Written by Cassidy Jakovickas
The lucrative nature of the Employee Retention Tax Credit (known as ERTC or ERC) has spurred a veritable gold rush as taxpayers have rushed to get their share. If you’re not familiar with the ERTC, I’d recommend one of my previous articles, “Are You Overlooking The Employee Retention Credit?”. But, if you’ve already learned about the ERTC and are now exploring your eligibility, you’ve likely heard of the ERTC suspension test.
There are many gray areas surrounding certain aspects of the ERTC eligibility suspension test that must be approached carefully and with professional guidance, especially since the IRS has indicated they will be scrutinizing ERTC claims in the coming years. Still, I hope to clarify the best practices and most reasonable interpretations of official guidance regarding the ERTC suspension test.
What Is The ERTC Suspension Test?
If you’re interested in claiming the ERTC, the first step is to determine whether you’re qualified. You can do that using either the gross receipts test or the suspension test.
The gross receipts test involves comparing your gross receipts for each calendar quarter in 2019 to the corresponding quarters in 2020 and 2021. For 2020, if your gross receipts are less than 50% of the corresponding 2019 quarter, you are considered an eligible employer for ERTC purposes. For 2021, if your gross receipts in any quarter dropped over 20% when compared to the same quarter in 2019, you are considered eligible for the 2021 ERTC amount for that quarter.
You can also use the suspension test to determine your ERTC eligibility. Using this method, you are considered an eligible employer if a government order specifically regulated the full or partial closure of your business. If you were considered an essential business, you can still qualify for the ERTC if a government order caused you to close more than a nominal portion of your operations.
Nominal Portion vs. Nominal Effect?
IRS Notice 2021-20 provides two safe harbors for you to use when determining your ERTC eligibility using the suspension test:
- — When more than a nominal portion of your operations are impacted by a COVID-19-related government order
- — When a COVID-19-related government order has a more than nominal effect on your operations
#1: Defining A Nominal Portion
This aspect of the ERTC suspension test applies when a portion, but not all, of your business operations have been impacted by a government order. IRS Notice 2021-20 provides either of the following definitions for a nominal portion of your business:
- 1. The gross receipts from the affected portion of the business comprise at least 10% of the total gross receipts (determined using gross receipts from the same quarter in 2019)
- 2. The hours of service performed by employees in that portion of the business make up at least 10% of the total service hours (determined using service hours from the same quarter in 2019)
#2: Defining A Nominal Impact
This safe harbor applies when no portion of your operations have been suspended, but you still made modifications to comply with a COVID-19 government mandate.
The safe harbor covering this provides that a modification will be considered to have a “more than nominal effect” on the employer’s operations if it results in a 10% or more reduction in an employer’s ability to provide goods or services in its normal courses of business.
There are other caveats to consider while assessing nominal impact:
- Nominal portion is connected to a nominal impact: Question 17 (Example 3,4, and 5) of IRS Notice 2021-20 determines nominal impact by assessing 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 to business operations that don’t impact operations, like mask requirements, are not considered as having a more than nominal impact on business operations.
- Parameters must be applied individually: Answer 18 also provides that guidelines must be applied on a case-by-case basis. Occupancy restrictions, for example, have a more-than-nominal impact on a restaurant with indoor dining, but not on a retailer who can accommodate customers regardless of the occupancy restrictions.
Qualifying Vs. Non-Qualifying Shutdowns
When we discuss a shutdown for ERTC eligibility purposes, it’s vital that we stick to reasonable interpretations of the available guidance regarding this sometimes-murky area. One aspect regarding ERTC-qualifying shutdowns is clear, and that is it must be tied to a government order. However, there are some misnomers about certain types of shutdowns that are worth clearing up.
What About CDC Guidelines?
Some business owners point to CDC guidelines as justification for their ERTC eligibility. However, in Notice 2021-20, Question 20 draws a distinction between an employer operating two locations, one subject to a government-mandated suspension and the other which merely adjusts operations according to CDC guidelines. The example describes the company as being partially suspended because of the location subjected to a mandated suspension. On the other hand, the location noted as merely “following CDC or DHS” guidelines is not considered to be suspended.
The example provided in IRS Notice 2021-20 indicates that, unless your state legally requires your business to adhere to CDC guidelines, it would be best to avoid using CDC guidelines for claiming the ERTC.
Is OSHA Guidance Sufficient?
In a related vein to using CDC guidance as justification for ERTC eligibility, many business owners have started arguing that, because OSHA rules mandate compliance with CDC guidelines, they can rely on OSHA rules as grounds for claiming the ERTC.
Dan Chodan, a brilliant CPA and active Twitter user, has nicknamed this particular argument the “OSHA argument” and thoroughly debunked it in an article on Think Outside The Tax Box. Though I can’t give Dan’s full breakdown the respect it deserves within this article, I can highlight some of his key points for you.
First, the COVID-19 page on the OSHA website specifically states that OSHA recommendations are advisory in nature and informational in content. Since the ERTC suspension test stipulates that only government-mandated closures are sufficient grounds to claim the ERTC, OSHA recommendations cannot be used to qualify for the ERTC unless a state legally requires a business to follow OSHA recommendations.
A second aspect of the OSHA argument centers on the General Duty Clause, which states that employers should furnish a workplace that is free from recognized hazards that will cause or “are likely to cause death or serious physical harm.” The problem with referencing the General Duty Clause is that it was created as part of a 1970 law, not in response to COVID-19 as required in IRC Section 3134(c)(2)(A)(ii)(I).
What if my vendors or suppliers were impacted?
Question 12 within IRS Notice 2021-20 asks whether a company whose suppliers are suspended is, by extension, considered suspended. The answer provides that, if the company is unable to “obtain critical materials from its suppliers because they were required to suspend operations, then the business would be considered an eligible employer.”
I’d like to emphasize that this hypothetical company’s eligibility is based on its inability to obtain supplies. This means that, if your supplier was suspended due to a mandated shutdown, it would be best to look for an alternative supplier before relying on your initial supplier’s shutdown for your ERTC eligibility.
What about suspended operations for a partial quarter?
Contrary to popular belief, suspending operations for less than a full calendar quarter does not qualify you for the full ERTC amount for that quarter. In Notice 2021-20, the IRS addresses several factors that are to be considered when trying to determine if an employer can continue comparable operations. The list of factors provided, which the IRS admits isn’t comprehensive, includes the following:
- Your ability to telework while continuing operations from another location.
- The percentage of portable work which can be completed at a remote location.
- The essentiality of your physical presence to continued operations. If your presence is critical, and operations cannot be performed remotely, then you are considered unable to continue comparable operations.
- The adjustments needed for telework operations, if you need to adjust your operations to allow for comparable operations via telework. Any significant delay beyond two weeks in adjusting and moving your operations may be deemed “subject to a partial suspension during that transition period.”
The last factor concerning telework adjustments gives us some insight into whether or not we can justify a position that claims eligibility for a full quarter when operational suspension did not last the full quarter. The language used specifically states that any operational pause caused by telework adjustments will qualify as a partial suspension during the time of transition only.
When Claiming The ERTC, Be Reasonable
The American Rescue Plan Act extended the statute of limitations for assessment of payroll tax returns on which ERTC is claimed for up to five years. It’s worth noting that erroneous refunds of ERTC will be treated as underpayments of Social Security or Medicare taxes and will be subject to assessments.
With any ERTC position, it’s best to reasonably interpret the available guidance from the IRS and local authorities so you avoid trouble later when the IRS begins scrutinizing ERTC claims.
Cassidy Jakovickas, CPA, is president and CEO of MBS Accountancy Corp. in Downtown Fresno.