When does a tax-exempt organization qualify for the ERC under the controlled-group rules?

To be eligible for the employee retention credit (ERC), a tax-exempt organization must apply a reasonable, good-faith interpretation of the controlled-group rules under Sec. 52, and that interpretation must be applied consistently throughout the Internal Revenue Code. The application of Regs. Sec. 1.414(c)- 5(b) meets this reasonable, good-faith interpretation in determining a tax-exempt organization’s eligibility for the ERC, according to the IRS Chief Counsel’s Office in a Chief Counsel Advice (CCA) memorandum.

Facts: Employer X, as the subject of the CCA memo is identified, is a tax-exempt organization under Sec. 501(c)(3). The organization is also an affiliate of a national organization and is a subordinate organization in a group exemption letter held by the national organization. Both Employer X and the national organization are managed by their own board of directors. Employer X functions under the direction of a CEO who is appointed by and reports to Employer X’s board of directors. Employer X’s directors, pursuant to its bylaws, are able to appoint or remove any director and designate a new one.

Employer X asserts that it is independent of the national organization since it has its own employer identification number and is managed by its own board of directors. Also, none of the directors of the national organization serve on Employer X’s board, and the national organization does not have the general power to appoint or remove any of Employer X’s directors. They also cannot designate any new directors to Employer X’s board.

In addition, no director of Employer X is an agent or serves on the board of the national organization, nor do they have the general power to appoint or remove any director or designate a new director to the national organization’s board. Also, no director of the national organization is an agent or employee of Employer X.

Employer X contends that it should not be aggregated with the national organization under Sec. 52 in determining its eligibility for and the amount of the ERC, which it claimed for the third calendar quarter of 2020.

The Chief Counsel’s Office, in the alternative, determined what would happen if all the facts above remained the same except that the national organization had the general power to remove or appoint three of the five directors (60%) of Employer X’s board.

Discussion: The ERC, as provided in Section 2301 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116- 136, and amended by the Consolidated Appropriations Act (CAA), 2021, P.L. 116-260, could be applied against applicable employment taxes for an eligible employer, including a tax-exempt organization, for qualified wages paid to some or all of its employees after March 12, 2020, and before Jan. 1, 2021. For calendar quarters in 2020, an employer qualified as an eligible employer if it carried on a trade or business for which the operation of the business was fully or partially suspended due to an appropriate governmental order limiting commerce, travel, or group meetings or there was a significant decline in gross receipts that began with the first calendar quarter for which gross receipts were less than 50% of gross receipts for the same calendar quarter in 2019, the CCA memo stated.

An organization that is tax-exempt under Sec. 501(a) is deemed to be engaged in a trade or business for purposes of the ERC (Notice 2021-20). The full or partial suspension of a tax-exempt organization’s operations due to a governmental order applies to all its operations.

The credit, for calendar quarters in 2020, equaled 50% of qualified wages for each employee for each applicable quarter, limited to $10,000 of qualified wages per employee for all calendar quarters. With respect to a large eligible employer, which is an employer that averaged more than 100 full-time employees in 2019, qualified wages are those wages paid where an employee was not providing services due to a full or partial suspension of operations due to a governmental order or where there was a significant decline in gross receipts. For eligible small employers, qualified wages are those wages with respect to an employee during a period in which the trade or business operation was fully or partially suspended due to a governmental order or where there was a significant decline in gross receipts.

All organizations that are members of a controlled group (Sec. 52(a) or (b)), members of an affiliated service group (Sec. 414(m)), or employers that are aggregated under Sec. 414(o) are treated as a single employer in determining their eligibility for and amount of the ERC, which applies to all calendar quarters in which the ERC under Section 2301 of the CARES Act or Sec. 3134 can be claimed.

Employers required to be aggregated are treated as a single employer for the ERC in determining whether a trade or business was fully or partially suspended by an appropriate order from a governmental authority, had a significant decline in gross receipts, was a large employer, and in determining the maximum credit amount per employee.

Secs. 52(a) and (b) and 414(b) and (c) provide controlled-group rules for parent-subsidiary, brother-sister, and controlled groups. Generally, corporations of a controlled group are treated as a single employer (Secs. 52(a) and 414(b)).

Even though Sec. 52 applies to tax-exempt organizations in determining eligibility for the ERC, the regulations do not address the application of the controlled-group rules for these organizations. However, Sec. 414 sets forth rules for controlled groups that are substantially the same as the rules under Sec. 52 applicable to “certain tax-exempt organizations” (see Regs. Sec. 1.414(c)-5(a)).

Regs. Sec. 1.414(c)-5(b) provides that common control exists between a tax-exempt organization and another organization if at least 80% of the directors or trustees of one organization are representatives of or directly or indirectly controlled by the other organization. Since regulations have not been issued on how Sec. 52 applies to tax-exempt organizations, these organizations must apply a reasonable, good-faith interpretation of the controlled-group rules in determining if they are eligible for the ERC. Applying Regs. Sec. 1.414(c)-5(b), modified by substituting “more than 50 percent” in place of “at least 80 percent” would be treated, according to the Office of Chief Counsel, as a reasonable, good-faith interpretation of the controlled-group rules in determining a tax-exempt organization’s eligibility for the ERC.

Conclusion: Since Employer X and the national organization are not members of a controlled group under Sec. 52, they are not required to be aggregated in determining the eligibility for and amount of the ERC, the CCA memo stated, assuming that the application of the controlled-group rules is applied on a consistent basis for all purposes under the Code.

Applying the alternative facts, Employer X’s assertion that it is not a member of a controlled group would not be a reasonable, good-faith interpretation of the controlled-group rules, since the national organization would have the general power to remove or designate more than 50%, in this case 60%, of the board of directors. In this situation, Employer X and the national organization would be required to be aggregated as members of a controlled group under Sec. 52 in determining their eligibility for the ERC.

■ CCA Memorandum 202430007

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business, and Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy, both at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor.