April 11, 2022

Employee Retention Credit Relief Still Available  for Private Equity Portfolio Companies

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As enacted by the CARES Act, the Employee Retention Credit program (ERC) is intended to award those employers who retained employees during the pandemic with a significant refundable tax credit—up to $26,000 per employee. Remarkably, ERC credits often exceed the initial payroll tax liabilities themselves. The ERC has already awarded millions of dollars to a broad spectrum of employers, including Portfolio Companies. Unfortunately, even after subsequent legislation further extended and expanded the ERC—emphasizing the Congressional intent to reward such employers—many Portfolio Companies still do not realize the real cash relief that’s available. Frost Law is working with private equity funds to help their Portfolio Companies receive this well-deserved cash benefit.

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Portfolio Companies—It’s All About the Controlled Group

Remember, the basic definition of “eligible employer” is one who experiences either: (1) fully or partially suspended business operations for any 2020 or 2021 calendar as a result of  governmental orders limiting commerce, travel, or group meetings due to COVID-19, or (2) a significant decline in gross receipts during a calendar quarter in 2020 or 2021.

The first item Portfolio Companies should understand is that an ERC-eligible employer is determined on a controlled group basis. As the IRS more specifically describes this: “An Eligible Employer, for purposes of the Employee Retention Credit, includes all members of an aggregated group that are treated as a single employer in accordance with the provisions of section 2301(d) of the CARES Act.”¹ [Emphasis added]. In other words, if multiple Portfolio Companies are sufficiently related to each other, they may be deemed a “single employer” and aggregated for purposes of, for example, determining whether there was a substantial decline in gross receipts.

Understanding this aggregated treatment makes it easier to see why typical private equity structures—i.e., those arrangements with funds which invest in multiple Portfolio Companies and utilize a separate management company which operates the private equity business itself—stand to benefit substantially from favorable ERC-specific controlled group provisions.

In all cases, though, a careful analysis of the impact is required. A full or partial suspension of any part of the aggregated businesses potentially qualifies all of the aggregated entities. And when comparing gross receipts during a calendar quarter with the corresponding 2019 quarter—all entities would be considered together. While such aggregation effect(s) may beneficially result in a greater number of qualifying employees for the credit, it may also produce a negative result where one aggregated entity suffered economically but another entity thrived. 

ERC Controlled Group Rules

The ERC controlled group rules are applicable to entities that operate a trade or business. This means that, generally, the majority of private equity funds themselves would not qualify as part of the controlled group; however, individual fund owners, must be analyzed to determine whether “ownership” exists to create a parent-subsidiary group or brother-sister group. And when a controlled group does not exist, because there are just so many fund owners, then each portfolio company’s employees and its gross receipts will be separately determined for ERC purposes.

Generally, if a parent-subsidiary or a brother-sister relationship exists, then a controlled group exists. But how do you know if either of these relationships exists?

  • The IRS has clarified that “a parent-subsidiary controlled group of corporations, generally, as one or more chains of corporations where the common parent corporation owns more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the value of all classes of stock of each corporation.”²
  • Where non-corporate entities play a role in the arrangement, the parent-subsidiary group includes only those organizations that operate trades or businesses
  • And according to the IRS, “A brother-sister controlled group of corporations, generally, is two or more corporations where: (1) five or fewer persons who are individuals, estates, or trusts own at least 80 percent of the total combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of each corporation; and (2) the same five or fewer persons, taking into account ownership only to the extent that it is identical with respect to each corporation, own more than 50 percent of the total voting power of all classes of stock entitled to vote, or total value of shares of all classes of stock of each corporation.”³

Simple Example of Portfolio Company’s ERC Eligibility

Consider a private equity firm that has Fund “Pi.”

Pi owns:

  • 70% of Portfolio Company “Ratio” 
  • 90% of Portfolio Company “Forever
  • Forever owns 100% of Portfolio Company “Math”
  • Forever owns 100% of Portfolio Company “Equations”

🡪Assume that each of the Portfolio Companies (Ratio, Forever, Math, and Equations) averaged 50 employees during 2019.

🡪The Private Equity Management Company is owned by Jack and Jill. Jack owns 35% of the Management Company, and Jill owns 35%. The remaining ownership is in the hands of various owners, each with 2% or less interest.

🡪Jack and Jill and all other management firm owners also own interests in Fund Pi, but no individual owns more than 2% of Fund Pi.

🡪Portfolio Companies Math is subject to a pandemic-related governmental order which suspends operations, but no other Portfolio Company is subject to such order.

🡪For purposes of this example, only the first quarter of 2021 is considered.

What are the key relationships found in this arrangement and what does it all mean?

  1. A parent-subsidiary controlled group relationship exists for Forever and Math, because Forever owns all of Math (i.e., more than 50%). Remember, even if one of the entities was a non-corporate entity, the result would be the same so long as Forever and Math operate a trade or business
  2. A parent-subsidiary controlled group relationship exists for Forever and Equations, because Forever owns all of Equations (i.e., more than 50%). 
  3. Portfolio Companies Equations and Math exist in a brother-sister controlled group relationship.
  4. Portfolio Companies Forever, Math and Equations all comprise a controlled group for ERC purposes.
  5. Neither Portfolio Company Ratio nor Portfolio Company Forever have a parent-subsidiary controlled group relationship with Fund Pi, because Fund Pi is not in a trade or business.
  6. Portfolio Companies Ratio and Forever would not have a brother-sister relationship, because there are not five or fewer individuals, accounting for the more than 50 owners of Fund Pi, that would own 50% of either Portfolio Company Ratio or the parent-subsidiary groups of Portfolio Companies Forever, Math, and Equations.

What this means, is that since Portfolio Companies Forever, Math and Equations are in parent-subsidiary (and/or a brother-sister) relationships, the aggregation rules will apply such that they are deemed a single employer. Thus, and Portfolio Companies Forever and Equations will be treated as subject to the suspension of operations which Portfolio Company Math actually experienced. 

Result: Each employer, Portfolio Companies Forever, Equations and Math would qualify for $350,000 per employer (50 employees x (70% x $10,000)). The total ERC for all three of these employers would be $1,050,000. 

Conclusion

The ERC remains available now—even for eligible Portfolio Companies. Numerous government orders restricted a broad range of ordinary business operations in the industry—and you may be one of many employers entitled to substantial cash benefits. The time to be analyzing ERC eligibility for Portfolio Companies is now—and we can help you maximize the benefits that may be available to you.

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