IRS Defines Nominal For Purposes Of The Employee Retention Tax Credit: The Definition Might Surprise Essential Businesses

On its face, eligibility for claiming the Employee Retention Credit (“ERC”) seems straightforward – I had to shutdown my business due to a government order so I can claim an ERC. We have all learned over the last few weeks that the devil is in the detail. Essential businesses have an additional hurdle to jump through if they are claiming an ERC because of a full or partial shutdown based on the most recent guidance issued by the IRS on Monday.

Essential Workers

As we all know by now, the two different ways for an employer to qualify for the ERC are as follows:

A full or partial suspension is broad sweeping. It is not limited to Federal government orders, but also includes any State or local government orders from an appropriate governmental authority provided they too limit commerce, travel, or group meetings due to COVID-19. Examples of governmental orders can include any of the following:


The general rule for essential business is that they are not considered to have a full or partial suspension if the governmental order allows the employer’s operations to remain open. The exception that so many essential businesses have been relying on is that they could indeed have a shutdown, if under the facts and circumstances, more than a nominal portion of their business operations were suspended by a governmental order. Essential employers, including hospitals, nursing homes, manufacturers, grocery stores, and childcare centers may be surprised by the IRS definition released on Monday, March 1, 2021. The determination of nominal is purely based on 2019 information, comparing 2019 gross receipts or 2019 employee hours of service performed for the business operations that are affected by the full or partial shutdown to the entire 2019 gross receipts or employee hours. If the 2019 gross receipts or hourly computation does not prove that it is more than a nominal division of the overall business for 2019, a gross receipts decline of 100% between 2020 and 2019 for that portion of the employer’s operations that were shutdown is irrelevant.

Prior to the IRS issuing Notice 2021-20, nominal was not defined. Therefore, many businesses referenced the conventional definition of nominal, which under the Merriam Webster definition is defined to include something trifle or insignificant. With the most recent Notice, the IRS has quantified nominal as less than 10%.

The IRS has been clear that while essential businesses generally will not be deemed to have a full or partial shutdown due to orders from an appropriate governmental authority, a glimmer of hope remained if an essential business could prove that more than a nominal portion of their business operations were suspended. How might that occur? Take a hospital as an example. Even though hospitals were deemed essential during the pandemic (and we all are forever grateful to those frontline workers) parts of their operations had to be shut-down, the most common example being elective surgeries during time periods where COVID-19 peaked in specific locations. Similarly, for manufacturing companies, it was not unusual that their manufacturing facilities be shut down while their warehouse facilities were allowed to remain open. You get the idea. Many essential businesses were impacted by shutdowns since March 12, 2021, even though some of their operations remained open.

Therefore, essential businesses must rely on the exception to prove that more than a nominal portion of their business operations were affected if they are to qualify for the ERC under a full or partial shutdown. As there was no IRS guidance as to what was considered “nominal”, businesses were all over the board when assessing whether an insignificant operation was affected. Prior to Notice 2021-20, businesses have measured operations as more than nominal if it made up as little as 2% of gross receipts or as high as 15%. While many advisors felt that a division that made up only 2% of gross receipts was an aggressive position, most thought the IRS would find 5% or greater to be acceptable. After all, nominal is generally defined as “insignificant”. I think most people would agree the inability to generate 5% of revenue could be significant. As a result, it was surprising when the IRS defined nominal as being more than 10%. The IRS guidance clearly states the parameters they believe are acceptable.

Under Notice 2021-20, solely for purposes of the ERC, a portion of an employer’s business operations will constitute more than a nominal portion of its business operations if either:

Test 1: the gross receipts from that portion of the business operations is 10 percent or greater than the employer’s total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or

Test 2: the hours of service performed by employees in that portion of the business 10 percent or greater than the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019).

Test 1

Let’s start with Test 1. It requires that the gross receipts for that portion of business operations affected by the full or partial shutdown be at least 10 percent or greater of the total gross receipts. The test should be determined using the gross receipts of the same calendar quarter in 2019.

Let’s review some examples. Assume that an order from a local official imposed a curfew on residents that impacted a restaurant’s operating hours, from June 1st through September 31st. The operating hours affect the entire business, and not just a portion (i.e. dine-in or carry out). Therefore, the operations affected would be deemed more than nominal, as operations associated with greater than 10% of the 2019 gross receipts were impacted.

Take Away: If the full or partial shutdown affects the entire business, it is deemed to affect more than a nominal portion of the business operations.

However, Test 1 only requires that the gross receipts from that portion of the business operations subject to shutdown be evaluated. Assume that the business performs radiology, and while they were considered an essential business, certain procedures were suspended from June 1st through August 30th. This included mammograms, bone density screenings, and elective procedures. The calculation evaluating the gross receipts of these procedures in 2019 is as follows:

Nominal Evaluation for Full Quarter

In this example, the only time that the divisions of mammography, bone density, and elective procedures were deemed more than nominal was the 1st quarter as it constituted more than 10% of the total gross receipts earned in the first quarter of 2019. However, qualified wages allowed to be evaluated for 2020 ERC purposes are only wages paid after March 12, 2020. The Radiologist office would only be able to review wages paid form March 12, 2020 through March 31, 2020 for purposes of the ERC. On the other hand, the divisions affected by the shutdown did not give rise to greater than 10% of the gross receipts in 2nd quarter of 2019, and therefore none of the wages from April 1st through June 30th, 2020 can be evaluated for the 2020 ERC.

Take Away: The entire calendar quarter in 2019 must be evaluated when assessing whether a division in a business is more than nominal, not just the 2019 time period that is the same time period in 2020 when the division was full or partially shutdown.

Still with me? Hang in there. The last part of Test 1 ties back to the fact that when assessing the ERC, and assessing 2019 gross receipts, we are required to assess the gross receipts of the single employer. The number of businesses combined as a single employer are based on the aggregation rules provided in Internal Revenue Code (“IRC”) Section 51(a) and (b), as well as IRC Section 414(m) and (o). Businesses that are aggregated as a single employer for purposes of the ERC, must assess the more than nominal test including all the gross receipts from their operations regardless of location or shutdown requirements. Therefore, if operations that were affected are only in a few business entities, but not performed in all the business entities that are aggregated, the operations could very well be considered nominal as they do not rise to 10% or greater the affiliated group 2019 gross receipts. The requirement that Test 1 be measured by a single employer, or aggregated group, could result in a business not qualifying for the ERC even though the operations that were shut down for a particular business entity are vastly more than nominal. The fact that the affiliated group cannot past the nominal test prohibits the ability for any business within the aggregated group to claim the ERC.

Take away: Test 1 requiring 2019 gross receipts are more than nominal, or greater than 10% of total 2019 gross receipts relate to divisions that were impacted by a full or partial shutdown, must be assessed at the aggregated group, or single employer level. Be cautious if the areas impacted by a full or partial shutdown are only operated in certain businesses within the aggregated group.

Test 2

Test 2 provides an alternative test for essential businesses to prove they were more than nominally affected by a partial shutdown, if the hours of service performed by employees in that portion of the business in the same calendar quarter of 2019 is 10 percent or greater of the total number of hours of service performed by all employees in the same 2019 calendar quarter.

This is where a great deal of unanswered questions remains. If it is a full-time employee, do we use 30 hours or 40 hours? If an hourly employee works more than 30 or 40 hours, do I count the total hours worked? The answer appears to be “yes”. Lastly, if they are paid vacation, sick, or other PTO for hours worked are those hours allowed to be included in the calculation? Are they really for hours or service performed? Some may argue that these hours be included because the employee would not have accrued the PTO hours unless they had been actively working. Others argue the exclusion of those hours because when being paid PTO no actual service is being provided. Needless to say, clarification from the IRS on how to measure hours, or reference to another IRC (such as Section 4980H) for the nominal test is needed. Until further guidance is provided, business should be consistent when testing a time period and ensure that they are comparing apples to apples. In other words, the same methodology should be applied to all divisions of the business in 2019.

Assuming that an hourly employee does not work more than a 30-hour work week, let’s review a simplistic example. Assume a manufacturing company’s warehouse remained open throughout the 2020 tax year, but the manufacturing line was not allowed to produce due to governmental order from April 1st through June 1st. There were 5 warehouse employees and 20 employees on the production line during the 2nd quarter in 2019, and no PTO was taken during this time period.

Nominal Hour Test

Based on the above calculation, the production employees for the manufacturing company would clearly represent a more than nominal part of the business operations. Therefore, the wages between Aprils 1st and June 1st of 2020 could be evaluated for purposes of the ERC.

Substantiation Requirements

The IRS did add substantiation requirements in Notice 20201-20, including a requirement for essential businesses who are seeking the ERC due to a full or partial governmental shutdown having more than a nominal affect on their business.

“An eligible employer will adequately substantiate eligibility for the employee retention credit if the employer creates and maintains records that include the …any records the employer relied upon to determine whether more than a nominal portion of its operations were suspended due to a governmental order or whether a governmental order had more than a nominal effect on its business operations.”

The eligible employer should maintain these records for at least four years.

Are business required to follow the IRS guidance provided by Notice 2021-20?

As explained by the IRS, such notices are historically intended “to provide substantive or procedural guidance on an expedited basis with respect to matters of general interest that would otherwise be covered by a regulation, revenue ruling, or revenue procedure.” These notices are used to advance the IRS’s position where further guidance is still being drafted. And while published notices can be relied upon by taxpayers to the same extent as revenue rulings or revenue procedures to avoid accuracy-related penalties, they do not have the force and effect of Treasury regulations and can be affected by subsequent legislation, regulations, revenue rulings, revenue procedures, and case law.

Many essential businesses will be relieved to see that the IRS defined what it considered to be an essential portion of an employer’s business for purposes of the ERC when it issued Notice 2021-20. This will provide essential businesses a “safe harbor” for purposes of assessing wages when calculating the 2020 ERC. For businesses that appear to fall out of the definition provided by the IRS, continued discussions with your business advisors is encouraged.

Speculating about the IRS’s position for the 2021 ERC? All of us are still waiting. Notice 2021-20 specifically states that it does not address the changes made by Section 201 of Consolidated Appropriations Act, 2021 that apply to the ERC for qualified wages paid after December 31, 2020. Like so many other areas right now, stay tuned!

I am a Tax Partner and Tax Innovation Director with The Bonadio Group in Rochester, New York. I am CPA licensed in New York and formally in Minnesota. I hold a Master’s