The Internal Revenue Service (IRS) recently updated its FAQs page and released guidance for parties engaging in mergers and acquisitions (M&A) in 2020. Because of the COVID-19 pandemic, businesses took advantage of multiple stimulus programs in the CARES Act in order to keep their doors open. One of the most popular stimulus programs, the Payment Protection Program (PPP), allows taxpayers to take out loans to keep their employees on the business’s payroll. Other businesses took advantage of the Employment Retention Credit (ERC), which entitles a taxpayer to a refundable credit equal to 50% of qualified wages per employee. For the ERC, qualified wages are capped at $10,000 ($5,000 credit) per employee.
Generally, taxpayers that received a loan under the PPP are not eligible for the ERC. If the taxpayer claimed ERC in the past and then took out a PPP loan, the ERCs may need to be recaptured. This poses problems for companies acquiring other firms. For the most part, businesses that are acquiring other firms (Acquirors) took advantage of ERCs because they had sufficient cash flow to keep employees on their payroll. On the other hand, businesses that are being acquired (Targets) usually took advantage of the PPP.
This poses problems in M&A transactions because the ERC uses an aggregation rule, which treats affiliated entities as a single employer. This rule aims to prevent affiliated groups from obtaining both the PPP loan and the ERC. Up until the IRS updated its FAQs page, it was unclear how this aggregation rule would affect M&A. The guidance addresses how Acquirors should treat a Target’s PPP loan for both equity and asset acquisitions.
FAQ 81a addresses how the ERC is affected in an equity acquisition under the aggregation rules when a Target has received a PPP loan.
PPP Loan Fully Satisfied or Escrow Established Pre-Transaction: If the Target has satisfied either of the following requirements prior to the transaction closing date, then the Acquiror’s post-acquisition employer group will not be treated as having received the PPP loan as a result of the transaction.
- The Target has satisfied the PPP loan in accordance with paragraph 1 of the Small Business Administration Notice effective October 2, 2020 (SBA October 2 Notice).
- The Target has 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.
Additionally, if the Acquiror pays wages to the Target’s employee post-closing, it will be able to claim ERCs for those wages, as long as one of the prior requirements is satisfied. The FAQs make it clear that any ERCs claimed by the Acquiror prior to the closing date will not be subject to recapture.
PPP Loan Not Fully Satisfied Nor Escrow Established Pre-Transaction: If the Target company, prior to the closing date, has not fully satisfied the PPP loan or established an escrow account in accordance with paragraphs 1 or 2.a of the SBA October 2 Notice, then the Acquiror will nevertheless not be treated as having received the PPP loan, provided that the Acquiror never received a PPP loan prior to the closing date and no member of the Acquiror’s aggregated group post-closing receives a PPP loan. In this scenario, however, the Acquiror cannot claim an ERC for wages paid to the Target’s employees post-acquisition. The Acquiror will not be subject to ERC recapture for ERC amounts claimed prior to closing or for any ERC claimed on wages paid to its pre-acquisition employees after the closing date.
FAQ 81b addresses how the ERC is affected in asset acquisitions, which depends on whether the Acquiror assumes the PPP loan obligations or not.
No Assumption of PPP Loan Obligations: If the Acquiror does not assume the Target’s PPP loan in an asset acquisition transaction, then the Acquiror will not be treated as having received a PPP loan by virtue of the transaction. The Acquiror will still be eligible for the ERC post-closing and will not be subject to any recapture, as long as it meets the requirements to claim the credit. Additionally, post-closing wages paid to employees being acquired in the asset purchase agreement are eligible for the ERC.
Assumption of PPP Loan Obligations: If the Acquiror assumes the Target’s PPP loan in an asset acquisition transaction, the Acquiror will still generally be able to claim the ERC and will not be treated as having received a PPP loan by virtue of the transaction. However, there is a limitation for wages paid to employees of the Target company post-closing. Specifically, wages paid by the Acquiror post-closing to any individual who was employed by the Target on the closing date shall not be treated as qualified wages and are ineligible for the ERC. The Acquiror can still claim the ERC for wages paid to its employees post-closing and will not be subject to recapture.
This guidance is favorable for most M&A transactions. The FAQs provide parties in a transaction with a high level of flexibility to structure their transactions so that the Acquiror retains its ERC eligibility. Further analysis may be required for hybrid transactions that are structured as a sale of equity but are classified as asset sales under the Internal Revenue Code. Nevertheless, the guidance is welcome and removes on uncertainty regarding M&A transactions slated to close by year-end.