On March 11, 2021, the United States Congress and President Joe Biden passed one of the biggest windfalls in American history for small business owners. The name of this blessed miracle is known as Recovery Startup Business provision to the Employee Retention Credit. This new provision is so special because it allows most small businesses that started after February 15, 2020 to get 70% of the wages it pays through payroll paid back to it by the IRS as a refundable tax credit! Read that again. It sounds too good to be true. But, it’s real.
Zooming out just a bit: the Employee Retention Credit has been around since the Covid relief bills started rolling out last year when the government decided to rev up the money printing presses. But, previously there were only two ways to qualify for the ERC: either (1) your business had to be subject to a partial or complete government shutdown due to Covid regulations or (2) you had to have a certain amount of year over year decline in gross income versus the same quarter in 2019 (50% decline for 2020, 20% decline for 2021). This new Recovery Startup Business provision makes a third category that is easy to fit into for thousands of small business owners.
Before we get too excited, there are some limitations on the Recovery Startup Business part of the ERC. Namely, the business is limited to a total credit of $50,000 per quarter. (Here, the IRS limits the actual credit payable. In other places, the IRS limits the amount of qualified wages, which is what you multiply times 70% to get the credit.) The other limitation is that for each individual employee, the maximum amount of qualified wages in a quarter is $10,000.
Per Section 3134(c)(5) of the American Rescue Plan Act, a Recovery Startup Business has 2 major requirements:
1) It began carrying on a trade or business after February 15, 2020 and
2) The average annual gross receipts of the business owner for the last 3 tax years averaged together is less than $1,000,000.
Let’s unpack those two requirements some.
First, the IRS does not specifically define what it means to “begin carrying on a trade or business.” There is a fact based analysis that looks at whether you have actually started the operation of the business. It is not as simple as the filing date of your LLC. The Supreme Court has held that “The taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. . . A sporadic activity, a hobby, or an amusement does not qualify.” Commissioner v. Groetzinger, 480 U.S. 23 (1987). Importantly, this means that you can start a new business today or tomorrow and potentially qualify for the Recovery Startup Business ERC credit! Your business need not already be in existence.
When it comes to the average gross receipts test, the key is that the same control group of owners is under $1 million in gross receipts on average over the last 3 years. Remember, we are looking at top line gross receipts, not profit or income. This is an important concept to understand if you personally have ownership in multiple businesses. If you own a business that grosses more than $1 Million a year on average, only the exact same ownership is precluded from getting the Recovery Startup Business Credit.
For example, if you own 25% of a restaurant that makes more than $1 million in gross revenue, your restaurant ownership group is precluded from starting a new company and being eligible for the Recovery Startup Business Credit. However, you, personally are not precluded. You could start your own business and still be eligible because it would be a different control group. For more information about the details of controlled groups, check out this blog.
There is one more downside that you need to be aware of when it comes to the Recovery Startup Business ERC, which is common to all of the employee retention credits. If you elect to have Uncle Same write you a check for 70% of wages that you paid through payroll, then you cannot deduct those wages on your tax return as a business expense. To figure out what this will cost you, multiply the wages you paid times your highest marginal tax bracket.
Here is a sample of what the calculations look like for claiming the Recovery Startup Business credit:
Amount paid through payroll from July 1-December 31, 2021 up to a cap of $10k per quarter per employee TIMES 70% = the amount of your ERC Check
Amount paid through payroll from July 1-December 31, 2021 up to a cap of $10k per quarter per employee TIMES your highest marginal tax bracket = how much you need to save for tax liability
The amount of your ERC Check – how much you need to save for tax liability = the financial benefit of claiming the ERC
One final point, if you own an LLC and are paying yourself through payroll, you are NOT ELIGIBLE FOR THE ERC. This is because the IRS considers you to be self-employed in that case. However, if you have elected s-corp status, you are no longer self-employed and are eligible for the credit.
If you need help navigating strategies in the world of the Employee Retention Credit, please feel free to reach out at firstname.lastname@example.org.