Employee Retention Credit (ERC) for Portfolio Companies
With the passage of the Consolidated Appropriations Act 2021, the Employee Retention Credit (“ERC”) was significantly expanded to provide a credit for all wages up to $10,000, per person per quarter, for the first and second quarters of 2021, as long as the eligible employer employed an average of 500 or fewer employees in 2019. An eligible employer is determined on a controlled group basis.
The specific controlled group rules that apply to the ERC include favorable provisions for typical private equity structures: Arrangements with funds investing in various portfolio companies and a separate management company that operates the private equity business. This article describes those rules, which are important not only for determining whether a business employs an average of 500 or fewer employees, but also whether a business’s gross receipts have declined by more than 20 percent.
The ERC controlled group rules apply to corporations and other types of entities if those other entities are operating a trade or business. Thus, most private equity funds would not be included as part of the controlled group. The individual owners of that fund, however, need to be considered to determine whether ownership is such that a parent subsidiary group or brother sister group exists. In most cases, there are so many fund owners that a controlled group does not exist and each portfolio company’s employees and gross receipts are separately determined for the ERC tests.
In general under these rules, a controlled group exists if there is a parent-subsidiary relationship or a brother sister relationship. A parent-subsidiary group of corporations exist when a corporate entity owns more than 50 percent of another corporate entity. If there are non-corporate entities involved, the parent-subsidiary group includes only those organizations that operate trades or businesses. A brother-sister group exists when the same five or fewer persons who are individuals, estates or trusts own more than 50 percent of two trades or businesses (including partnerships), taking into account only ownership that is identical with respect to such entity. In addition, the entities cannot be an affiliated service group or management organization under the IRC Section, 414(m) rules, the same rules that apply to determine related entities for qualified retirement plan discrimination testing.
Example: A private equity firm has two funds, Fund I and Fund II.
- Fund I owns 75 percent of Portfolio Company A and 85 percent of Portfolio Company B
- Portfolio Company B owns 100 percent of Portfolio Company C
- Fund II owns 90 percent of Portfolio Company D and 65 percent of Portfolio Company E.
- Assume each portfolio company had an average of 300 employees in 2019.
- The private equity management company is owned 40 percent by X and 30 percent by Y, with the remainder owned by others with no more than a five percent interest, totaling 30 percent.
- X, Y and the other management firm members own interests in each of the funds, but no one person owns more than two percent of either fund.
In this example, Portfolio Company B and Portfolio Company C would be a parent-subsidiary controlled group, because Portfolio Company B owns 100 percent of Portfolio Company C. This result would be the same if one of the entities was a non-corporate entity since they both operate a trade or business. Portfolio Company A and Portfolio Company B would not be a parent subsidiary group with Fund I since Fund I is not in a trade or business. In addition, A and B would not be a brother sister organization, because there are not five or fewer individuals, taking into account the more than 50 owners of Fund 1, that would own 50 percent of either Portfolio Company A or the parent subsidiary group of Portfolio Companies B and C. Fund II would not have any parent-subsidiary controlled group since Fund II is not operating a trade or business or brother-sister controlled group because there are not five or fewer individuals who own more than 50 percent indirectly of Company D or E. Assuming none of these organizations are service organizations (groups of professionals such as doctors, dentists, engineers, architects, etc.) or organizations the principal purpose of which is management, there would be no controlled group as an affiliated service group or management organization.
If every member of this group of portfolio companies was an eligible employer, because it experiences a greater than 20 percent decline in gross receipts comparing the first quarter of 2021 with the first quarter of 2019, then a refundable employee retention credit of $12,600,000 is available for A, D and E. In addition, the B and C group could claim a credit for wages and allocable health care benefits for individuals who are not performing services. It would also be important to review 2020 facts to determine if there are additional credits there. The refundable credits can be claimed by reducing employment tax deposits currently, providing immediate cash flow to the entities.
This conclusion depends on proper application of the controlled group rules and the ability to be an Eligible Employer for purposes of the ERC. With gross receipts determined on a cash basis, entities may be able to manage cash flow in the remainder of the first quarter of 2021 to become an eligible employer.
Now is the time to be making this analysis. The professionals at Cherry Bekaert LLP are ready to help you maximize the benefits available to you.
 In general, the ERC is available to eligible employers. For 2021, an eligible employer is one who experiences either 1) a partial or full suspension of operations due to a federal, state or local government order limiting operations due to COVID or 2) a decline in gross receipts of at least 20 percent, determined on a cash basis, when comparing the operations in the first or second quarter of 2021 with the same quarter of 2019 or the fourth quarter of 2020 with the fourth quarter of 2019.
 Each of A, D and E would be entitled to $2,100,000 (300 employees times $10,000 in wages paid during the quarter times 70 percent) for both the first and second quarter. B and C would be entitled to a credit based on wages and allocable health care costs paid to employees who are not rendering services.