How Private Equity Funds Can Leverage the Employee Retention Credit
Private equity (PE) funds looking to maximize their return on investment (ROI) may generate cash by claiming the recently enhanced employee retention credit (ERC) for their eligible portfolio companies. The ERC is a refundable tax credit first introduced as part of 2020’s CARES Act that provides employers a credit up to $33,000 per employee for “qualified wages.”
An eligible portfolio company with 31 employees, for example, could receive over $1 million from the U.S. Treasury for its ERC, whether it has any federal income tax liability or not.
While the ERC may be lucrative, navigating the qualification and calculation considerations for PE portfolio companies can be complex. Below we summarize ERC eligibility requirements and benefits and provide insight into the various considerations PE firms and portfolio companies should evaluate as they determine whether and to what extent they qualify for the credit.
To be eligible for the ERC, an employer must either demonstrate that a) its operations were fully or partially suspended due to a governmental order related to COVID-19 or b) it incurred a decline in gross receipts based on specific thresholds set for 2020 and/or 2021.
To determine employer eligibility, all entities that are treated as a single employer under the IRC controlled group rules or are otherwise aggregated are considered one employer for purposes of the ERC rules. Due to the ownership structures of PE portfolio companies, special considerations must be evaluated on a facts-and-circumstances basis to determine whether other portfolio companies directly or indirectly owned or controlled by the fund may need to be considered in determining eligibility for the ERC.
The ERC is calculated differently for 2020 and 2021. For each of these calendar years, the ERC equals a percentage of up to $10,000 of “qualified wage” and allocable health plan expenditures paid to employees during the eligibility periods, namely, March 13, 2020 to December 31, 2020 and January 1, 2021 to December 31, 2021 (“qualified ERC costs”). The amount of the ERC allowed for each employee is capped as shown below.
|% of Qualified ERC Costs||Cap Per Employee|
The definition of “qualified wages” for ERC purposes depends on the employer’s average headcount in 2019 and varies for the 2020 and 2021 ERC calculation.
To determine the number of full-time employees, PE portfolio companies should consult with their tax advisor or MFA to determine which aggregation considerations may apply. Depending on each portfolio company’s relationship with its PE sponsor, a facts-and-circumstances evaluation will determine whether the portfolio company may or may not have to include employees of other portfolio companies under common control by the fund in its full-time employee count. This is important if a portfolio company’s full-time employee count is under 100 or 500 in 2019 when calculating its ERC for 2020 and 2021 but aggregating additional employees of portfolio companies under common control by the fund could increase the count above the 100 and 500 full-time employee thresholds, requiring a different calculating methodology to determine qualified wages.
The employee retention credit may provide significant opportunities for your fund or company. Evaluating whether and when the government order or gross receipts test is met or the aggregation rules apply, what wage and health-plan expenses qualify, and the amount of the ERC requires a nuanced and complicated analysis. This article does not address every potential situation and factor to be considered, and professional advice may be needed. Please connect with us to review your unique circumstances.
Material discussed in this communication is meant to provide general information and should not be acted on without obtaining professional advice tailored to you or your company’s individual and specific needs. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used by any person or entity, for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This information is for general guidance only and is not a substitute for professional advice.
The information contained herein should not be construed as personalized investment advice. Investment in securities involves the risk of loss, and past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this document will come to pass. Historical performance results for investment indexes and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. There can be no assurances that your portfolio will match or outperform any particular benchmark.
Information presented is believed to be factual and up-to-date; however, MFA makes no guarantee as to accuracy, completeness, suitability, or validity of any information within this communication and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages from its display or use. Any forward-looking statements are believed to be reasonable; however, MFA gives no assurance that such expectations will prove to be correct.