Claiming Employee Retention Credit Under the Suspension Test

ERC Eligibility

To claim the Employee Retention Credit, employers must be eligible by having met one of three requirements during the indicated period of the COVID-19 pandemic:

• The employer experienced a significant decline in revenue.
• The employer was more than nominally impacted by a partial or full suspension of activities due to governmental orders.
• A supplier critical to your business was impacted by government orders and that then caused a full or partial suspension of activities for your business.

The Suspension Test

The second qualification is often referred to as the suspension test. The language regarding eligibility is ambiguous at best, leaving employers to interpret the ruling and make 'best guess' assumptions about their eligibility.

Common scenarios that lead to confusion surround businesses that were forced to close during COVID-19 due to non-critical supply chain issues or staffing issues rather than government orders. These scenarios don't necessarily meet the eligibility criteria for the Employee Retention Credit because government orders didn't drive closures.

Nominal Portion and Nominal Effect

If an employer can prove that they partially or fully stopped operations as a direct result of a government order, they must demonstrate that they were more than nominally impacted. This is called nominal portion and nominal effect.

Clear guidance is provided for determining whether the full or partial closure had more than a nominal effect on a business. The nominal portion test is satisfied if either of the following occurs:

• The suspended portion of the business comprises at least 10% of the business's gross receipts in the same calendar quarter in 2019.
• The hours of service by employees in the relevant portion of the business's operations comprise at least 10% of all hours worked in the same calendar quarter in 2019.

If an employer did not suspend operations, they might qualify via the nominal effect route. A nominal effect occurs when operations are modified by government order rather than suspended, and the employer's ability to provide services or goods is decreased by at least 10% as a result. There are no clear guidelines around nominal effect, making it much more difficult to articulate and calculate.

The employer cannot qualify under both standards; those whose services were suspended must prove the impact was more than a nominal portion, while those whose services were modified must prove a more than nominal effect.

Here's an example to illustrate the difference:

A salon owner is required to close for three months during the peak of COVID-19 because of governmental shutdown orders. During this period, the salon can still sell and ship salon products online but cannot provide any services to its clients. During the same quarter in 2019, salon services comprised 85% of their gross receipts. The salon is eligible for the Employee Retention Credit because the government-mandated suspension impacted more than a nominal portion.

The next quarter, the salon reopens for services, but mask mandates have required them to modify their operations, so two services are not performed: facials and upper lip waxes. During the same quarter in 2019, employees spent 4% of their total hours on these two services. The salon can't prove that the modification has had more than a nominal effect and will not qualify for the Employee Retention Credit this quarter.

Schedule an ERC Review Today

Any law that can be interpreted so broadly puts employers at risk. Misinterpreting ERC guidelines can lead to audit and assessment of fines and back taxes. The IRS has made it clear that they intend to scrutinize ERC credits claimed to ensure guidelines were reasonably interpreted and followed.

If you haven't claimed the Employee Retention Credit and are wondering if you're eligible, there's still time to review and claim any available credits—up to $26,000 per employee. Schedule your ERC review today to get started.