On Wednesday August 4, 2021, the IRS issued Notice 2021-49 which expanded the Employee Retention Credit (ERC) through the third and fourth quarters of 2021, and provided further guidance and changes as follows:
Expansion of the Credit Through End of 2021
Eligible employers are now entitled to claim the Employee Retention credit for the third and fourth quarters of 2021. The maximum amount of the credit through December 31, 2021 remains at 70% of qualified wages, where qualified wages is capped at $10,000 per calendar quarter, for a maximum credit of $7,000 per employee.
The previous quarter election that was available for the first and second quarter of 2021, where a taxpayer could elect to use the previous quarter in place of the current quarter, is also extended through the third and fourth quarter of 2021. For example: A taxpayer 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 80% of its gross receipts in the second quarter of 2019. The employer could then use the alternative quarter election to be an eligible employer for the third quarter of 2021.
Recovery Startup Businesses
For the third and fourth quarters of 2021, the credit has been expanded to include “recovery startup businesses,” defined as an employer:
- That began carrying on a trade or business after February 15, 2020.
- That is not otherwise an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.
- For which the average annual gross receipts for the three-taxable-year period ending with the taxable year that precedes the calendar quarter for which the credit is determined does not exceed $1,000,000.
The amount of the credit that is allowed for a recovery startup business for each of the third and fourth calendar quarters of 2021 cannot exceed $50,000.
The determination for whether an employer is a recovery startup business is made separately for each calendar quarter.
For example: If an eligible employer is a recovery startup business in the third quarter of 2021 but is not a recovery startup business in the fourth quarter of 2021 (because it is an eligible employer due to a full or partial suspension or a decline in gross receipts during the fourth quarter of 2021), the $50,000 limitation applies to the third quarter of 2021 but does not apply to the fourth quarter of 2021.
The aggregation rules that require looking at affiliated entities with common ownership of 80% or more as a whole with regards to the gross receipts test, or the full or partial suspension of operations test, also apply in determining if an employer is a recovery startup business. The aggregation rules will apply with respect to the $50,000 limitation on the credit.
Gross Receipts Safe Harbor
Section III.E. of Notice 2021-20 provides a safe harbor that permits an employer that acquires a business in 2020 or 2021 to include the gross receipts of the acquired business in its gross receipts for 2019 to determine whether the employer experienced a significant decline in gross receipts. Total gross receipts are included regardless of the fact that the employer did not own the acquired business during a calendar quarter in 2019.
For an employer that came into existence in the middle of a calendar quarter in 2020, the employer should use the first calendar quarter of existence as the base period to determine whether it experienced a significant decline in gross receipts.
For example: An employer that came into existence in the third quarter of 2020 should use the third quarter of 2020 as the base period in comparing the gross receipts for the first three quarters in 2021, and should then 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.
Modified Definition of Qualifying Wages for “Severely Financially Distressed Employers”
Ordinarily, to qualify for the ERC for any calendar quarter in 2021, an eligible employer would need to show a decline in gross receipts of 20% or more compared to the same calendar quarter in 2019. For a large eligible employer (an employer with more than 500 full-time-equivalent employees during calendar year 2019) only the wages paid to an employee during the qualifying quarters NOT to work were eligible for the credit.
Applicable only to the third and fourth quarter of 2021, Section 3134(c)(3)(C)(ii) provides some relief for eligible large employers considered “severely financially distressed”. A severely financially distressed employer is one whose gross receipts for the calendar quarter are less than 10% of its gross receipts from the same calendar quarter in 2019. A severely financially distressed employer that is a large employer may treat all wages paid to its employees during the quarter in which the employer is considered severely financially distressed as qualified wages.
For example: Employer A is a large eligible employer with gross receipts in the third quarter of 2021 equal to 15% of its gross receipts in the third quarter of 2019. Employer A would not be considered a financially distressed employer for the third quarter of 2021 since their gross receipts were not less than 10% of the third quarter of 2019. Therefore, only the wages paid to employees not to work would be eligible for the credit for the third quarter 2021.Follow-up example: Employer A is a large eligible employer with gross receipts in the second quarter of 2021 that are less than 10% of the gross receipts in the second quarter of 2019. The severely financially distressed employer rules do not apply for the second quarter of 2021, however the employer can elect for the third quarter of 2021 to use the previous quarter numbers, and since Employer A meets the definition of a severely financially distressed employer for the second quarter, Employer A can be treated for the third quarter of 2021 as a severely financially distressed employer and therefore can include wages paid for the employees to work in the determination of the credit, and is not limited to only claiming a credit on wages paid to employees not to work.
Clarification on the Overlap of Qualifying Wages in Conjunction with Other Programs
The IRS has clarified that the Employee Retention Credit cannot be claimed for qualified wages that have already been taken into account as payroll costs in connection with:
- A shuttered venue grant under Section 324 of the Economic Aid to Hard-Hit Small Business, Non-Profits, and Venues Act.
- A restaurant revitalization grant under Section 5003 of the American Rescue Plan Act of 2021.
Qualifying wages also continue to not be eligible for the ERC if those wages have already been used to qualify for PPP Loan forgiveness.
Interaction Between the ERC and 45B Credit
Neither Section 2301 of the CARES Act or Section 3134 cross-reference Section 45B. Section 45B(c) denies a deduction for any amount taken into account in determining the credit under Section 45B, this does not prevent eligible employers from receiving both the ERC and Section 45B credit for the same wages.
Clarification of Full-Time Employee
The term “full-time employee” means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month.
For purposes of determining whether an eligible employer is a large or small employer, eligible employers are not required to include full-time equivalents when determining the average number of full-time employees.
However, for purposes of identifying 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
Qualified wages are limited to wages as defined in Section 3121(a) and compensation as defined in Section 3231(e), with certain modifications relating to the inclusion of qualified health plan expenses and, for calendar quarters in 2021, remuneration paid for services to certain governmental employees.
Section 3121(a)(12) and similarly Section 3231(e)(3) exclude from the definition of “wages” and “compensation” any tips received by an employee in any calendar month in the course of employment by an employer unless the amount of cash tips is $20 or more. Therefore, if cash tips received by an employee in a calendar month are $20 or more, all of the cash tips received by the employee in that calendar month are included in wages.
Timing of the Qualified Wages Deduction Disallowance When Filing an Income Tax Return
An employer’s deduction for qualified wages, including qualified health plan expenses, is reduced by the amount of the Employee Retention Credit. For many taxpayers, the 2020 income tax return may have already been filed prior to the taxpayer filing an adjusted employment tax return for a calendar quarter in 2020 to claim the ERC.
The IRS has clarified that when a taxpayer claims a credit for 2020 after having filed their 2020 income tax return, the taxpayer should file an amended income tax return to reduce the wages reported on the original return for the amount of the credit received.
Whether Wages Paid to Majority Owners and Their Spouses Are Treated as Qualified Wages
Wages paid to employees with the following relationships to a majority owner (more than 50% owner) of an entity are not qualified wages:
- A child or a descendant of a child.
- A brother, sister, stepbrother, or stepsister.
- The father or mother, or an ancestor or either.
- A stepfather or stepmother.
- A niece or nephew.
- An aunt or uncle.
- A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
- An individual (other than a spouse) who for the taxable year of the taxpayer has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.
Notice 2021-49 addresses the question of whether owner or spouse wages are treated as qualified wages, whereby the IRS has applied the attribution rules of Section 267(c) in an unexpected way.
The IRS has determined that for purposes of determining a majority owner of an entity, ownership is attributed to any brother, sister, ancestor, or lineal descendant, regardless of whether they also have any ownership in the entity.
For example: Corporation A is owned 100% by Owner B and both the owner and the spouse are employees of the entity. The taxpayer has a child; therefore, the child can be attributed to also have 100% ownership of the entity even though they don’t otherwise directly have any ownership or connection to the entity. Both the Owner B and the spouse are then considered related to the child who is now attributed to be a majority owner, and therefore neither of the Owner B or spouse wages will be qualified for the credit.
This means if a more than 50% owner of an entity has any living relatives, the wages paid to that owner or the spouse will not be qualified wages for purposes of the claiming the credit.
This unexpected explanation has caused some additional confusion and it is hoped the IRS will further clarify or restate this explanation.
Deadline to Claim the ERC
The deadline to report a correction of overreported taxes on a previously filed Form 941 is the later of:
- 3 years from the date the Form 941 was filed, or
- 2 years from the date you paid the tax reported on the Form 941.
E.g. If a Q4 2019 Form 941 was filed on January 28, 2020, it is considered filed on April 15, 2020. If an error is discovered that overreported tax, to correct the error, Form 941-X must be filed by April 18, 2023.
Eligible employers who want to claim the ERC for Q2, Q3 or Q4 of 2020 must submit their 941X Form by April 15, 2024.
Eligible employers who want to claim ERC refunds for Q1, Q2 or Q3 of 2021 must submit their 941-X Form by April 15, 2025.