What Are the ERC Aggregation Rules for Businesses?

The Employee Retention Credit (ERC) was a tax benefit for businesses that kept employees on payroll during the COVID-19 pandemic. The period to file new claims has ended, with a final deadline of January 31, 2024. The IRS is now processing a backlog of claims with intense scrutiny. For business owners with interests in multiple companies, eligibility required applying aggregation rules that treated certain commonly owned businesses as a single employer to determine if they qualified for the credit.

Defining a Controlled Group for ERC

Businesses with significant overlapping ownership were often combined and treated as one entity under controlled group rules. These rules, found in the Internal Revenue Code, analyze ownership structures to determine if businesses are economically intertwined. The regulations prevented business owners from splitting a larger enterprise into smaller companies to circumvent employee count thresholds or other qualifying factors.

A parent-subsidiary relationship exists when one corporation (the parent) directly owns more than 50% of another corporation’s (the subsidiary’s) stock, based on voting power or value. For instance, if Company A owns 85% of the stock in Company B, they formed a parent-subsidiary controlled group. They were treated as a single employer for the ERC.

A brother-sister controlled group exists if two or more businesses satisfy two tests. The first is the 80% common ownership test, which requires that five or fewer individuals, estates, or trusts own at least 80% of each business in the potential group.

The second requirement is the 50% identical ownership test. The same five or fewer owners from the first test must have identical ownership exceeding 50% of each entity. To calculate an individual’s identical ownership, you use their smallest ownership percentage across all companies being tested. For example, if someone owns 30% of Company X and 40% of Company Y, their identical ownership is 30%. The sum of these identical percentages for all owners must be greater than 50%.

Ownership tests must also consider attribution rules, where ownership can be attributed from one person or entity to another. Family attribution rules can treat an individual as owning stock held by a spouse, child, grandchild, or parent. Similar rules exist for attributing ownership from partnerships, estates, and trusts to their partners or beneficiaries.

A combined group exists when three or more corporations are linked. This involves a parent-subsidiary group where the parent company is also a member of a brother-sister group. All entities in this structure were treated as a single employer.

Understanding Affiliated Service Groups

Affiliated service group regulations also required aggregation for the ERC. These rules apply to service-based businesses, like law or medical firms, that are legally separate but operationally intertwined. The goal was to prevent businesses from splitting functions into separate entities to circumvent certain rules.

The “A-Org” test identifies a group with a First Service Organization (FSO) and another service organization (the A-Org). An FSO’s principal business is performing services. An A-Org is a shareholder or partner in the FSO and regularly performs services for it. For example, if a law firm (FSO) has a partner that is a separate corporation (A-Org) providing paralegal services to the firm, an affiliated service group may exist.

The “B-Org” test does not always require common ownership. A B-Org is an organization whose main function is performing services for an FSO or a related A-Org. These services must be of a type historically performed by employees in that field, and 10% or more of the B-Org must be owned by highly compensated employees of the FSO or A-Org.

For example, a large medical practice (FSO) may have its highly compensated physicians collectively own a separate lab company. If that company provides all lab services for the practice, it could be a B-Org. The ownership by key employees and the nature of the services would likely create an affiliated service group, requiring aggregation.

Impact of Aggregation on ERC Eligibility

After determining that businesses formed an aggregated group, they were treated as a single employer for all ERC eligibility tests. This single-employer treatment could alter whether the group qualified. Qualification was based on either a significant decline in gross receipts or a suspension of operations due to a government order.

For the gross receipts test, all members of the aggregated group had to combine their financial data. The group’s total gross receipts for a calendar quarter were compared to the same quarter in 2019. For 2020, a significant decline meant quarterly gross receipts were less than 50% of 2019’s. For 2021, the threshold was less than 80% of the same 2019 quarter.

The suspension of operations test was also applied at the group level. If a government order caused a full or partial suspension for one member, the entire aggregated group was considered to have a suspension. This allowed an entire group to qualify based on the impact to a single member, even if other members were not directly subject to a shutdown order.

For the suspension test to apply to the whole group, the suspended business activity had to be more than a nominal part of the group’s total operations. IRS guidance defined this as the suspended portion accounting for at least 10% of the group’s total gross receipts or 10% of its total employee hours, compared to the same quarter in 2019.

Calculating the ERC for an Aggregated Group

An aggregated group calculated the credit based on collective employee data. The limit on qualified wages applied across the entire group, not to each member company separately. For 2020, the credit was 50% of up to $10,000 in qualified wages per employee for the year. For 2021, the credit was 70% of up to $10,000 in qualified wages per employee per quarter.

This rule prevented claiming multiple credits on the same employee’s wages if they worked for more than one member company. For example, an employee worked for both Company A and Company B (members of a controlled group) in Q2 2021. If they earned $8,000 from Company A and $6,000 from Company B, their total wages were $14,000, but the group could only use a maximum of $10,000 in qualified wages for that employee.

After calculating the total credit for the group, it was allocated back to the individual member companies. The allocation was done on a pro-rata basis, based on each member’s share of the qualified wages that generated the credit. Using the previous example, of the $10,000 in qualified wages, Company A paid $8,000 and Company B paid $2,000. Company A would be allocated 80% of the ERC from that employee, and Company B would receive 20%.

This allocation method allowed each legal entity to claim its proportional share of the tax credit on its employment tax return, such as Form 941. Proper documentation of these calculations and allocations was necessary to substantiate the claim in an IRS audit.