The IRS recently clarified eligibility for the employee retention credit after an Acquiring Employer acquires a Target Employer that received a Paycheck Protection Program (PPP) loan. In most circumstances, the Acquiring Employer’s group and its members remain eligible for the credit, but in some circumstances, the Target Employer remains ineligible.
How PPP Loans and the Employee Retention Credit Work
PPP loans and the employee retention credit were both enacted by the Coronavirus Aid, Relief, and Economic Relief (CARES) Act of 2020. Both are intended to help small businesses and their employees cope with the business and economic impacts of the COVID-19 pandemic.
PPP loans are made by private lenders, but they are fully guaranteed by the Small Business Administration. Repayment is forgiven if the borrower uses the loan proceeds to pay payroll, mortgage or rent, and utility costs.
The employee retention credit is a refundable credit of up to $5,000 for each full-time employee that a qualified employer continues to pay after:
- the employer is ordered to fully or partially shut down, or
- the employer’s quarterly gross receipts fall below 50% of its receipts for the same quarter in 2019.
The employer claims the credit against its quarterly employment taxes. Any excess credit is fully refundable, but any erroneous refund may have to be recaptured as an additional employment tax liability.
An employer that takes a PPP loan generally cannot claim the employee retention credit unless the loan is repaid by May 19, 2020.
Employee Retention Credit After Acquisition of PPP Borrower’s Assets
The rules for coordinating PPP loans, the employee retention credit and business acquisitions are simplest if the Acquiring Employer acquires the assets of the Target Employer. In that case:
- The Acquiring Employer remains eligible for the employee retention credit after the acquisition (assuming it meets the other credit requirements), and
- Its credit for qualified wages paid before the acquisition is not subject to recapture.
However, if the Acquiring Employer assumes the Target Employer’s PPP loan obligation, the employer retention credit does not apply to any wages the Acquiring Employer pays after the acquisition to a worker who was employed by the Target Employer on the acquisition date.
Employee Retention Credit After Acquisition of PPP Loan Borrower’s Stock
Similar rules apply when:
- the Acquiring Employer acquires stock or another equity interest in the Target Employer, and
- under the aggregation rules, the Target Employer becomes a member of an aggregated group with the Acquiring Employer that is treated as a single employer.
Thus, the members of the Acquiring Employer’s aggregated group generally retain their eligibility for the employee retention credit, and they do not have to recapture any credit for their pre-acquisition wages.
However, the effect of the acquisition on the Target Employer’s eligibility for the credit depends on whether the Target Employer repaid the PPP loan or established an escrow account.
Loan Repaid or Escrow Account Established
Members of the aggregated employer group generally retain their eligibility for the employee retention credit if, before the acquisition closing date, the Target Employer:
- fully satisfied the PPP loan, or
- submitted a forgiveness application to the PPP lender and established an interest-bearing escrow account in accordance with Small Business Administration (SBA) procedures.
In this case, after the closing date the Aggregated Employer Group is not treated as having received a PPP loan if:
- the Acquiring Employer (including any member of its pre-transaction aggregated employer group) did not receive a PPP loan before the closing date, and
- no member of the Aggregated Employer Group receives a PPP loan on or after the closing date.
When these conditions are satisfied, any employer that is a member of the aggregated employer group, including the Target Employer, may claim the employee retention credit for qualified wages paid on and after the closing date, as long as that employer is otherwise eligible for the credit.
And, as mentioned above, any employee retention credit claimed by the Acquiring Employer’s pre-transaction aggregated employer group for qualified wages paid before the closing date is not subject to recapture.
No Loan Repayment or Escrow Account
If the Target Employer has not repaid the PPP loan or established an escrow account before the acquisition closing date, only the Target Employer is treated as having received the PPP loan. Thus, the aggregated employer group (other than the Target Employer) is still eligible for the employee retention credit if:
- the aggregated group, including any member of the pre-acquisition group, did not receive a PPP before the acquisition, and
- no member of the group receives a PPP loan after the acquisition.
Thus, any employer (other than the Target Employer) in the group may claim the employee retention credit for qualified wages paid on and after the date the acquisition closes if that employer otherwise qualifies for the credit. In addition, any credit claimed by the Acquiring Employer’s pre-transaction group for qualified wages paid before the closing date is not subject to recapture.
However, the Target Employer that received the PPP loan and remains obligated to repay it is ineligible for the credit for wages paid before or after the acquisition.
Acquisition Rules are a Generous Application of Generous Programs
PPP loans and the refundable employee retention credit are both unusually generous programs. The IRS approach to continued eligibility for the credit after an acquisition of a PPP borrower is similarly generous, and likely to be just as welcomed by affected taxpayers.
By Kelley Wolf, J.D. LL.M.