The IRS has updated their FAQ on the Employee Retention Credit (ERC) added by the CARES Act in March to give guidance when an employer acquires stock or assets of another employer that received a Paycheck Protection Program (PPP) loan.[1]

Under the ERC, no credit may be claimed by an employer who received a PPP program loan, regardless of whether or not the employer sought forgiveness of some or all of the loan. This raises a question about what happens if an employer who did not obtain a PPP loan later acquires an employer who did obtain such a loan. Does that employer and related entities now lose access to the ERC due to having acquired a “tainted” entity?

The new FAQ questions sought to give some guidance on these issues to help clarify matters.

Acquisition of the Equity of an Employer Who Took Out a PPP Loan

The first new question looks at the situation when an entity acquires the stock or equity interests of another entity that had taken out a PPP loan and where the target employer becomes a member of an aggregated group with the acquiring employer under the PPP rules.[2]

The IRS outlines two structures under which the employer is eligible for the ERC on and after the transaction date. The first deals with the case when the acquired employer’s loan is fully satisfied or an escrow was established prior to the transaction:

PPP loan is fully satisfied or escrow established pre-transaction

If the Target Employer had received a PPP loan, but prior to the transaction closing date, the Target Employer fully satisfied the PPP loan in accordance with paragraph 1 of the Small Business Administration Notice effective October 2, 2020 (the SBA October 2 Notice), or submitted a forgiveness application to the PPP lender and established an interest-bearing escrow account in accordance with paragraph 2.a of the SBA October 2 Notice, then, after the closing date, the Aggregated Employer Group will not be treated as having received a PPP loan, provided that the Acquiring Employer (including any member of the Acquiring Employer’s pre-transaction Aggregated Employer Group) had not received a PPP loan before the closing date and no member of the Aggregated Employer Group receives a PPP loan on or after the closing date. In this case, any employer that is a member of the Aggregated Employer Group, including the Target Employer, may claim the Employee Retention Credit for qualified wages paid on and after the closing date, provided that the Aggregated Employer Group otherwise meets the requirements to claim the Employee Retention Credit. In addition, 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.[3]

If the above conditions are not met, the IRS outlines the following method by which the employer continues to be able to claim the credit—but not for amounts paid to the target employer’s employees:

PPP loan is not fully satisfied and no escrow established pre-transaction

If the Target Employer had received a PPP loan, but prior to the transaction closing date, the PPP Loan is not fully satisfied and no escrow account was established in accordance with paragraphs 1 or 2.a of the SBA October 2 Notice, then, after the closing date, the Aggregated Employer Group (other than the Target Employer) will not be treated as having received a PPP loan, provided that the Acquiring Employer (including any member of the Acquiring Employer’s pre-transaction Aggregated Employer Group) had not received a PPP loan before the closing date and no member of the Aggregated Employer Group receives a PPP loan on or after the closing date. Any employer (other than the Target Employer) that is a member of the Aggregated Employer Group may claim the Employee Retention Credit for qualified wages paid on and after the closing date, provided that the Aggregated Employer Group otherwise meets the requirements to claim the Employee Retention Credit. In addition, 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. However, the Target Employer that received the PPP loan prior to the transaction closing date and that continues to be obligated on the PPP loan after the closing date is ineligible for the Employee Retention Credit for any wages paid to any employee of the Target Employer before or after the closing date.[4]

Note that the key difference is that, if the loan was not paid off and no escrow had been established, the acquired entity’s payroll would not qualify for the ERC. But the other members of the group could continue to qualify for the ERC credit.

Acquisition of the Assets of an Employer Who Took Out a PPP Loan

If the acquiring employer acquires the assets, rather than the equity interests, of a target employer, the rules are somewhat different depending on whether the acquiring employer does or does not assume the PPP loan obligations of the target employer.

If the acquiring employer does not assume the PPP loan obligations of the target employer, the following rules apply:

No assumption of PPP loan obligations

An Acquiring Employer that acquires the assets of a Target Employer that had received a PPP loan will not be treated as having received a PPP loan by virtue of the asset acquisition, provided that the Acquiring Employer does not assume the Target Employer’s obligations under the PPP loan. In this case, the Acquiring Employer will be eligible for the Employee Retention Credit after the transaction closing date if the employer otherwise meets the requirements to claim the credit. In addition, any Employee Retention Credit claimed by the Acquiring Employer for qualified wages paid before the closing date will not be subject to recapture under section 2301(l)(3) of the CARES Act.[5]

However, the results are not quite as good for the combined organization if the entity does assume the PPP loan obligations:

Assumption of PPP loan obligations

If, as part of the acquisition of the Target Employer’s assets and liabilities, the Acquiring Employer assumes the Target Employer’s obligations under the PPP loan, then after the transaction closing date, the Acquiring Employer generally will not be treated as having received a PPP loan, provided that the Acquiring Employer had not received a PPP loan before or on or after the closing date; however, the wages that may be treated as qualified wages after the closing date will be limited. Specifically, the wages paid by the Acquiring Employer after the closing date to any individual who was employed by the Target Employer on the closing date shall not be treated as qualified wages. Subject to this limitation, the Acquiring Employer may claim the Employee Retention Credit for qualified wages paid on and after the closing date, provided that the employer otherwise meets the requirements to claim the Employee Retention Credit. In addition, any Employee Retention Credit claimed by the Acquiring Employer for qualified wages paid before the closing date will not be subject to recapture under section 2301(l)(3) of the CARES Act.[6]

If the PPP obligation is assumed by the buyer, the employees of the target will not be allowed to be treated as employees on which the ERC can be claimed.

[1] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, https://www.irs.gov/newsroom/covid-19-related-employee-retention-credits-interaction-with-other-credit-and-relief-provisions-faqs (retrieved November 18, 2020)

[2] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, Question 81a

[3] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, Question 81a

[4] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, Question 81a

[5] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, Question 81b

[6] COVID-19-Related Employee Retention Credits: Interaction with Other Credit and Relief Provisions FAQs, IRS Website, November 16, 2020, Question 81b