On August 4, 2021, the IRS released Notice 2021-49 that provides additional guidance regarding claiming the Employee Retention Credit (ERC) for employers who pay qualified wages after June 30, 2021, and before January 1, 2022 [IR 2021-165, Notice 2021-49].
The Employee Retention Credit is a refundable tax credit against certain employment taxes of the qualified wages an eligible employer pays to employees after March 12, 2020, up to certain limitations. Established under the Coronavirus Aid, Relief and Economic Security (CARES) Act, the ERC was due to expire on December 31, 2020.
The Consolidated Appropriations Act (CAA) of 2021, extended the ERC through June 30, 2021. The CAA also expanded the ERC rate of credit from 50% to 70% of qualified wages.
The American Rescue Plan Act (ARPA) extends the ERC from June 30, 2021, until December 31, 2021. ARPA also:
- reduces the required year-over-year gross receipts decline from 50% to 20%;
- provides a safe harbor that allows employers to use prior quarter gross receipts to determine eligibility;
- increases the limit on creditable wages from $10,000 in total to $10,000 per calendar quarter (i.e., $10,000 for first quarter 2021 and $10,000 for second quarter 2021); and
- increases the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees (meaning wages qualify for the credit even if the employee is working) (small eligible employer definition).
Our closer look examines how the Notice addresses questions that the Treasury Department and IRS have been asked about the ERC.
Definition of full-time employee.
The Notice addresses whether “full-time equivalents” (Code Sec. 4980H(c)(2)(E)) are counted in determining whether an eligible employer is a large eligible employer vs. a small eligible employer. The Notice clarifies that “full-time equivalents” do not need to be included in determining the average number of full-time employees. However, in terms of “qualified wages,” an employee’s status as a full-time employee is “irrelevant and wages paid to an employee who is not full-time may be treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied.”
Treatment of tips as qualified wages.
The Notice clarifies that qualified wages are limited to wages as defined under Code Sec. 3121(a) and compensation under Code Sec. 3231(e) including qualified health plan expenses, and for calendar quarters in 2021, remuneration paid for services to certain governmental employers. The notice explains that cash tips of $20 or more per month are treated as “wages” or “compensation” under Code Sec. 3121(a) and Code Sec. 3231(e), and therefore may be treated as qualified wages if all other requirements are satisfied.
Section 45B credit.
The IRS has received questions regarding whether an employer may claim the ERC and Section 45B credit on the same wages. The Section 45B credit may be claimed on the employer’s share of FICA taxes on excess tips received by its employees “in connection with the providing, delivering, or serving of food or beverages for consumption if the tipping of employees delivering or serving food or beverages by customers is customary” (Code Sec. 45B(a); Code Sec. 45B(b)(2)). The credit is equal to the amount of FICA tax paid by the employer on the portion of tips exceeding the amount treated as wages for the purpose of satisfying federal minimum wage requirements (Code Sec. 45B(b)(1)). The Notice states that there is no provision in CARES Act or subsequent legislation that prevents the receipt of both the ERC and the Code Sec. 45B credit for the same wages, therefore employers are permitted to claim both the ERC and Code Sec. 45B credit for the same wages.
Timing of qualified wages deduction disallowance.
Notice 2021-20 explained that under Code Sec. 3134(e) and Section 2301(e) of the CARES Act, an employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the employee retention credit. The IRS clarified that when a taxpayer claims a retroactive credit to a retroactive adjustment such as eligibility of PPP borrowers to claim the ERC, or files an amended employment tax return to claim the ERC, the taxpayer should file an amended federal income tax return or administrative adjustment request (AAR), if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken for those same wages on the original return. Code Sec. 280C(a) requires tracing to the specific wages generating the applicable credit. To satisfy this tracing requirement, the taxpayer must file an amended return or AAR, as applicable.
Wages of majority owners and spouses.
The notice addresses whether wages paid to an employee who owns more than 50% (majority owner) of the value of a corporation may be treated as qualified wages, as well as whether wages paid to a spouse of a majority owner may be treated as qualified wages.
Generally, the CARES Act provides similar rules for ERC purposes to Code Sec. 51(i)(1) that relate to the Work Opportunity Credit. The Notice clarifies if the majority owner of a corporation has no brother or sister (whether by whole or half-blood), ancestor, or lineal descendant as defined in Code Sec. 267(c)(4), then neither the majority owner nor the spouse is a related individual within the meaning of Code Sec. 51(i)(1) and the wages paid to the majority owner and/or the spouse are qualified wages for purposes of the employee retention credit, assuming the other requirements for qualified wages are satisfied. The Notice provides a number of examples to clarify this issue, including an example where wages of a majority owner or spouse may not be treated as qualified wages.
Example: Corporation D is owned 34% by Individual L, 33% by Individual M, and 33% by Individual N. Individual L, Individual M, and Individual N are siblings. Corporation D is an eligible employer with respect to the first calendar quarter of 2021. Individual L, Individual M, and Individual N are employees of Corporation D. Pursuant to the attribution rules of Code Sec. 267(c), Individual L, Individual M, and Individual N are treated as 100% owners. Individual L, Individual M, and Individual N have the relationship to each other described in Code Sec. 152(d)(2)(B). Accordingly, Corporation D may not treat as qualified wages any wages paid to Individual L, Individual M, or Individual N.
Alternative quarter election for calendar quarters in 2021.
As provided in Notice 2021-23, the determination of whether an employer is an eligible employer is based on a decline in gross receipts is made separately for each quarter. Employers are not required to use the alternative quarter election consistently. For example, an employer may be an eligible employer due to a decline in gross receipts for the second quarter of 2021 if its gross receipts for the second quarter are equal to 75% of its gross receipts in the second quarter of 2019 (i.e., the employer does not rely on the alternative quarter election for the second quarter); the employer could then use the alternative quarter election to be an eligible employer for the third quarter of 2021.
Gross Receipts Safe Harbor in Notice 2021-20.
The Notice explains that rules provided under Notice 2021-20 for determining gross receipts for an employer that came into existence in 2019 may be applied for employers who came into existence in the middle of 2020. For example, an employer that came into existence in the third quarter of 2020 should use that quarter as the base period to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2021 and should use the fourth quarter of 2020 for comparison to the fourth quarter of 2021 to determine whether it experienced a significant decline in gross receipts.
IRS payroll industry call.
In an August 5 IRS payroll industry call, the IRS highlighted two types of ERC eligible businesses:
- Recovery startup businesses. The IRS noted in the call that current provisions do not explain what are qualified wages for claiming the ERC by a recovery startup business. A recovery startup business is one that: (1) began operations after February 15, 2020 whose average annual gross receipts for a three-taxable-year period ending with the taxable year which precedes such quarter does not exceed $1,000,000, and (2) experiences a full or partial suspension of operations due to a governmental order or experiences a significant gross receipts decline. A spokesperson for the IRS clarified that if a business is a recovery startup business and a small eligible employer (Code Sec. 3134(c)(3)(A)(ii)), it may treat all wages paid to an employee during the quarter as qualified wages. Further, aggregation rules do apply in determining whether a business is a recovery startup business. Finally, the IRS has determined it is appropriate for a tax exempt (Code Sec. 501(c)) organization to qualify as a recovery startup business if it meets all requirements.
- Severely financially distressed employers. The IRS explained that severely financially distressed employers may claim the ERC for qualified wages paid in the same quarter they are claiming the credit.
An IRS spokesperson noted that the IRS is aware that the proposed infrastructure bill (H.R. 3684) contains a provision that would effectively cut off the ERC after the 3rd quarter except for recovery startup businesses. It is monitoring the situation.