The Employee Retention Credit (ERC), also known as ERC credit or ERC tax credit, has proven to be one of the most lucrative incentives currently available to aerospace companies, though many companies are unaware of the potential cash benefit they could receive.
Given the substantial downturn in air travel during the COVID-19 pandemic, many aerospace companies could be eligible for the credit. Learn the eligibility requirements and benefits of the credit as detailed below.
How the ERC Credit Can Help Recovery for the Aerospace Industry
The ERC presents an opportunity for many companies to accelerate recovery.
Cash generated from the credit can be used to expand business operations, refine processes, and invest in the future adaptability of the business. The ERC can also help aerospace companies position themselves to weather future challenges during recovery.
What Are the Benefits of the ERC?
The ERC is well timed to assist with economic recovery, given that the tax credit increased from a maximum of $5,000 per employee per year for 2020 to a maximum of $7,000 per employee per qualified quarter in 2021.
The ERC can provide companies that are eligible for the federal tax credit with additional cash flow to broaden strategic horizons, including up to $26,000 per employee. Credits of over $1 million per eligible quarter are even common for companies with as few as 150 employees.
Credits are also fully refundable, even if the company has tax losses, and can be taken in addition to the Paycheck Protection Program (PPP) and other incentives.
Aerospace Business ERC Credit Eligibility Requirements
To qualify for the ERC, aerospace and defense companies must have experienced a significant decrease in revenue in a quarter within 2020 or 2021 compared with the same quarter in 2019. Many aerospace companies experienced this revenue decrease, due to the pandemic-induced pause in air travel.
How Can You Tell if Your Aerospace Company Is Eligible for the ERC?
For your company to qualify:
- Revenue reduction must be at least 50% for 2020 quarters.
- Revenue reduction must be 20% for quarters in 2021.
- All quarters must be compared with the equivalent quarter in 2019.
Additional approaches can be used to determine eligibility and continued eligibility in each quarter.
Companies that experienced a full or partial suspension due to emergency orders from a government authority that limited commerce, travel, or group meetings may qualify. However, most aerospace companies are considered essential businesses and thus were generally not subject to any such suspensions, with some possible exceptions.
ERC Employee Requirements
The ERC primarily means to provide the most help to small and midsized businesses. Therefore, there are limitations surrounding the average number of full-time employees for the 2019 calendar year.
Employee Requirements for the ERC in 2020
Businesses with 100 or fewer full-time employees can apply the credit to wages for all employees, including those who weren’t performing services.
Employee Requirements for the ERC in 2021
Businesses with 500 or fewer full-time employees can apply the credit to wages for all employees, including those who weren’t performing services.
The full-time employee count is measured based on the 2019 calendar-year period.
Companies using professional employer organizations (PEO) can still claim the credit. However, the use of a PEO can add complexity to the process.
There can be significant nuances in determining if an aerospace company meets or exceeds these 2019 full-time employee thresholds. The process generally requires professional analysis to ensure the correct count of full-time employees has been determined.
ERC Limitations and Considerations Relevant to Aerospace
Companies exploring the ERC need to be aware of the following considerations:
- Complex controlled group rules
- Interplay with other state and federal tax credits
- ERC accounting implications
- Audits of ERC claims
ERC Credit and Complex Controlled Group Rules
Controlled group rules apply to both the revenue decrease requirements and to the count of 2019 full-time employees. These rules require consolidation of the revenue and employee counts for certain parent and subsidiary companies as well as brother-sister entities that have a certain level of common ownership. Both of these scenarios are common among aerospace companies.
Aerospace companies with international operations face additional complexities with opaque guidelines. Generally, such companies only need to include domestic employees in their employee count. In certain situations, revenue associated with related foreign entities may need to be included in the eligibility analysis.
Further ERC Considerations for Private Equity Firms
While many midsized aerospace companies are owned by private equity (PE) firms, it’s important to note that this generally doesn’t lead to complications with the controlled group requirements.
PE firms don’t typically own their portfolio companies. Instead, those companies are usually part of a widely held fund, which therefore doesn’t require consolidation among portfolio companies.
ERC Credit Interplay with Other Tax Credits
Another consideration relevant to aerospace businesses is the interplay with other state and federal tax credits.
Aerospace companies often use other wage-based tax incentives such as the R&D tax credit and, to a lesser extent, the Work Opportunity Tax Credit.
Provisions within the ERC rules require that the same wages used in the R&D credit can’t be used for the ERC for the 2021 tax year. Therefore, wages used to calculate the ERC must be backed out of the R&D credit calculation.
Fortunately, this tends to have a minimal impact on the R&D credit since various strategies exist to help minimize the adjustment to R&D credit wages.
Other Accounting Implications for ERC Credits
The ERC carries with it a multitude of other technical accounting implications.
The ERC is effectively taxable, for federal income tax purposes, in the tax year the quarter falls. While the credit amount isn’t considered taxable income, the taxpayer is required to forgo labor deductions in the amount of the credit, therefore making it taxable.
Generally, no adjustments need to be made for state purposes. Properly accounting for the credit from a GAAP perspective will depend on several factors specific to each company.
Auditing of ERC Credits
Contemporaneous documentation of ERCs at the time of filing strengthens the claim for internal and external audit purposes.
As of May 26, 2022, the IRS hasn’t started significant audit activity around ERC credit claims, but it’s expected to begin auditing these filings. In the interim, many companies are engaging external financial statement auditors to examine their ERC claims to assess whether they’re materially accurate and well documented in preparation for possible IRS examination.
This is done to assess whether a contingent liability or a reserve needs to be booked to offset the credit or if other financial statement disclosures are needed.
What Does an ERC Credit Audit Check?
External financial statement auditors have been primarily assessing the validity of the following aspects of ERC claims in anticipation of IRS audits focusing on these same core issues.
- Eligibility, in light of potential controlled groups
- Employee count considerations, in light of potential controlled groups
- Wage qualifications
- Adherence to ERC credit procedures
Coordination with other CARES Act provisions
We’re Here to Help
To learn more about how your aerospace or defense business can pursue the ERC and other tax credits, contact your Moss Adams professional.
You can also find further insights at our Aerospace & Defense Practice and Tax Credits & Incentives Services.