IRS eases burden on ERC eligibility under gross receipts test

On Aug. 10, 2021, the IRS released Rev. Proc. 2021-33, providing a taxpayer-friendly safe harbor that permits an employer to exclude certain items from “gross receipts,” solely when determining employee retention credit (ERC) eligibility. For many employers, application of this safe harbor could be significant.

The items covered by the safe harbor are:

1. Paycheck Protection Program (PPP) loans forgiven, and
2. “ERC-Coordinated Grant” amounts received, limited to:
   a. Shuttered venue operator grants, and
   b. Restaurant revitalization grants

Background

In general, amounts received with a forgiven PPP loan or ERC-Coordinated Grant are included in the calculation of gross receipts (although they are excluded from gross income). Prior to the safe harbor, employers who received one or more of these benefits were required to include those amounts in their quarterly revenue when testing for eligibility under the significant decline in gross receipts test. For many employers, this inclusion pushed them past the threshold of eligibility, rendering them ineligible or causing them to rely on the less-favorable suspension test.

The IRS commented in Rev. Proc. 2021-33 that it believes congressional intent is that an employer should be able to participate in the PPP and ERC-Coordinated Grant relief programs and also claim the employee retention credit. However, the IRS further states that without the safe harbor, participation in these programs might preclude an employer from claiming the ERC with respect to a calendar quarter in which there is the decline in gross receipts solely because its participation in the relief program resulted in a temporary increase in gross receipts.

Accordingly, the IRS provided a safe harbor that permits an employer to exclude the amount of the forgiveness of a PPP loan and the amount of ERC-Coordinated Grants from the definition of gross receipts, solely for the purpose of determining eligibility to claim the ERC.

Application of the safe harbor

An employer may elect to use the safe harbor by simply excluding the amount of the forgiveness of a PPP loan and the amount of ERC-Coordinated Grants from its gross receipts when determining eligibility to claim the ERC on its employment tax return. No election statement is needed.

To claim the safe harbor, an employer must consistently apply the safe harbor in determining ERC eligibility. The IRS defines this consistency as:

1. Excluding the amount of the forgiveness of any PPP loan and the amount of any ERC-Coordinated Grant from its gross receipts for each calendar quarter in which gross receipts for that calendar quarter are relevant to determining eligibility to claim the ERC, and
2. Applying the safe harbor to all employers treated as a single employer under the ERC aggregation rules.

Safe harbor example

Employer X has gross receipts from operations of $10 million in Q1 2019 and $7.5 million in Q1 2021. Employer X also has a forgiven PPP loan in the amount of $1 million during Q1 2021. The loan forgiveness amount is required to be recognized in gross receipts under section 448(c), despite not being includable in federal taxable income, resulting in total gross receipts of $8.5 million for that quarter. Under the general rule, when testing eligibility in Q1 2021, Employer X has a 15% decline in gross receipts. The employer does not qualify, falling short of the greater-than-20% eligibility threshold.

However, when applying the safe harbor outlined in Rev. Proc. 2021-33, the $1 million forgiven PPP loan is excluded from Q1 2021 gross receipts, resulting in only $7.5 million of gross receipts for ERC qualification purposes. The employer now shows a 25% decline in gross receipts, exceeding the greater-than-20% threshold and thus qualifying for the ERC. In addition, by making the election to rely on the prior quarter’s gross receipts, Employer X may be eligible for Q2 2021 as well, resulting in two full quarters of eligibility.

Effective date

This revenue procedure applies for purposes of determining eligibility to claim the ERC for wages paid after March 12, 2020, and before Jan. 1, 2022.

We encourage you to connect with your Baker Tilly advisor regarding how the above may affect your tax situation.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.