How Private Equity Funds May Positively Impact EBITDA with the Employee Retention Credit
BDO offers a look at what PE firms need to know about the Employe Retention Credit
Private equity (PE) funds typically do not consider tax planning an effective strategy for boosting portfolio company earnings before interest, taxes, depreciation, and amortization (EBITDA).
This is because realized tax benefits and the accompanying tax planning expenses generally do not positively impact EBITDA, thus causing an unintended impact on this critical metric used to evaluate a company’s operating performance. However, the federal employee retention credit (ERC) may positively impact EBITDA, and in addition, the nonrecurring fee paid to support the credit may qualify as an EBITDA add- back.
Specifically, PE funds looking to maximize financial performance may generate cash by claiming the recently enhanced ERC for eligible portfolio companies. The ERC is a refundable payroll tax credit first introduced as part of the Coronavirus Aid, Relief, and Economic Security Act, commonly referred to as the CARES Act, that provides employers a credit up to $26,000 per employee for qualified wages paid to employees after March 12, 2020, and before September 30, 2021.1 Although Congress does not permit taxpayers to claim the ERC for calendar year 2022, PE funds may still claim the credit for these prior years on behalf of their eligible portfolio companies.
The ERC is one of many tax credits and incentives offered by federal, state, local and non-U.S. governments. BDO helps organizations identify, negotiate and secure tax credits and incentives — including retroactive and future opportunities — to minimize total tax liability and increase cash flow.
Many portfolio companies have been able to avoid reporting a financial loss during the pandemic by claiming the ERC. For example, an eligible company with 40 employees could receive over $1 million in retention credit and would not need to report a federal income tax liability to qualify. While the ERC may provide PE funds substantial benefit, navigating the qualification and calculation considerations for PE portfolio companies can be complex
ERC Benefit & Eligibility Requirements
PE companies must carefully evaluate the ERC eligibility requirements before determining whether and to what extent they qualify for the credit. To determine eligibility for the ERC, an employer must be able to demonstrate either: (i) its operations were fully or partially suspended as a result of a governmental order related to COVID-19 (the government order test); or (ii) it incurred a significant decline in gross receipts (the gross receipts test). Notably, qualified wages are calculated differently for 2020 and 2021 and may also be subject to a facts-and-circumstances evaluation to determine the total ERC benefit available to a portfolio company.
Maximizing EBITDA
While the ERC may provide significant opportunities for PE portfolio companies, a nuanced and complicated analysis is necessary to evaluate whether the governmental order test or the gross receipts test is met and, ultimately, the amount of a proper ERC claim. This article does not address every potential situation and factor to be considered and, therefore, PE portfolio companies should seek professional guidance. Specialized tax advisors have developed significant expertise working with PE funds and their portfolio companies to identify and document ERCs in a manner that helps maximize EBITDA, net income, and free cash flow.
BDO’s ERC Calculator makes it easy to find out if you qualify for the credit, and if so, by how much. Click here to calculate your benefit.
Contact
David Wong
Partner and Business Incentives & Tax Credits National Practice Leader
dwong@bdo.com
