One of the most enjoyable ERC myths to dispel has been that the employer-size thresholds governed by the PPP should work the same, or similar to, the size thresholds applicable to the ERC. The misapplication of the “small” versus “large” employer tests tend to arise from the erroneous assumption that the PPP’s size and affiliation rules are the same or similar to the ERC’s size and aggregation rules. Yes, both tests use 500 employee count as the bright-line delineator between those that are “in” and those that are “out.” However, there are two major definitional distinctions within each test that can produce dramatically different results in favor of the ERC:
Definitions under “Aggregation”
PPP: The PPP used a more subjective and general rule of “control,” but it was commonly understood based on SBA guidance that 50% of the vote or value of an employer would constitute control. Private equity (PE) and venture capital (VC) portfolio companies were hit particularly hard by the requirement that majority-owned companies under the same controlling fund vehicle would have to aggregate employees to determine whether they crossed the 300 or 500 employee thresholds.
ERC: The ERC uses “tried-and-tested,” objective rules that have existed for many years in the Internal Revenue Code under Section 52(a), 52(b), and 414(m). While commonly controlled groups of corporations continue to use a 50% thresholds, the sweet spot of opportunity may actually be found through the application of the “five or fewer” test, which uses an 80% threshold in place of a 50% threshold, requiring five or fewer individuals to hold the vote or value of the tested employer.
“What type of employers might unexpectedly fit within the ERC eligibility pool?”
PE or VC Owned Portfolio Companies are often owned by non-operating partnerships with “widely-held” ownership.
Privately-Owned (e.g., HNW) Companies with significant minority shareholder interest(s) (20%+) also stand to prosper under the ERC, as such businesses may not be required to be combined with other related businesses.
Definitions of “Employee”
PPP: In testing the employer headcount for the PPP, the SBA ultimately made it explicitly clear that both full-time and part-time employees should be tested for the headcount. Further, foreign employees were required to be brought into the test (though not without much confusion beforehand), which pushed many medium-sized multinational employers over the limit.
ERC: On the other hand, and similar to the PPP affiliation rules, the ERC leverages the internal Revenue Code (Section 4890H) to evaluate headcount using an average monthly “Full-Time Employee” test to determine whether an employer is “small” versus “large.” An FTE is defined as an employee who provided 30 hours of service per week or 130 hours per month (treated as the monthly equivalent of 30 hours per week) during a calendar month. An employer that operated for all of 2019 calculates its FTEs by taking the sum of the number of FTEs in each calendar month in 2019 and dividing that number by 12. One place for employers to perform a litmus test on headcount is to refer to their Affordable Care Act reported employees on Form 1094-C, which uses the 4980H test
“What type of employers might squeeze into ERC “small” employer status after excluding part-time and/or foreign employees?”
Retail, hospitality, amusement, and fitness businesses are notorious for employing a large proportion of their workforce as hourly, part-timers, often with only a few managers, assistant managers, and corporate staff falling into the “full-time” category.
High-turnover and seasonal businesses may wish to keep a close eye on how the hiring and firing (or off-seasoning) of employees affects their FTE count. Summer camps, winter resorts, and sporting team-related business should be on the lookout!
U.S. businesses with foreign operations or ownership should also be aware that they are not required to count their foreign workers.
If you’ve concluded that your company is on the outside looking in at the ERC because of your perceived “over-size,” we encourage you to reach out to our team of technical experts at Sagemont Tax so we can take a commitment-free, no-cost second look at your eligibility.