The ERC’s Overlooked “Alternative” Testing Quarter for a 20% Decline: Q4 2020
The Employee Retention Credit (“ERC”) is undoubtedly the sleeper stimulus program of the summer. Oftentimes trumping the dollar-value benefit of one or both PPP loans, business owners and operators that have chanced upon the ERC have been quietly rejoicing after working their way through this exceedingly complex refundable tax credit package. This persistent group of individuals refused to go quietly into the night and are now patiently waiting for five, six, or seven-figure checks from the U.S. Treasury. However, there are many businesses out there that have misdiagnosed their eligibility and have prematurely drawn inaccurate conclusions on their ERC opportunities. It is the mission of ERC Tax Experts to further educate and spread awareness to all businesses on the ERC, particularly those meriting a second opinion on ERC eligibility.
Our crack-staff of CPAs, lawyers, and payroll specialists have tirelessly studied and tenaciously worked their way through virtually every possible ERC fact pattern for clients across various industries, spread out over all four corners of the US. While we’re not a huge fan of the term “loopholes,” our efforts have allowed us to develop an arsenal of, let’s say, “secret weapons” that have allowed us to find opportunities for our clients that, while surprising, are fully supported by the 150+ pages of IRS technical guidance. Over the course of the rest of this year, ERC Tax Experts will be sharing a weekly series of Hidden Loopholes, ERC Myths, and Best Practices. This week, we begin with a Hidden Loophole that’s been right under your noses since the Consolidated Appropriations Act (CAA) came out in December 2020…
“The Overlooked ‘Alternative’ Testing Quarter”
Under the ERC “1.0” (or “ERC Light”) released with the Cares Act, a somewhat obscure “look-forward” rule was introduced that effectively prescribed that if an employer met the 50% decline in gross receipts test in a given quarter, they would automatically qualify until at least the end of the following quarter. In fact, the employer can continue to dip in future quarters until such employer had “rebounded” back to 80% of comparable 2019 gross receipts.
For example, an employer with a 51% decline in Q2 2020, 24% decline in Q3 2020, and a 2% decline in Q4 2020, surprisingly will qualify as an eligible employer for all three quarters. This is a result of the employer not “rebounding” back to 80% in Q3 of 2020. On the other hand, if such employer had reached 81% in Q3 of 2020, they would not have spilled their eligibility into Q4 2020. As a result of this generous rule, qualifying in any quarter of 2020 under the 50% test will automatically qualify an employer for a minimum of 6 months of ERC eligibility.
Under ERC “2.0” (or “ERC 180 Proof”) released with the CAA, the creative lawmakers on Capitol Hill decided to keep business and their advisors on their toes by swapping out the “look-forward” rule with a “look-back” rule (which they coined the “Alternative Quarter” test). Under ERC 2.0, an employer looking to qualify as an eligible employer in Q1 or Q2 of 2021 was now permitted to qualify using a 20% decline threshold in either the current quarter or by reference to a 20% decline in the previous quarter. If you flip this look-back rule on its head, it turns out looking almost identical in practice to the look-forward rule, as a 20% decline looks a lot like (or exactly like!) the “un-rebounded” period described in ERC 1.0 (e.g., less than 80% recovery).
If your head isn’t already spinning already, just keep the general rule of thumb that whether you think of it as a look-forward, or look-back rule, qualifying in any given 2020 quarter using a 50% threshold, or any given 2021 quarter using a 20% threshold will almost always push your business into 6 months of eligibility. The lone exception? Unfortunately, Q4 2021 does not grant one the joy of spilling the ERC into 2022!
But what about using a 20% test in a 2020 quarter…that can’t surely be possible right? Wrong! If you look closely enough at the CAA, combined with guidance from the IRS, it is actually possible to qualify Q1 2021 by reference to a look-back to Q4 2020, comparing the latter to Q4 2019 using the 20% threshold. Pretty cool, right?
After getting past the awkwardness of using the 20% threshold in 2020, you’ll be elated to remember that in 2021 the ERC bumps up from $5,000 to $7,000 per employee. Even sweeter is the sound that the maximum credit of $7,000 per employee can be realized in each 2021 quarter, as opposed to the $5,000 credit that was available only once over the 2020 calendar year. To put the icing on the cake, the IRS recently announced in Notice 2021-49 that the “look-back” test does not have to be used consistently over 2021.
Therefore, an employer might qualify for Q1 2021 by reference to a 20% decline in Q4 2020, and then can still qualify for Q2 2020 based on Q2 2021’s standalone results against Q2 2019.
If you’ve made it this far and feel a pounding sensation in your head, please don’t hesitate to reach out to ERC Tax Experts so that we can pair you up with one of our technical specialists to help put the “easy” in the ERC.
Stay tuned next week for our next weekly series where we dispel a common ERC myth: “I think I’m a ‘LARGE’ employer!” In this series, we’ll compare the SBA’s size test under the PPP to the far more generous size test under the ERC.