The IRS recently updated their Frequently Asked Questions (FAQs) for the employee retention credit, to update the six following questions:
- 2. Who is an Eligible Employer?
- 18. Are Federal, State or local government entities eligible to receive the Employee Retention Credit?
- 21. Are tribal governments and tribal entities eligible for the Employee Retention Credit?
- 21a. How do the aggregation rules apply to tribal governments and tribal entities?
- 81a. How is eligibility for the Employee Retention Credit affected if an employer acquires the stock or other equity interests of a target employer that had received a Paycheck Protection Program (PPP) loan and, under the aggregation rules, the employers are treated as a single employer as a result of the transaction?
- 81b. How is eligibility for the Employee Retention Credit affected if an employer acquires the assets of an employer that received a Paycheck Protection Program (PPP) loan?
The six updated questions appear to address two main areas, the qualification of Tribal Governments and the treatment of Paycheck Protection Program (PPP) loans in Mergers and Acquisition transactions. This second issue has been a significant concern in some deals recently. Various industry groups, particularly AICPA and ABA asked for additional guidance and, if possible, a reasonable approach for dealing with M&A concerns. The IRS FAQs provide some very taxpayer-favorable responses on these M&A issues.
Mergers and Acquisitions involving entities with Employee Retention Credits and PPP Loans
The new FAQs address the issue of how to determine employee retention credit eligibility for an entity that acquires an employer (or the assets of an employer) that has taken PPP loans. Under the CARES Act, the employee retention credit and PPP loans are mutually exclusive. If a company took a PPP loan, the company is not eligible for the employee retention credit. Importantly, the CARES Act provides that if a company obtains a PPP loan and has already received an Employee Retention Credit, the Employee Retention Credit may have to be ‘recaptured’ by the IRS. Please see our prior coverage here for more information.
In several M&A transactions, a company that did not take a PPP loan and has applied for, or may apply for, an Employee Retention Credit has considered buying a target company but has discovered that the target took a PPP loan. This has raised significant questions about the Employee Retention Credits already applied for or received. Would they have to be recaptured if the buyer purchased a company with a PPP loan? What about vice versa? If the buyer has a PPP loan, is it permitted to buy a company that received an Employee Retention Credit? For how long would this interaction be a problem?
The IRS addresses some of these issues in the new FAQs. The FAQs first speak to the eligibility of an employer that has not taken a PPP loan and either has received or might yet request Employee Retention Credits. This employer later acquires the stock or other equity interests of a target employer that had received a PPP loan.
1. Equity Purchase
a. Where a PPP loan of a target employer is fully satisfied or the target employer has submitted a forgiveness application to the PPP lender and establishes an interest-bearing escrow pre-transaction, the post-transaction aggregated employer group will not be treated as having received a PPP loan. This would actually allow an employer in that aggregated group (including the recently acquired target) to claim the employee retention credit post-closing.
b. Where the PPP loan is not fully satisfied and no escrow is established pre-transaction, the IRS has provided that the new aggregated employer group (other than the acquired employer) would still generally be treated as not having received a PPP loan.
However, the acquired employer that received the PPP loan prior to the transaction closing date would continue to be ineligible for the employee retention credit with regard to any wages paid to any employee of the target employer before or after the closing date.
Further, any Employee Retention Credit claimed by the acquiring employer’s pre-transaction aggregated employer group for qualified wages paid before the closing date will not be subject to recapture under section 2301(l)(3) of the CARES Act.
2. Asset Acquisition
The FAQs also address two types of asset acquisitions, one where the acquiring employer does not assume the PPP loan obligations of the target employer, and another where the acquiring employer assumes the PPP loan obligations of the target employer.
a. In both situations, the acquiring employer will not be treated as having received a PPP loan.
b. Where the acquiring employer assumes the PPP loan obligations, the acquiring employer cannot include wages in an employee retention credit claim paid to any employee that was employed by the target employer on the closing date of the transaction.
As above, any Employee Retention Credit claimed by the acquiring employer’s pre-transaction aggregated employer group for qualified wages paid before the closing date will not be subject to recapture under section 2301(l)(3) of the CARES Act.
Tribal Governments
The guidance on Tribal Governments has been anticipated, as the previous FAQs had only identified Tribal Governments as generally eligible and noted that additional guidance would be forthcoming. The new FAQs provide a very broad definition for establishing that a Tribal Government is carrying on a trade or business, saying:
“… solely for purposes of the Employee Retention Credit, a tribal government is treated as carrying on trade or business activities, and all activities conducted by the tribal government will be considered part of those trade or business activities. In addition, solely for purposes of the Employee Retention Credit, any entity that a tribal government reasonably believes shares the same tax status as the tribal government (tribal entity employer) is treated as carrying on trade or business activities, and all activities conducted by the tribal entity employer will be considered part of those trade or business activities.”
The new FAQs on Tribal Governments also mention the application of the aggregation rules for the purposes of the determining eligibility for the employee retention credit, saying that the general aggregation rules of 52(a) and (b) and 414(m) and (o) apply and that they should be applied using a reasonable, good faith interpretation. This is helpful, but of course leaves many questions about the reasonable application of the aggregation rules.
Key takeaways
The additional guidance on PPP loans is favorable to taxpayers, and the guidance on Tribal Governments establishes that a careful analysis is required for an employee retention credit claim. More guidance is needed, and is hopefully forthcoming on these and other common issues. Regardless, any taxpayer looking to utilize the above FAQs should consult with their tax professional regarding the potential application to an employee retention credit claim.
