Employee Retention Tax Credit

Financial Statement Presentation of Government Grants

Our last blog, dated December 21, 2021, made mention of the employee retention tax credit (“ERTC”). This tax credit originated from no less than three separate acts of Congress over a twenty-one-month period in 2020 and 2021. The legislative purpose was to provide economic assistance to entities suffering from the COVID-19 pandemic. While this series of laws tended to make the ERTC more generous, it also added much confusion and complexity. Not a big surprise when it comes to such a widespread government program.

The structure of the ERTC was to provide refundable payroll tax credits to entities as an incentive to retain employees during the pandemic. The entity obtained the credit by incurring qualifying payroll expenses and certain health insurance costs. The credit could be taken as an advance on IRS Form 7200 or credit on either a timely filed IRS Form 941 or amended IRS Form 941-X. Like most legislation, the aim was noble, but the practical application became complex.

This blog, however, will not discuss how to navigate the complexity of obtaining the ERTC. That is pretty much history now, since the program ended September 30, 2021, for most business entities. (Certain “Recovery Startup Businesses” remained eligible for the credit through December 31, 2021). So instead, we will briefly describe the possible approaches for the accounting and financial statement presentation of the ERTC available to a for-profit business entity.

A Little Related History First. The choices available for financial accounting and presentation of the ERTC may be limited to the company’s financial statement election made under the Paycheck Protection Program (“PPP”). There were four methods available to account for the government funding received under the PPP. Those methods were as follows:

  1. As debt under FASB ASC 470-Debt,
  2. By analogy to International Accounting Standard 20, Accounting for Government Grants and Disclosure of Government Assistance (“IAS 20”),
  3. By analogy to the not-for-profit model (“NFP model”) described in FASB ASC 958-605-25-13,
  4. By analogy to the gain contingency recognition model presented in FASB ASC 450-30.

Two Scenarios.

Suppose the business entity previously applied for a PPP loan and elected to account for the loan as a grant under IAS 20. How should the entity subsequently account for the ERTC?

  • Since the entity had selected, as an accounting principle, to account for government grants by analogy under IAS 20, then all subsequent governmental grants (i.e., the ERTC) must consistently be accounted for the same way.
  • The same would be true if the entity had previously chosen to account for the PPP loan under the NFP model or by analogy to the gain contingency model. Those would be accounting elections that the entity should consistently follow for similar governmental grants from period to period.

But, on the other hand, suppose the business entity previously applied for a PPP loan and elected to account for the loan as debt under FASB ASC 470. Or, what if the business entity did not make an application and therefore did not receive government assistance under the PPP. In those two cases, how should the entity account for the ERTC?

  • Since the ERTC is a refundable tax credit and not a loan, the treatment as debt is not available.
  • The ERTC cannot be accounted for under FASB ASC 740, Income Taxes, because the credit applies to payroll taxes, not income taxes.
  • Therefore, the entity would be free to elect any of the remaining three options as described 2,3, or 4 above.

The Three Methods to Account for ERTC.

  1. IAS 20 Model. If the company estimates that it is probable it will meet the conditions contained in the grant, and the ERTC will be received, it may account for the ERTC under the IAS 20 model. Bear in mind, though, that the likelihood that the conditions of the law will be met must meet the probable threshold under GAAP, a high bar to reach. The standards define “probable” as a future event or events that are likely to occur. While no percentage threshold is given in authoritative accounting standards, in practice, many CPAs consider a 75% or greater likelihood of occurrence as necessary to meet the probable requirement.

    If the probable threshold is met, the entity would recognize the tax credits as income” on a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate.”

    Under IAS 20, the ERTC is presented in the statement of income as either: 1) A separate caption or under a general caption such as Other Income, or 2) as a reduction to the related expenses.

    Generally, U.S. GAAP does not permit the netting of income against the related expense. Accordingly, we expect that most companies who choose the IAS 20 model would elect to present ERTC income as either a separate caption or under a general caption such as Other Income, as described above.

    If all or a portion of the previously recognized income is deemed repayable in a subsequent accounting period, it will be accounted for prospectively as a change in estimate.

  2. NFP Model. Suppose a business entity anticipates complying with the eligibility criteria and expects to receive the ERTC. Another acceptable approach would be, by analogy, to follow the not-for-profit model. Under the NFP model, a conditional contribution is “…accounted for as a refundable advance until the conditions have been substantially met or explicitly waived by the donor.” Therefore, the ERTC amount would be carried on the balance sheet as a refundable advance until the criteria for forgiveness are substantially met or explicitly waived. At that point, the refundable advance would be recognized as income.

  3. Gain Contingency Model. Another method a business entity may elect if it expects to comply with the requirements of the law is by analogy to the gain contingency recognition model presented in FASB ASC 450-30. Under this model, the ERTC is recorded as a deferred income liability. As a result, grant income will not be recognized until the period when the grant proceeds are realized or realizable.
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