Understanding the Employee Retention Credit (ERC) Shutdown Test | Employee Retention Credit Partially Suspended

Understanding the Employee Retention Credit (ERC) Shutdown Test | Employee Retention Credit Partially Suspended

After the start of the Covid-19 pandemic in March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which provided numerous aid packages for both individuals and businesses. Part of the legislation was the Employee Retention Credit, which was designed to provide impacted businesses with a tax credit to help fund employee wages. Subsequent legislation extended this credit to 2021 as well.

To maximize your credit for 2020 and 2021, it’s crucial to fully understand (and document) your company’s eligibility based on the ERC shutdown test. Here’s everything you need to know to qualify.

Employee Retention Credit Eligibility Requirements

As a credit, the ERC directly reduces your business’s tax obligation. You may be eligible for the credit due to either a full or partial suspension of your operations. Even essential companies with impacted revenue or operations may be qualified.

Your application must be as detailed as possible to increase your chances of getting approved based on essential IRS guidance. Learn the eligibility requirements, plus our best tips for submitting your application for the ERC.

General ERC Eligibility Requirements

The eligibility requirements for the ERC were updated in 2021.

2020 qualifications:

Qualifying wages of up to 100 full-time employees
A decrease in gross revenue of at least 50% compared to the corresponding quarter in 2019
Or either a full or partial suspension of business operations created by a government mandate

2021 qualifications:

Qualifying wages of up to 500 full-time employees
A decrease in gross revenue of at least 20% compared to the corresponding quarter in 2019
Or either a full or partial suspension of business operations created by a government mandate

ERC Government Shutdown Tests

So, how do you determine if your business experienced a full or partial suspension due to a government order? In general terms, a suspension constitutes a government order impacting operations in either hours or service capacity. If a business faces a direct order to suspend its business entirely, they qualify under the ERC. If a company or portion of a business was deemed essential but was limited in hours and service capacity, it may still qualify as a partial suspension. This ERC shutdown test may seem straightforward at first, but there are a lot of murky areas that the IRS has addressed.

Your business was essential, but supplier shutdowns impacted operations. Even if your business was considered “essential” throughout the pandemic and wasn’t subject to shutdown orders, you may still have experienced a shutdown if your suppliers were unable to make deliveries of critical goods or materials due to a governmental order caused the supplier to suspend its operations. Documenting these negative setbacks that hurt your revenue could help qualify as a partial suspension.

Your business was required to reduce operating hours due to a governmental order. The ERC partial suspension test acknowledges that some companies may have scaled back on hours or the scale of operations in part rather than in full due to a governmental order. An example would be a business where part of the staff was able to work remotely, but other operations required in-person work and were shut down.

Another example, a dine-in restaurant that switched to carry out and delivery during the pandemic would be considered a partial shutdown since their operations were reduced but not completely stopped.

Your business operates in multiple jurisdictions with varying degrees of shutdowns based on location. According to the IRS, this would still be considered a partial shutdown. It’s important to note all states and locales where you operated since some may have had stricter shutdown rules than others.

Shutdown Impact

Once you’ve determined if you experienced a full or partial shutdown, the IRS wants you to prove you were affected by greater than 10%. This is what IRS calls “Nominal Impact.” Here’s how that works.

The Size Test

The size test for ERC qualification means that more than a nominal portion of your operations were suspended because of the government order; you can qualify for the Employee Retention Tax Credit (ERTC). This is measured by either a reduction greater than 10% of the total gross receipts or a greater than 10% reduction in the total employee service hours for the specific quarter measured year over year.

The Effect Test- Nominal Impact

Another way to qualify after a partial or full shutdown is the “Effect Test” or “Nominal Impact.”. To meet the effect test, the IRS has said that you either have to demonstrate that the suspended portion of your business made up a greater than 10% portion of total operations or that modifications made to the company due to governmental orders resulted in a greater than 10% impact to your ability to provide goods or services to your customers. For example, a restaurant had to limit occupancy to 50% due to a governmental order and could only seat guests in every other booth. Or, a dance studio had to cut group lessons and only offer one-on-one classes due to a governmental order. The business would pass the Effect or Nominal Impact test in each of these scenarios.

Best Practices to Demonstrate ERC Shutdown Eligibility

It’s not too late for eligible businesses to apply for the Employee Retention Credit. To claim the 2020 credit, the application must be submitted by April 15, 2024. The deadline for the 2021 credit is April 15, 2025. IRS form 941-X is required to claim eligible employee wages.

However, the IRS has left many gray areas regarding guidelines for the ERC shutdown test and has noted that it doesn’t plan to issue any further guidance. So it’s essential to be as thorough as possible when applying for the credit to maximize your tax savings.

Legacy Tax & Resolution Services can help you apply for this tax credit. Here are some of the things to include in your application.

Revenue activities: Explain your business operations and how you typically generate revenue.
Changes in income-producing strategies: Include details on how you adjusted your operations throughout the pandemic to continue bringing in cash flow.
Total revenue: Analyze precisely how much your revenue fell between 2019 and 2020 and 2019 and 2021 on a quarterly basis.
Operating locations: Be specific with all the different states and jurisdictions in which you operate.
Employee working hours: Talk about any changes in employee scheduling and the number of hours of work that had to be adjusted to comply with social distancing best practices.
Sales metrics: Give detail to exactly how your business sales were impacted. Perhaps your foot traffic significantly dropped, or you had difficulty closing deals over video or phone compared to in-person meetings.
Vendor disruptions: Even essential businesses experienced troubles, particularly from other vendors who may not have continued smooth operations. List out vendor names, dates, and specific challenges and setbacks your business experiences because of third parties.