How Do the ERC's Overlooked Alternative Testing Quarter Election And "Lookback Period" Rules Affect Your Business?
In the early days and aftermath of the COVID-19 pandemic, the federal government enacted a number of stimulus programs intended to help individuals and businesses affected by the accompanying economic fallout. Of these programs, perhaps the least understood and most under-utilized is the Employee Retention Tax Credit, also known as the Employee Retention Credit or ERC. The ERC’s byzantine and at times subjective rules can be confusing, and as a result of this complexity some eligible employers fail to avail themselves of its tax benefits. One of these rules, the “Alternative Testing Quarter” or “Lookback Period,” can help many businesses qualify for the ERC, but can be overwhelming for business-owners to decipher on their own. In this post, we’ll break down the Alternative Testing Quarter’s guidelines and explain how employers can take advantage of this important option.
What is the ERC?
The ERC, introduced as part of the CARES Act of 2020 and expanded as part of the American Rescue Plan of 2021, was intended to encourage businesses to keep employees on their payroll despite COVID-19-induced downturns in business. The refundable tax credit entitles eligible employers to “50% of up to $10,000 in wages paid by an eligible employer whose business has been financially impacted by COVID-19” for 2020, and up to 70% of $10,000 in wages paid in each calendar quarter of 2021 except for Q4.
To qualify for the ERC, an employer must have carried on a trade or business during 2020 or 2021 and either: (a) experienced a full or partial suspension of operations (“FPSO”) due to governmental COVID-19 orders; or (b) experienced a significant decline in gross receipts (“SDGR”) during a calendar quarter. (There is also a third way of qualifying, as a Recovery Start-up Business, but this is not applicable to trades or businesses that were in operation prior to February 15, 2020.)
Calculating Significant Decline in Gross Receipts
To determine whether it qualifies under the SDGR test, an employer generally must compare its gross receipts for a given calendar quarter in 2020 or 2021 to the equivalent calendar quarter in 2019 (that is, January-March of 2020 or 2021 would be compared to January-March 2019).
For 2020, an employer qualifies for the ERC under the SDGR test if its revenues declined by more than 50% when compared to the corresponding 2019 calendar quarter. For example, an employer with $100,000 in gross revenues in the first quarter of 2019 would qualify for the ERC if its revenues in the first quarter of 2020 were less than $50,000.
For 2021, Congress significantly lowered this high bar of eligibility. In 2021, an employer qualifies for the Employee Retention Credit with revenues of less than 80% of the relevant comparison quarter in 2019. For example, an employer whose revenues were $100,000 in Q1 2019 would qualify if its revenues in Q1 2021 were less than $80,000.
While there are a number of variables that often complicate this seemingly-straightforward analysis, once all necessary adjustments have been made, an employer’s SDGR eligibility ultimately boils down to a relatively simple calculation as described above.
The Alternative Quarter Election Rule
For 2021, ERC eligibility rules were also loosened with the introduction of the “Alternative Quarter Election” (or “Lookback Period”) rule. Using this rule, a business that qualifies for the Employee Retention Credit in one quarter of 2021 (based on SDGR) but does not qualify in the next quarter can still claim the ERC for that next quarter. For example, a business that qualifies for the ERC based on a >20% revenue reduction in the first quarter of 2021, but has gross receipts exceeding 80% of Q2 2019 revenue in Q2 of 2021, can use the Alternative Quarter Election to qualify in the second quarter of 2021.
The below illustration demonstrates how the Alternative Quarter Election might function in practice:
|Quarter||2019 Revenue||2020 Revenue||2021 Revenue|
For 2020, the employer in our example qualifies for the first and fourth quarters of 2020 based on the 2020 SDGR test of 50%. (It also qualifies for Q2 2020, for reasons we will explore a bit later — but let’s not get ahead of ourselves.) In 2021, the employer qualifies for all three available quarters. (While Q4 2021 was at one point an eligible ERC quarter, the Infrastructure Investment and Jobs Act repealed Q4 2021 from the ERC program.)
In the first quarter of 2021, the employer’s gross receipts are less than 80% of gross receipts in the corresponding 2019 quarter — so Q1 2021 is an eligible quarter. In Q2 2021, the employer would not qualify under the traditional SDGR test, since gross receipts exceeded 80% of those in the corresponding quarter of 2019. However, because the employer qualified in the immediately preceding quarter, it is eligible for the ERC based on the Alternative Quarter Election rule.
Importantly, using the Alternative Quarter Election in one quarter does not mean an employer cannot return to the traditional SDGR test in the following quarter. As a result, the employer in our example can also qualify in the third quarter of 2021 using the standard SDGR test, as its Q3 2021 gross receipts were less than 80% of those in Q3 2019.
Is the Alternative Quarter Election Rule Available for 2020?
Sort of. While 2020’s ERC is governed by somewhat different rules than 2021’s, a version of the lookback period does exist. Per the IRS FAQs, an employer that suffers a greater than 50% decline in gross receipts in any 2020 calendar quarter qualifies for that quarter as well as all subsequent 2020 quarters unless there is a subsequent 2020 quarter in which gross receipts exceed 80% of those in the corresponding 2019 quarter. The SDGR period ends with the quarter following the quarter with gross receipts in excess of 80% of 2019 levels.
This all may sound rather technical, so let’s return to our example in the chart above. Earlier, we alluded to the fact that the employer in our example qualifies to claim the ERC in Q2 2020 even though its gross receipts of $81,000 exceeded 50% of the corresponding 2019 gross receipts. In fact, Q2 2020 would be eligible even if its gross receipts were $1,000,000 or more! This is because it follows a calendar quarter in which there was a greater than 50% decline in gross receipts, and SDGR eligibility in 2020 only ends with the quarter following a quarter exceeding 80% of 2019 levels.
Furthermore, if we change the facts in the above example to reflect $79,000 of gross receipts in Q2 2020 (rather than $81,000), then all four quarters of 2020 would be eligible. This is because there would be no rebound to 80% of 2019 gross receipts in any 2020 calendar quarter following the >50% decline in Q1. This would hold true even if Q4 2020 gross receipts were higher than those in Q4 2019, since 2020 eligibility does not end until the quarter following the quarter exceeding 80% of gross receipts in the corresponding 2019 quarter.
What Else Do Employers Need to Know About the Alternative Quarter Election?
The 2021 Alternative Quarter Election rule is not limited to using one 2021 quarter to qualify the following 2021 quarter. ERC claimants may also use Q4 2020 to qualify Q1 2021 based on the lookback rules. This is true even if Q4 2020 is itself not an eligible quarter! For example, if Q4 2020 had a 35% decline in gross receipts as compared to Q4 2019, its revenue reduction can qualify Q1 2021 even though Q4 2020 fails to meet the 50% threshold necessary for qualification in 2020! Since Q4 2020 had a >20% reduction, which is the SDGR eligibility threshold for 2021, when applying the lookback rules Q1 2021 can qualify based on Q4 2020’s 35% reduction – even though Q4 2020 itself does not qualify.
Are You Maximizing Your Benefit Under the Employee Retention Credit?
To say that the ERC eligibility rules are complex is an understatement, and many employers – even some who claim the credit – are leaving money on the table. Expert help can ensure your business receives the maximum refund it is entitled to. ERTC Funding has engaged some of the most knowledgeable legal, accounting and tax experts to help businesses of all sizes maximize their ERC eligibility. Take our 60-second quiz to find out if you may qualify for the ERC!