One of the biggest tax opportunities in recent years is the Employee Retention Credit, also called the ERC tax credit or ERTC. The ERC is a refundable tax credit that is designed to give financial relief to employers impacted by COVID-19. There are two ways to qualify:
- Experiencing a decline in gross receipts in 2020 or 2021 when compared to 2019
- Experiencing a full or partial shutdown due to a government order due to COVID-19
Although the gross revenue test is fairly straightforward, the ERC suspended operations test involves many nuances and opportunities for mistakes to occur. I decided to write a clear-cut guide for taxpayers who want to evaluate their ERC eligibility based on the suspension test.
Quick note: Don’t be fooled by big promises by greedy ERC shops
Many ERC shops have popped up and force-qualified taxpayers to receive huge ERC amounts so they get a hefty percentage. The problem is that, when the IRS inevitably starts auditing ERC claims in the coming years, taxpayers – not the ERC shops – will be responsible for justifying the ERC amount received.
If a person can’t produce clear documentation that substantiates their ERC qualification, they will be subject to penalties and fees. So, when researching your ERC eligibility, be sure to research for yourself and avoid blindly trusting a tax professional’s word that you are eligible. You don’t need to become a tax expert. But you should know enough about the ERC to make an informed decision on who to trust for ERC services.
What is the ERC suspended operations test?
The suspended operations test says that to qualify for the ERC, you must have experienced a full or partial shutdown in 2020 or 2021 due to a government order related to COVID-19.
On the surface, this sounds quite clear, but many clarifications need to be made. Let’s get started…
How is a shutdown defined for the ERC suspended operations test?
For ERTC purposes, you are considered to have experienced a shutdown when a government order specifically directed you to restrict access to your business location or forced you to reduce your level of operations comparable to 2019.
If only a portion of your business was closed while another area remained open, you may qualify for ERC under a partial shutdown. To be considered a partial suspension of operations, the shutdown must have affected more than a nominal portion of your business.
What is a nominal portion of my business?
In Notice 2021-20 (page 28), the IRS clarifies that a shutdown fulfills the nominal portion requirement if either:
- The gross receipts from that portion of the business equal 10% or more of the company’s total receipts for that quarter (when compared to 2019)
- The hours of service performed within that portion of the business comprise 10% or more of the company’s total service hours for that quarter (when compared to 2019)
An example of the nominal portion requirement
For example, let’s say you own an auto business that is comprised of a dealership and auto repair center. In 2020 and 2021, your state’s COVID-19 guidance ordered you to close your dealership but allowed your auto repair shop to remain open as an essential service.
If your auto sales comprised 40% of your 2019 gross receipts and auto repairs made up 60% of your total revenue in 2019, you would fulfill the nominal portion requirement.
The “more than nominal impact” test for no-shutdown scenarios
If your business operations were not suspended but you made modifications in response to a direct government mandate, you can explore the nominal impact test. The IRS states that a modification is considered to have “more than a nominal impact” on business operations if it results in a 10% or more reduction in your ability to provide goods or services during normal business hours.
Many gray areas can be tricky to navigate so it’s vital to speak with a tax professional about your specific facts and circumstances. However, here are a few caveats to note for the “more than nominal” requirement:
- Nominal impact is tied to nominal portion: Question 17 (Example 3, 4, and 5) of IRS Notice 2021-20 determine the nominal impact in a hypothetical scenario by asking whether a nominal portion of operations was affected.
- Modifications must have a more than nominal effect: Answer 18 in IRS Notice 2021-20 states that modifications that don’t impact operations, like masks, are considered to not have a “more than nominal” impact.
- Guidance should be applied on a case-by-case basis: Answer 18 in Notice 2021-20 clarifies that nominal impact determinations depend on your unique circumstances and industry. Occupancy restrictions might fulfill the “more than nominal” impact test for a restaurant, but not for a retail store.
What is considered a government-ordered shutdown for the ERC suspension test?
Many taxpayers and even ERC shops have pointed to CDC guidelines and OSHA guidance as sufficient grounds to claim the ERC tax credit. However, this is incorrect.
In Notice 2021-20, Question 20 distinguishes between two business locations that have suspended operations, one due to a government mandate and the other because of CDC guidelines. The first location is described in the Notice as fulfilling the partial suspension requirement. The second location, however, is described as merely “following CDC or DHS” guidelines and is not considered to have passed the ERC suspension test.
Unless a government mandate from your state or the federal government legally requires you to comply with the CDC guidelines, it is best to avoid using CDC guidance as grounds to claim the ERC.
OSHA rules and recommendations
Similar to CDC guidelines, many taxpayers have tried to use OSHA rules to justify their ERC eligibility. However, Dan Chodan – a CPA who has dubbed this the “OSHA argument – has done a tremendous job of debunking this mistaken idea. I’ll summarize his arguments below:
- The COVID-19 page on the OSHA website explicitly states that OSHA recommendations are advisory in nature and informational in content. Because the ERC suspension test requires a government mandate, not merely a recommendation, the OSHA rules are not valid grounds to claim the ERC.
- OSHA’s General Duty Clause, which states employers must furnish a safe workplace free from harm and threats, is also used to validate ERC claims. However, the General Duty Clause was created in 1970 – not in response to COVID-19 as required in IRC Section 3134(c)(2)(A)(ii)(I).
Do supplier or vendor shutdowns give me ERC eligibility?
Vendor shutdowns have an indirect impact on business operations, which has led many people to ask whether a vendor’s suspension is sufficient to qualify for the ERC. The IRS addresses supplier shutdowns in question 12 of IRS Notice 2021-20, noting that, if a business is unable to get “critical materials from its suppliers because they were required to suspend operations, the business would be considered an eligible employer.”
It’s important to understand that ERC eligibility, in this scenario, is based on your inability to obtain the supplies needed to provide goods or services. I’d highly recommend looking for an alternative supplier before using vendor suspension as grounds for your ERC eligibility. Keep any documentation or proof of your search, like emails or requests for proposals, for an alternative supplier, in case the IRS investigates your ERC claim later.
What if my operations were only suspended for part of a calendar quarter?
A popular misconception about ERC suspensions is that being suspended for any portion of a calendar quarter means you qualify for that entire quarter. This is not true.
A key consideration when determining ERC eligibility is whether or not you were able to continue comparable operations to normal conditions, despite any modifications you made to your operations.
Notice 2021-20 outlines some factors to consider when you are determining whether or not your operations are comparable:
- The ability to telework and continue normal operations in a location other than your office
- The percentage of portable work which can be completed at a remote location
- The essentiality of your physical presence to your business operations. If your presence is critical, then you are considered unable to continue comparable operations while working remotely
- The adjustments needed to allow telework operations, which is a measure of how long it took you to shift from in-office to telework-based operations. A delay over two weeks may qualify you as “subject to a partial suspension during that transition period.”
It’s worth noting that the last factor about time to adjust to teleworking shows us that any operational pause will qualify as a partial suspension during the time of suspension only.
Look at these ERC amounts – then give us a call to check your ERC eligibility
We’ve helped numerous clients claim the ERC and, more importantly, understand how they qualified for it. Here are just some of the amounts we’ve claimed for clients through our ERC services:
- A sports shop qualified for the first quarter of 2021 and claimed $58,255.
- A recreation venue claimed the ERC for the second, third, and fourth quarters of 2020 and received $360, 384.26.
- A multi-location hotel brand qualified for 2020 and the first two quarters of 2021 and claimed $484, 948.99 in ERC.
When you’re ready to talk with our professionals about your ERC eligibility, fill out our ERC questionnaire and we’ll get started.