Navigating the Employee Retention Credit (ERC) Shutdown Test

Employee Retention Credit Eligibility Requirements

As a credit, the ERC directly reduces your business’s tax obligation. You may be eligible for the credit due to either a full or partial suspension of your operations. Even essential businesses with impacted revenue may be eligible.

In order to increase your chances of getting approved based on basic IRS guidance, it’s important to be as detailed as possible in your application. Learn the eligibility requirements, plus our best tips for submitting your application for the ERC.

General ERC Eligibility Requirements

The eligibility requirements for the ERC were updated in 2021. 

2020 qualifications:

• Qualifying wages of up to 100 full-time employees
• A decrease in gross revenue of at least 50% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate 

2021 qualifications:

• Qualifying wages of up to 500 full-time employees
• A decrease in gross revenue of at least 20% compared to the corresponding quarter in 2019
• Or either a full or partial suspension of business operations created by a government mandate

ERC Government Shutdown Tests

So, how do you determine if your business experienced a full or partial suspension due to a government order? In general terms, a suspension constitutes a government order having an impact on operations in either hours or service capacity. If a business faced a direct order to fully suspend their business, then they qualify under the ERC. If a business or portion of a business was deemed essential but were limited in hours and service capacity, they may still qualify as a partial suspension. This ERC shutdown test may seem straightforward at first, but there are a lot of murky areas that have been addressed by the IRS. 

Your business was essential but supplier shutdowns impacted operations. Even if your business was considered essential throughout the pandemic and wasn’t subject to shutdown orders, you may still have experienced a shutdown if your suppliers were unable to make deliveries of critical goods or materials due to a governmental order that caused the supplier to suspend its operations. Documenting these negative setbacks that hurt your revenue could help qualify as a partial suspension.

Your business was required to reduce operating hours due to a governmental order.  The ERC partial suspension test acknowledges that some businesses may have scaled back on hours or the scale of operations in part rather than in full due to a governmental order. An example would be a business where part of the staff was able to work remotely, but other operations required in-person work and was shut down. 

Alternatively, a dine-in restaurant that switched to carry out and delivery during the pandemic would  be considered a partial shutdown since their operations were reduced but not completely stopped. 

Your business operated in multiple jurisdictions with varying degrees of shutdowns based on location. According to the IRS, this would still be considered a partial shutdown. It’s important to note all states and locales in which you operated, since some may have had stricter shutdown rules than others.

Shutdown Impact

Once you’ve determined if you experienced a full or partial shutdown, the IRS wants you to prove you were affected greater than 10%. Here’s how that works. 

The Size Test

The size test for ERC qualification means that more than a nominal portion of your operations were suspended because of the government order, you can qualify for the tax credit. This is measured by either a reduction greater 10% of the total gross receipts or a greater than 10% reduction in the total employee service hours for the specific quarter measured year over year. 

The Effect Test

Another way you can qualify after a partial or full shutdown is the effect test. To meet the effect test, the IRS has said that you either have to demonstrate that the suspended portion of your business made up a greater than 10% portion of total operations, or that modifications made to the business due to governmental orders resulted in a greater than 10% impact to your ability to provide goods or services to your customers. For example, a restaurant had to limit occupancy to 50% due to a governmental order and could only seat guests in every other booth. Or, a dance studio had to cut group lessons and only offer one-on-one classes due to a governmental order. In each of these scenarios, the business would pass the effect test.

Best Practices to Demonstrate ERC Shutdown Eligibility

It’s not too late for eligible businesses to apply for the Employee Retention Credit. To claim the 2020 credit, the application must be submitted by April 15, 2024. The deadline for the 2021 credit is April 15, 2025. IRS form 941-X is required to claim eligible employee wages.

However, the IRS has left quite a lot of gray area in terms of guidelines for the ERC shutdown test and has also noted that it doesn’t plan to issue any further guidance. So it’s important to be as thorough as possible when applying for the credit in order to maximize your tax savings. 

Lendio can help you apply for this tax credit. Here are some of the things to include in your application. 

• Revenue activities: Explain your business operations and how you typically bring in revenue. 
• Changes in income-producing strategies: Include details on how you adjusted your operations throughout the pandemic in order to continue bringing in cash flow.
• Total revenue: Analyze exactly how much your revenue fell between 2019 and 2020 on a quarterly basis. 
• Operating locations: Be specific with all the different states and jurisdictions in which you operated.
• Employee working hours: Talk about any changes in employee scheduling and number of hours of work that had to be adjusted in order to comply with social distancing best practices.
• Sales metrics: Give color to exactly how your business sales were impacted. Perhaps your foot traffic significantly dropped or you had difficulty closing sales over video or phone compared to in-person meetings. 
• Vendor disruptions: Even essential businesses experienced disruptions, particularly from other vendors who may not have continued smooth operations. List out vendor names, dates, and specific challenges and setbacks your business experiences because of third parties.