Employee Retainment Credit

Tax planning is not often seen as a successful approach for increasing portfolio company earnings before interest, taxes, depreciation, and amortization by private equity (PE) firms (EBITDA). This is due to the fact that realized tax advantages and the costs associated with tax planning typically do not have a positive impact on EBITDA. As a result, this causes an unwanted impact on this essential statistic that is used to evaluate the performance of an organization’s operations.

However, the federal employee retention credit (ERC) may have a favorable impact on EBITDA, and in addition, the one-time charge that was paid to support the credit may be eligible to be deducted as an EBITDA add-back. To be more specific, private equity funds that are striving to maximize their financial performance have the opportunity to produce income by claiming the recently improved ERC for qualifying portfolio businesses. The Earned Revenue Credit (ERC) is a refundable payroll tax credit that was initially introduced as part of the Coronavirus Aid, Relief, and Economic Security Act, which is more commonly known as the CARES Act. The ERC offers employers a credit of up to $26,000 per employee for qualified wages paid to employees after March 12, 2020 and before September 30, 2021. The ERC was initially introduced as part of the CARES Act. Even if Congress has decided not to let taxpayers claim the ERC beginning in the year 2022, private equity firms can still claim claims for the credit on behalf of their eligible portfolio companies for the years previous to 2022.

By claiming an application for the ERC, a large number of portfolio firms were able to circumvent the need that they record a financial loss caused by the epidemic. For instance, a qualified company with forty employees may be entitled to more than one million dollars in employee retention credit and would not be required to acknowledge having a federal income tax due in order to qualify. Although the ERC may bring major benefits to private equity funds, the qualification and calculation factors for private equity portfolio businesses might be difficult to navigate. The eligibility conditions for the ERC are summarized here. Private equity portfolio firms need to evaluate these requirements before determining whether or not they are eligible for the credit and, if so, to what amount.

Eligibility Requirements

In order for an employer to qualify for the ERC, they need to satisfy at least one of the following requirements:

  • The criteria for governmental orders requires that the employer’s operations have been completely or partially halted as a result of a government order connected to COVID-19; or

The test of gross receipts:

  • In the year 2020, the employer had a decline in quarterly gross revenues of more than fifty percent when compared to the same calendar quarter in 2019. This occurred during the year 2020’s first calendar quarter. The end of the quarter in which the company experiences a decline in gross revenues of less than twenty percent is the cutoff point for eligibility.
  • The employer saw a decline in gross revenues of more than 20 percent during a calendar quarter in 2021 when compared to the same calendar quarter in 2019. This occurred throughout the year 2021. Employers who began their operations in 2019 and employers that did not exist in the previous year are subject to a different set of regulations. There is also the possibility of doing a look-back of one quarter, which compares the total gross revenues for the previous quarter to those of the same quarter in 2019.

For the purposes of the ERC rules, all entities that are treated as a single employer under the controlled group rules of IRC Section 52(a) or (b) or are otherwise aggregated under IRC Section 414(m) and (o) are considered to be one employer for the purposes of these rules. This is done so in order to determine employer eligibility. Because of the ownership structures of private equity portfolio companies, special considerations need to be evaluated on a facts-and-circumstances basis in order to determine whether or not other portfolio companies directly or indirectly owned or controlled by the fund need to be taken into account when determining whether or not an applicant is eligible for the ERC.

ERC Benefit

For the years 2020 and 2021, the ERC will be computed differently. For each of these calendar years, the ERC is equal to a percentage of up to $10,000 of “qualified wage” and allocable health plan expenditures paid to employees during the eligibility periods. These eligibility periods are as follows: March 13, 2020 to December 31, 2020 and January 1, 2021 to September 30, 2021 (“qualified ERC costs”). The maximum ERC contribution that may be made by an employee is limited to the amount specified in the table below. The percentage of the employee’s qualified ERC costs that are capped

  • 2020 50 percent $5,000
  • 2021 70 percent $7,000

For the purposes of the ERC, the definition of “qualified wages” is dependent on the employer’s average number of full-time employees in 2019, and the definition shifts somewhat for the ERC calculation in 2020 and 2021.

For 2020:

  • If an eligible employer had one hundred or fewer full-time employees in 2019, then qualifying wages include both wages and health plan expenditures paid to all employees throughout the period of eligibility. This applies only if the eligible employer has fewer than one hundred full-time employees. For employers that are eligible and have more than one hundred full-time employees in 2019, qualifying wages include wages and health plan costs paid to employees who are not performing services owing to COVID-19 during the period in which the business is eligible.

For 2021:

  • If an eligible employer had 500 or less full-time employees in 2019, then qualifying wages include both wages and health plan expenditures paid to all employees during the period in which they were eligible for benefits. This applies only if the employer had fewer than 500 full-time employees. Wages and health plan costs given to employees who are not performing services owing to COVID-19 throughout the period of eligibility are considered qualifying wages for employers who are eligible and have more than 500 full-time employees in 2019.

PE portfolio firms should speak with a tax adviser before determining the number of full-time employees at their company. This will determine them to determine whether or not the aggregation issues mentioned before need to be evaluated. An evaluation of the facts and circumstances will be used to determine, based on the relationship that each portfolio company has with its PE sponsor, whether or not a portfolio company is required to count full-time employees who also work for other portfolio companies that are controlled by the same fund. This will depend on whether or not the other portfolio companies are under common control of the fund. This is significant because there were minimum employee thresholds in place during certain quarters when the ERC was in effect. As a result, a portfolio company that would not have been eligible due to the existence of the minimum employee threshold may become eligible after the application of the aggregation rules.

Maximizing EBITDA

Although the ERC may provide significant opportunities for private equity portfolio companies, a nuanced and complicated analysis is required to evaluate whether the governmental order test or the gross receipts test is met, when the aggregation rules apply, what wage and health-plan expenses qualify, and ultimately the amount that a proper ERC claim should be. This essay does not handle every possible circumstance and element that should be taken into consideration; as a result, private equity portfolio firms should seek the assistance of an expert. Working with private portfolio funds and the firms in their portfolios, specialized tax advisers have established a large amount of skill in locating and documenting ERCs in a manner that contributes to the maximization of EBITDA, net income, and free cash flow.


The articles that we post take into account the most recent information that was accessible at the time of writing. The CARES Act of 2020 was responsible for the establishment of the ERC; the Consolidated Appropriations Act of 2021 (CAA) was responsible for its expansion; and the American Rescue Plan Act of 2021 was responsible for its extension (ARPA).

There are a number of provisions in the Consolidated Appropriations Act, 2021 (CAA), which was passed as part of a coronavirus relief package on December 27, 2020. These provisions are intended to provide assistance to businesses and individuals who have suffered economically as a result of the coronavirus pandemic. Provisions that are helpful for businesses that have secured or are eligible to get a loan under the Paycheck Protection Program (PPP) and provisions that are beneficial for employers that are eligible for the Employee Retention Credit are both included in the CAA (ERC). The CAA also covers the interaction that might occur between the ERC and the research and development (R&D) tax credit for companies who have the intention of claiming both of these credits. To be more specific, the CAA:

Allowance for deduction of expenditures paid with revenues from forgiven PPP loans

Before the CAA was passed into law, Section 1106(i) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provided that any PPP loan forgiveness will be excluded from gross income, and IRS Notice 2020-32 clarified that costs paid using forgiven PPP loan proceeds are not deductible for income tax purposes, even if they would have been deductible otherwise. These provisions were in place before the CAA was passed into law.

In order for expenses to qualify as QREs for the R&D tax credit, they must first be deductible. As a direct result of this, wages that were paid using the proceeds of a forgiven PPP loan were not qualified to be QREs. The previous guidance allowed many taxpayers’ R&D credits to be reduced as a result of PPP loan forgiveness; the CAA eliminates this unfavorable result by permitting expenses paid with forgiven PPP loan proceeds to be deductible. This is one of the many ways in which the CAA improves upon the previous guidance.

Alterations to the ERC that have an impact on the R&D tax credit

The ERC is a refundable payroll tax credit for wages and health plan expenses paid or incurred by an employer whose operations were either fully or partially suspended due to a COVID-19-related governmental order, or where the employer experienced a significant reduction in gross receipts. The ERC was first introduced under the CARES Act and then expanded under the CAA. It was first introduced under the CARES Act.

During the first two quarters of 2021, the ERC will only be able to reimburse a maximum of $10,000 in eligible wages and health plan charges per employee each quarter. In the context of the ERC, “health plan expenditures” refer to both the employer and employee-paid components of those expenses (if paid with pre-tax salary reduction contributions). For the purposes of the research and development tax credit, pre-tax health plan expenditures do not qualify as qualifying wages (i.e., they will not reduce the credit).

In addition, the ERC’s criterion for being considered a “big employer” will grow from 100 to 500 employees beginning in 2021 as a result of the CAA. As a result of this, a greater number of employers could be able to include all qualified wages paid to employees throughout a qualifying quarter, regardless of whether or not the employee worked for the company during that period. Because of this change, there is a possibility that more employees who are delivering services may qualify for the ERC. This might have a big impact on the R&D tax credit.

Revelations to Us

It is no longer the case that wages paid to employees engaged in qualifying research and who are included in PPP debt forgiveness applications would lower a taxpayer’s QREs or have a negative impact on the R&D tax credit.

Taxpayers who are qualified for the ERC and who also claim R&D credits should do an analysis of their qualified wages for both the ERC and the R&D credit in order to reduce the negative impact on both credits. Taxpayers should claim as ERC-eligible qualified health plan expenses and qualified wages expenses that are not potentially QREs as well, for example, expenses related to employees who did not perform any R&D-creditable “qualified service.” This will help mitigate the negative impact that this will have on the R&D credit available in 2021.

Our experts in Business Incentives & Tax Credits are familiar with the dynamic relationship that exists between the ERC and the R&D credit, and they are available to assist your company in minimizing the effect that the ERC will have on the R&D credit.

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