Additional Guidance on the Employee Retention Credit

The IRS recently released additional guidance on the Employee Retention Credit (ERC) in Notice 2021-49 and in Rev. Proc. 2021-33. Notice 2021-49 provides guidance for claiming the ERC in the third and fourth quarters of 2021 as well as providing clarification on previously unanswered questions. Rev. Proc. 2021-33 provides guidance on the exclusion of forgiven Paycheck Protection Program (PPP) loan proceeds and other incentives from the calculation of gross receipts, solely for purposes of the ERC.

Here’s what you need to know about the changes to the Employee Retention Credit program.

What is the Employee Retention Credit?

The ERC was originally enacted as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and has been extended twice, first as part of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) and second as part of the American Rescue Plan Act (ARPA).

The ERC is a refundable tax credit of up to $5,000 per employee for 2020. For 2021 the ERC can be up to $7,000 per employee per quarter. The ERC is available to businesses and other employers, including nonprofit organizations, that have been fully or partially suspended by a government order or had a significant decline in gross receipts.

Do you qualify for the ERC?

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What does Notice 2021-49 mean for the Employee Retention Credit?

Notice 2021-49 builds upon the rules created in Notices 2021-20 and 2021-23  by applying those rules to the third and fourth quarters of 2021. Notice 2021-49 also creates new rules and clarifies certain ambiguities.

Clarifications for All Periods

Timing of the Deduction Disallowance

Notice 2021-49 reinforces the language in Notice 2021-20 that the wage deduction disallowance is tied to the year in which the qualified wages were paid or incurred. Unfortunately, that may mean eligible employers who claimed the 2020 credit after filing their 2020 tax return claiming a full deduction for wages paid will need to amend their 2020 tax return to back out the wage deduction by the amount of the ERC claimed for 2020.

Full-time Employees versus FTEs

Notice 2021-49 provides clarification around two key issues eligible employers faced in the application of the ERC. First, Notice 2021-49 reinforces that full-time employees, not full-time equivalents, are the basis for determining whether an eligible employer qualifies as an eligible small employer. Second, the Notice reiterates that an employee’s full-time status is irrelevant when determining qualified wages.

Qualified Wages and Tips

Notice 2021-49 also addresses two questions with respect to qualified wages and tips. First, cash tips of more than $20 in a month are includable as qualified wages for the ERC. Second, an eligible employer can claim both the ERC and the FICA Tips tax credit pursuant to IRC section 45B on the same wages.

Related Individuals

Notice 2021-49 provides clarification on the inclusion of majority owner wages for the ERC. The Frequently Asked Questions released in April 2020 left uncertainty that wasn’t completely clarified in prior Notices, specifically whether the definition of “related individuals” included majority owners for ERC purposes (with the result being wages paid to majority owners are not ERC eligible). Notice 2021-49 clarifies that through the application of the ownership attribution rules, a direct majority owner’s ownership is attributed to each of the owner’s family members. A member of Congress has criticized this guidance but it is uncertain at this point whether the government will reverse course.

Alternative Quarter Election

Notice 2021-49 clarifies that eligibility for each quarter is determined independently. For the 2021 ERC, an eligible employer can utilize the current quarter or the alternative quarter to qualify using gross receipts.

New Provisions

Applicable Employment Taxes

For the third and fourth quarters of 2021, Notice 2021-49 outlines that the ERC will be taken against the employer’s share of Medicare tax first (but after other credits), with the remainder refundable. The ERC for earlier periods first offsets the employer’s portion of Social Security tax.

Recovery Startup Business

Employers beginning business after February 15, 2020 who do not qualify for the ERC under either the significant decline in gross receipts or suspension of operations criteria can qualify as a recovery startup business (RSB). The amount of ERC available per employer is a maximum of $50,000 per quarter for a total of $100,000.

Notice 2021-49 provides additional guidance for RSB qualification, including that the business is deemed to have started when it became a going concern performing activities for which it was formed. The aggregation and affiliation rules under IRC section 52(a) for controlled group of corporations, 52(b) for partnerships, proprietorships, etc. under common control, and 414(m) and 414(o) for affiliated service groups continue to apply, and gross receipts for the group cannot exceed an average of $1,000,000 for the three tax years preceding the quarter in which the ERC is claimed. Finally, Notice 2021-49 also outlines that certain tax-exempt organizations can qualify for the ERC as an RSB.

Severely Financially Distressed Employer

Qualification as a Severely Financially Distressed Employer (SFDE) is defined as having a greater than 90% decline in gross receipts in a calendar quarter versus the same quarter in 2019 (or 2020 if not in business in 2019) and allows a large employer to be treated as a small employer with respect to qualified wages in the third and fourth quarters of 2021. Notice 2021-49 clarifies that an employer can utilize the alternative quarter election to qualify.

What does Revenue Procedure 2021-33 mean for the ERC?

Rev. Proc. 2021-33 provides relief and clarification for employers determining eligibility for the ERC using gross receipts. The revenue procedure generally provides that an employer is not penalized for participating in other relief provisions when determining gross receipts solely for purposes of the ERC.

The ERC relies on IRC sections 6033 and 448(c) for the definition of gross receipts for tax-exempt organizations and non-tax-exempt organizations, respectively. PPP loan proceeds, shuttered venue grants, and restaurant revitalization grants are included as gross receipts pursuant to the definitions in the code.

Rev. Proc. 2021-33 provides a safe harbor for employers to exclude those amounts from gross receipts solely for ERC eligibility purposes if the exclusion is applied consistently across all relevant periods and consistently across all members of the aggregated group. Employers are required to retain records to support ERC claim.

Potential Legislation Impacting the ERC

The Infrastructure Investment and Jobs Act (H.R. 3684) (recently passed by the Senate but not yet law) proposes to terminate the ERC on September 30, 2021, rather than December 31, 2021. However, RSBs would remain eligible through the end of 2021. At this point it is unclear whether H.R. 3684 will become law.

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New guidance on the ERC has a direct impact to many organizations. Make sure you know how these changes affect you.