Recovery Startup Business definition for ERC

Hi, I've got a question about who can qualify as a "recovery startup business" to claim the Employee Retention Credit.

A recovery startup business is a business that is smaller than $1M in annual gross receipts and "which began carrying on any trade or business after February 15, 2020." They're eligible for the Employee Retention Credit for July-December 2021, although they're limited to $50,000 of credit per quarter.

My question is, what counts as beginning to carry on a business after 2/15/2020?

Scenario 1: Sole proprietorship has been operating since 2019, but they incorporate the business on 7/1/2021 by forming a new corporation. It's the same operation for all practical purposes, but legally it's a brand new entity that started after 2/15/2020. Is this a recovery startup business?

Scenario 2: LLC disregarded entity (Schedule C) has been operating since 2019, but the LLC made an election to the taxed as an S corporation, effective in 2021. I'm thinking that this is not a recovery startup business, because LLC's are not disregarded for payroll tax purposes, and the ERC is a credit against payroll taxes.

Scenario 3: Corporation has been operating with employees since 2019. In 2021, the corporation forms a new LLC disregarded entity, which starts an employee leasing business. The LLC hires employees that worked for the corporation, and then leases those employees back to the corporation. There was no employee leasing business prior to 2/15/2020, so this would be a recovery startup business, right?

This just seems like a tremendous opportunity -- but I wanted to make sure it wasn't just a tremendous opportunity for abuse.

Do I need to tell all my sole proprietorships to form a corporation? (Some sole proprietorships have no employees, but the owner would be an employee if they incorporate.)

Do I need to tell all my business clients to start a new employee leasing business that leases only to their existing business?

It seems like an easy way for existing businesses to reduce payroll taxes by $100k by jumping through a few hoops. I'm not a fan of government handouts, but I do like to reduce taxes paid in using any legal method.

Sec. 3134(c)(5): "The term ‘recovery startup business’ means any employer which began carrying on any trade or business after February 15, 2020..."

So a new corporation or LLC is an employer which began carrying on a business after 2/15/2020, even if the business began under a related but different entity/employer, correct?

So all our existing business clients can fill out some LLC paperwork and get up to $100k in payroll tax credits?

Am I crazy? I can't find anyone else talking about the huge implications of this.

Ok, I’ve been doing some thinking. My potential solution to the question is this: Yes, a new LLC qualifies as a recovery startup business even if it’s taking over business operations from a predecessor, but only if there was a legitimate reason to start the new LLC. To artificially start a new LLC and transfer employees to it for the sole purpose of claiming the ERC would be abusive.

Real life example: We got a new client recently, an LLC Sch. C, that has been in business for a while. We observed that they would do better as an S corp. But the LLC owned a big piece of real estate that we don’t want to be in a corporation, so we didn’t want to just make an S election for the existing LLC. So they’re going to start a new LLC making an S election and transfer all the employees & operations to that, while the real estate remains in the existing LLC disregarded entity (Sch. E self-rental). (Plus there are liability advantages to separating out the real estate.) We will claim the ERC for the new LLC as a recovery startup business.

But we won’t form a new LLC to transfer our staff to it just to claim the ERC.

I don’t want to be like the fraudsters promoting the PPP for fake companies, obviously.

But what bothers me is that this conclusion isn’t actually supported in the code, the way I read it. If Congress didn’t want people to transfer employees to a new LLC to get the ERC, they should have said so. I wish the IRS would come out with a clarification. Any thoughts?

So I was looking at the gross receipts test, and Sec. 3134(c)(5)(B) references Sec. 448(c)(3) for the rules concerning gross receipts, and Sec. 448(c)(3)(D) says that you have to treat predecessors for the business as being part of the calculation for the gross receipts test.

So would you say that because you have to consider predecessors in the Sec. 3134(c)(5)(B) gross receipts test, therefore we also have to consider predecessors in the Sec. 3134(c)(5)(A) business start date test?

So just for the record, I was working on some ERC for some other clients this week, and it hit me: This whole idea is blown out of the water by the aggregation rules. The new business and old business would have to be combined, and they would no longer be a recovery startup business. I don't know why I didn't think of it before.

I think this link will answer some of your questions:

https://twitter.com/danchodan/status/14 ... 7339501572

Wow, thanks, that's some awesome analysis.

So, to summarize, generally the aggregation rules will kill it. But if it's clearly a separate trade or business, with nothing comingled or shared, it should work -- except that your average revenues in 2018-2020 for your existing business (plus the new business if it started in 2020) still have to be under $1 million.

He didn't exactly address my idea of the new business being an employee leasing business. But I'm feeling like, based on his analysis, that would be pretty iffy.