Since its introduction in March of 2020, the Employee Retention Credit (“ERC”) has provided significant tax benefits to several industries, including restaurants. A refundable credit, ERC provides a source of cash when the refund is paid by the IRS but the amount of the credit must also be included as an item of income in the company’s financial statements. Since the credit has a direct impact on the company’s financial statements, any company that is subject to debt covenants should be aware of the impacts of the ERC on the debt covenants.
Due to the significant cash in-flow provided by the credit, many owners may have the desire to take a distribution of cash from the company when the credit is received. However, the company may be limited on the distribution amount that can be taken based on the impact the income from the ERC has on debt covenant calculations. A company should be proactive in managing its debt covenant calculations and if a debt covenant may be failed due to a distribution of ERC refunds being distributed to owners, attempt to obtain a waiver from the bank to pay the distributions to its owners.
In addition, some debt covenants may indicate non-recurring gains/losses are not to be included in the debt covenant calculation. If you are passing your debt covenants only because ERC refunds are being recognized as part of EBITDA, please ensure you are allowed to include the income from ERC in your EBITDA calculation.
Article written by:
Director, Tax & Business Advisory Services