Previously, I talked about the IRS updating the standard for showing that a government closure had at least a nominal effect on your business. In the last post I covered how businesses that own more than one entity handle the Employee Retention Credit (the ERC). Today, we’ll cover how you go about protecting yourself if you decide to claim the ERC.
First, let’s get the big picture. You can qualify for the ERC by either having sales that are lower compared to the same quarterly period in 2019 (50% decline required in 2020, 20% decline required in 2021) OR by being subject to a partial or complete shutdown of business operations due to a government order related to Covid-19. Whether or not you qualify for the ERC is not the subject of this blog. Our focus is on how do you go about documenting the ERC once you have decided to claim the credit.
Luckily, the IRS lays out exactly what it will be looking for if you are one of the unlucky ones who gets hit with an audit (literally knocking on wood as I type this, lol). Starting on page 100 of IRS Notice 21-20, the substantiation requirements are laid out. To protect yourself and sleep better at night, you should have your documentation ready to go in advance.
The documents must include all of the following information:
1. Proof that you were an eligible employer (average of 100 or less employees in 2019). This is as easy as stating the number of average employees you had in 2019. If it is under 100, you are good to go.
2. The actual government order that you are claiming caused the business to be partially or fully suspended. You will need to state who issued the order, how the order impacted you, and the dates when the order was in effect. Or, if you are relying on year over year sales decline to get the ERC, you must have all of the financial recordsthat you are relying on available.
3. Records to establish that the government order had a more than nominal effect on your business. This is a tough one because the letter of the law is so unclear. I previously addressed the issue at length here if you would like to further read up on the line between nominal effect and no nominal effect. (It’s a very thin line with tens of thousands of dollars at stake.)
4. Records of how much each employee made during each quarter. You will need this to prove that you did not exceed the qualified wage limitations. ($10,000 for the year for 2020 or $14,000 per quarter for 2021).
5. Finally, if you are an aggregated group (ie, you own several different businesses with the same controlled ownership), then you must provide documentation to address how your aggregated status effects the ERC. For more information about that, see my last blog.
The IRS also wants you to have available for their inspection copies of any forms 7200 you filed (to get advances on the ERC payments) and all payroll tax filings from the given period. There is no set template for how you are supposed to present this information. Just make sure to address all of the above topics as required in Notice 21-20.
One last point that is SUPER IMPORTANT. If you personally work in the company that you own and get paid through payroll, your wages are not eligible for the ERC if you are self-employed. This is a huge catastrophic bummer for many small businesses.
But, there is a way around this problem. If you elect s-corp status, then the IRS takes the position that you are magically no longer self-employed. You heard that right, the difference between the federal government cutting you a check for 70% of what you pay yourself through payroll or not is whether you have filled out a short form and sent it to them. If you filled out the form on time, you win. If not, you lose. (Yes, I am oversimplifying, but only slightly.) You can try to file s-corp status late, but there is no guarantee it will be accepted by the IRS if you are asking for it retroactively.
Next time, I’ll cover possibly the biggest windfall to hit American small business in my lifetime: the newest addition to the Employee Retention Credit family - the Recovery Startup Business credit.