2019. Calendar appointments and other business records can also be used to show the more than nominal impact. Revenue does not have to have decreased to use this qualification.
The employee retention credit has changed several times since its inception, and it now offers a significant refundable tax credit to many more business owners. As a tax preparer, it can be hard to stay on top of the ever-changing ERC regulations. Referring your clients to an ERC expert can allow them to take advantage of this lucrative program without adding hours of labor to your practice.
Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing. All taxpayer circumstances are different, and NATP recommends contacting research services if you have specific questions about your clients’ tax situations.