This is part 2 of a 3-part series that reviews the latest developments of the Employee Retention Credit (ERC), which was first introduced as part of the CARES Act in the Spring of 2020.
As the IRS begins to examine Employee Retention Credit (ERC) claims, it is crucial for companies that received an ERC refund to prepare for the potential IRS audit that could hit their desks. Note that the American Rescue Plan Act (ARPA) included a special five-year statute of limitations for the IRS to assess a deficiency for ERC claims in the third quarter of 2021 (instead of the normal three-year period). This longer period suggests the IRS is planning to review many of these claims and may need this extra time to complete its work.
To that point, It is important to ensure you keep thorough and complete paperwork when claiming an ERC refund, supporting:
- Qualifying quarters or portions of quarters
- Details of the calculation of the credit itself
- Payroll records supporting the ERC claim
Substantiating claims under partial suspension rules
By far, the most difficult ERC claims to substantiate will be those filed under the partial suspension rules. The primary factor that needs to be in place is a governmental order that required suspension of operations of some type.
What constitutes a governmental order for these purposes?
- According to IRS guidance, orders from Federal, State or local governments are considered “orders from an appropriate governmental authority” if they limited commerce, travel or group meetings due to COVID-19 that affects an employer’s operation of its trade or business. This can include orders that limited hours of operation and if they are from a State or local government that has jurisdiction over the employer’s operations (referred to as a “governmental order”).
What does not constitute a governmental order for these purposes?
- Statements from a governmental official, including comments made during press conferences or in interviews with the media,
- The declaration of a state of emergency by a governmental authority, if it does not limit commerce, travel or group meetings in any manner,
- A declaration that does limit commerce, travel or group meetings, but does so in a manner that does not affect the employer’s operation of its trade or business, and
- Guidance from the CDC or other health departments, where orders are not issued.
How to document your claim for an ERC refund under the shutdown rules
Once it is determined that a governmental order was in place and that it impacted your trade or business, the next question to ask is how to document this. It is often best for you, as the business owner, or a company representative, to prepare a detailed explanation of how the various government orders and restrictions impacted your business. You or a representative can offer the best determination of this impact, being the closest to the business operations. Another possibility is to have the legal counsel for the company prepare a memo citing the specific governments orders, and how these led to a company shutdown. The legal memo should also reference how the company’s position followed IRS guidance.
Key factors to consider regarding the impact on your business operations are:
- Capacity restrictions
- Forced reduction in hours to comply with mandates (i.e., cleaning/sanitizing)
- A more than nominal portion of operations were suspended due to governmental orders (see below)
- Inability of employees to perform their jobs in a comparable manner
- Dates should be documented for any of the above factors listed as having impacted your business
This information should be documented concurrent with preparation of the ERC calculations (not later upon audit) to ensure an accurate depiction of the business impact and to lend integrity to the explanation.
Documenting the Timeframe for Qualification under the Shutdown Rules
The timeframe for calculating ERC wages in the suspension under governmental orders, in contrast to whole quarters qualifying under the gross receipts testing rules, is driven solely by the date(s) covered under the order. Once the order is lifted, wages cease to qualify. For example, if a government order that impacted a business more than nominally is lifted on May 30, 2020, wages on or after that date do not qualify for the ERC. Be sure to include a copy of the applicable governmental order, listing the dates it covered, in your documentation.
Determination of a more than nominal portion
How is it determined that a “more than nominal portion” of a business was affected by a government order? How is it decided if a “more than nominal effect” on business operations occurred? According to IRS guidance, your business operations are deemed to constitute more than a nominal portion or effect on business operations if either:
- The gross receipts from that portion of the business operations are not less than 10% of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or
- The hours of service performed by employees in that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).
Key Takeaways
Portions of the ERC are subjective in nature (i.e., the government shutdown provisions), and IRS guidance has not addressed all aspects of the ERC. Because of this, it may be challenging to comply with IRS guidelines and document the ERC claimed in the event of an audit. If the company obtained an outside ERC study, this documentation should be requested from the study provider. If they do not have this ERC documentation or will not provide it to you, you should still prepare this documentation. You may need to obtain outside assistance from a trusted advisor to help gather this support.
Click here to read part 1.
Click here to read part 3.
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About our authors
Debbie Warden
Debbie Warden, CPA, is a tax director with more than 25 years of experience providing tax and accounting services to businesses and individuals with special attention to minimizing tax liabilities through tax planning, including tax credits and other incentives. Her background in both public accounting and industry gives her insight into the challenges faced by businesses and the strategies available to overcome them.
Jim Brandenburg
Jim Brandenburg, CPA, has extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies.
Tom Bayer
Thomas Bayer, CPA, CExP, has 30 years of experience providing a broad range of accounting, tax and business advisory services to commercial clients across various industries. Tom has specialized expertise in the areas of tax planning and compliance, business advisory services and business succession planning.
