Employers impacted by COVID-19 that may be eligible for the employee retention tax credit (ERTC) finally have some additional guidance from the IRS that addresses a few unanswered questions, although some outstanding questions are still unanswered.
The ERTC was originally enacted by in the CARES Act in March 2020. Its use by taxpayers was significantly increased when additional statutes expanded and extended it. First, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) passed in December 2020 provided a number of changes to the ERTC including allowing employers to take the ERTC and a PPP loan both. Most of these changes were applicable starting Jan. 1, 2021 and (at the time) only applied to the first two quarters of 2021.
We discussed many of the Relief Act changes in our article on the IRS’s initial guidance in Notice 2021-20 that was issued in March 2020 covering the 2020 ERTC.
Subsequently, the IRS issued Notice 2021-23 with some additional guidance on the Relief Act changes that are effective in 2021. These are covered in our prior alert from April 2021.
Congress again extended the ERTC from June 30, 2021 to Dec. 31, 2021 in the American Rescue Plan Act (ARPA) passed in March 2021.
Now, the IRS has issued Notice 2021-49 (the Notice) to clarify some previously unanswered questions in the prior two notices and to include provisions for the extensions and additions to the ERTC provided in ARPA that were not addressed in the prior guidance.
American Rescue Plan Act additions to 2021 ERTC
The Notice restates that the ARPA extended the ERTC for the third and fourth quarters of 2021 and that the credit now applies against Medicare taxes (or the RRTA equivalent) rather than Social Security taxes. The credit remains refundable so this change does not limit employers’ credit but rather is a reporting and government funding matter. The maximum credit remains $7,000 per employee per quarter for the third and fourth quarters.
The ARPA added a “recovery start-up business” to the list of eligible employers as a third category of eligible employer (beyond being impacted by government orders or having a significant decline in gross receipts). The Notice clarifies that when a trade or business is started is determined using section 162 principles, and that a tax-exempt employer would use all of its operations and average annual gross receipts under section 6033 in determining whether it is a recovery start-up business. Further, a recovery start-up business that is a small employer can include all wages paid as qualified wages up to the $50,000 maximum credit allowed for recovery start-up businesses.
The Notice also provides some guidance for “significantly financially distressed companies” which is a new provision added by ARPA that allows certain large employers to use all wages paid for ERTC purposes.
For the third and fourth quarters, wages used for (i) PPP loan forgiveness, (ii) the shuttered venue operators grant or (iii) the restaurant revitalization grant cannot also be used for ERTC purposes. The Notice also discusses ARPA “double dipping” rules for credits described in sections 41, 45A, 45P, 45S, 51, 1396, 3131 and 3132 of the Code. Under these rules, the same wages cannot be used for both these credits and for ERTC purposes.
As a reminder, ARPA extended the statute of limitations from the normal three years to five years for any ERTC claimed in the third and fourth quarters, as restated in the Notice.
The Notice further provides that the guidance in Notices 2021-20 and 2021-23 continues to apply for the third and fourth quarters as much of the ARPA extension mirrors prior statutes on ERTC provisions.
Clarifications on unanswered questions for 2020 and 2021 ERTC
In addition to covering changes and additions by ARPA, the Notice also covers some areas that were still uncertain based upon the statute and prior notices. Specifically, the Notice provides:
- Full-time equivalents do not have to be included in the full-time employee count but their wages are considered for qualified wages for purposes of the credit calculation.
- Tip income is generally included in qualified wages, with limited exceptions per the section 3121(a) definition; further, the same wages can be used for the employee retention credit and the section 45B credit.
- Taxpayers claiming 2020 employee retention credits must reduce the wage deduction on the 2020 income tax return, requiring an amended return or administrative adjustment request (AAR) for taxpayers that filed the 2020 federal income tax return prior to calculating the 2020 employee retention credit.
- The election to use the preceding quarters’ gross receipts to measure a significant decline in gross receipts applies quarter-by-quarter allowing the employer to make a different decision each quarter in 2021.
- Wages paid to a majority (more than 50%) owner of a corporation, or a majority owner’s spouse are not qualified wages unless the majority owner does not have any living parents, children or siblings. This is because of interaction in sections 51(i)(1), 152(d)(2) and 267(c). Certain related minority owners may fall under the same rule. These requirements are complex; any company in this situation should carefully review these rules.
- A partner cannot be an employee of the partnership in which the partner is an owner and thus generally should not have 3121(a) wages from that entity for purposes of the ERTC.
- Rules in Notice 2021-20 for calculating 2019 gross receipts when acquiring businesses in 2020 or starting a business in 2019 apply the same to businesses acquired in 2021 or businesses started in 2020.
Some employers have little time left before the extended due date for filing 2020 federal income tax returns. This puts pressure on determining a reasonable estimate for any 2020 employee retention credits without having to file an amended return or AAR. Those that have already filed 2020 income tax returns without analyzing the applicability of the credit still have the opportunity to do so while the statute of limitations remains open; however, the burden and cost of filing those amended returns or AARs will have to be weighed with the amount of anticipated credit. This also highlights the need to analyze 2021 credit applicability sooner rather than later so that the same time crunch does not apply to the 2021 income tax filings.
As a note, the infrastructure bill released on August 1st includes a provision which would limit qualified wages (for employers that are not a recovery start-up business) to those paid on or before Sept. 30, 2021; in other words, the employee retention credit may no longer apply in the fourth quarter of 2021 if the bill passes as currently drafted. As of the date of this article, the bill has not yet been considered by the House or the Senate.