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Additional Guidance On The Employee Retention Credit Issued By IRS

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On August 4, 2021, the IRS issued Notice 2021-49, which provides long overdue guidance for employers that have taken or are considering taking the employee retention credit (ERC) as initially made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and modified and extended under the American Rescue Plan Act of 2021 (ARPA). Generally, the maximum ERC for 2020 is $5,000 per employee, while the maximum for 2021 is $28,000 per employee.

The ARPA extended the ERC for wages paid after June 30, 2021 and before January 1, 2022. The IRS previously issued nearly 100 frequently asked questions (FAQs) and two notices (Notice 2021-20 and 2021-23) in an attempt to provide guidance on the ERC. However, these FAQs and notices fail to address some important questions, such as whether cash tips received by employees and wages paid to an owner with more than 50% ownership of a company are qualified wages for the ERC. Notice 2021-49 addresses this issue and clarifies other issues related to the mechanics of the credit. The notice also clarifies and provides additional guidance for several other important provisions of the ERC as modified by the ARPA.

In addition, on August 10, 2021, the IRS issued Revenue Procedure 2021-33, which provides a safe harbor for employers to exclude (1) the amount of the forgiveness of a Paycheck Protection Program (PPP) loan under the Small Business Act, (2) a shuttered venue operator grant under the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), and (3) a restaurant revitalization grant under the ARPA from “gross receipts” for purposes of determining eligibility to claim the ERC.

Background

The CARES Act provides for a refundable tax credit for eligible employers that pay qualified wages, including certain health plan expenses, to some or all employees after March 12, 2020 and before January 1, 2021.

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) amended and made technical changes to the ERC for qualified wages paid after March 12, 2020 and before January 1, 2021, primarily expanding eligibility for certain employers to claim the credit. The Relief Act also extended the ERC to qualified wages paid after December 31, 2020 and before July 1, 2021 and modified the calculation of the credit amount for qualified wages paid during that time. The Relief Act permitted employers to qualify for the ERC if they experienced revenue declines of 20% (previously 50%), and it changed the definition of large employer from an employer that averaged 100 employees to one that averages 500 employees, enabling businesses with 500 or fewer employees to take the ERC for all wages paid, rather than only for wage payments for which no services were provided. The Relief Act also allowed employers that received PPP loans to also take the ERC, retroactive to March 2020.

The following summarizes Revenue Procedure 2021-33 and some of the most significant issues addressed in Notice 2021-49.

Safe Harbor for Gross Receipts – Revenue Procedure 2021-33

Under Internal Revenue Code Section 448(c) for for-profit entities and Section 6033 for tax-exempt organizations, PPP loan forgiveness, shuttered venue operator grants and restaurant revitalization grants are not included in employers’ gross income but are included in gross receipts. Revenue Procedure 2021-33 provides a safe harbor for employers to exclude those amounts from gross receipts solely for determining ERC eligibility. The IRS said that Congress intended for employers to be able to participate in these relief programs and also claim the ERC. Therefore, including amounts provided under those relief programs in gross receipts for determining eligibility for the ERC would be inconsistent with Congressional intent.

Under the revenue procedure, an employer is required to consistently apply the safe harbor by (1) excluding the amount of the forgiveness of any PPP loan and the amount of any shuttered venue operator grant and restaurant revitalization grant from its gross receipts for all relevant quarters in determining eligibility to claim the ERC, and (2) applying the safe harbor to all employers treated as a single employer under the ERC aggregation rules.

Employers elect to use the new safe harbor by excluding amounts under those relief programs when claiming the ERC on Form 941, Employer’s Quarterly Federal Payroll Tax Form (or 941-X if filing an amended return). In other words, a separate “election” form is not needed. If an employer revokes its safe harbor election, it must adjust all employment tax returns that are affected by the revocation. Employers must retain in their records support for claiming the ERC, including their use of this new safe harbor for determining gross receipts.

Clarifications to the ERC Under Notice 2021-49

Applicable Employment Taxes

Notice 2021-49 confirms that, for the third and fourth quarters of 2021, eligible employers can claim the ERC against the employer’s share of Medicare tax (or the portion of Tier 1 tax under the Railroad Retirement Tax Act) after these taxes are reduced by any credits allowed under the ARPA for qualified sick leave wages and qualified family leave wages, with any excess refunded.

Recovery Startup Business

An ERC of up to $50,000 per quarter is available to “recovery startup businesses.” A recovery startup business is an employer that began carrying on a trade or business after February 15, 2020. The notice clarifies that an employer is not considered to have begun carrying on a trade or business until such time as the business has begun to function as a going concern and performed those activities for which it was organized.

The notice also states that a not-for-profit organization can be treated as an eligible employer due to being a recovery startup business based on all of its operations and average annual gross receipts. For ERC purposes, a not-for-profit organization is deemed to be a “trade or business.”

Further, a recovery startup business that has 500 or fewer full-time employees may treat all wages paid with respect to an employee during the quarter as “qualified wages.”

Finally, the aggregation rules apply when determining whether an employer is a recovery startup business, as well as to the $50,000 limitation on the credit. Thus, a recovery startup business would need to apply IRC Sections 52(a) (for related corporations), 52(b) (for related non-corporate entities, such as partnerships, trusts, etc.) and 414(m) (affiliated service group rules).

Qualified Wages

Qualified wages generally are determined differently based on whether the employer is a small or large employer, in that qualified wages for large employers are limited to wages paid to an employee for time the employee is not providing services due to a full or partial suspension of business operations or a decline in the employer’s gross receipts.

The notice clarifies the rule for qualified wages for a “severely financially distressed employer” (SFDE). An SFDE is an employer that, in the third or fourth quarter of 2021, has gross receipts of less than 10% of its gross receipts for the same quarter in 2019. For SFDEs, qualified wages are any wages paid in the quarter, regardless of the size of the employer. This is different from the standard ERC rule, which limits qualified wages for large employers to wages paid while the employee is not performing services.

Full-Time Employees Versus Full-Time Equivalents

Confusion abounds about the definition of “full-time employee” and whether “full-time equivalents” are to be included when determining whether an employer eligible for the ERC is a large or small employer. Notice 2021-49 clarifies that eligible employers are not required to include full-time equivalents when determining the average number of full-time employees. The notice also confirms that wages paid to an employee who is not a full-time employee may be treated as qualified wages if all other requirements are met.

Treatment of Tips and FICA Tip Credit

Considerable confusion has arisen as to whether tips count as qualified wages for the ERC, since customers (not the employer) generally pay the employee the tips. Notice 2021-49 clarifies that cash tips are qualified wages if all other requirements to treat the amounts as qualified wages are met. The notice also confirms that eligible employers are not prevented from receiving both the ERC and the FICA tip tax credit on the same wages.

Timing of Qualified Wages Deduction Disallowance

The IRS has provided guidance on the timing of the disallowance for wage deductions on the employer’s federal tax return relating to qualified wages claimed for the ERC. The IRS previously confirmed that employers must reduce the deduction claimed for employee wages on their federal tax return by the amount of qualified wages claimed under the ERC. Notice 2021-49 confirms that this reduction in the deduction amount must occur in the same tax year the ERC is claimed. Accordingly, if an employer files a claim for the credit for a prior tax year, it must also file an amended federal tax return to reduce the amount of the wage deduction claimed in the corresponding period.

Related Individuals

The IRS previously stated that wages paid to related individuals, as defined by IRC Section 51(i)(1), are not taken into account for ERC purposes. Notice 2021-49 clarifies that, by applying the ownership attribution rules, the definition of a “related individual” includes a majority owner (i.e., a person with more than 50% ownership) of an entity if the majority owner has a brother or sister (whether by whole or half-blood), ancestor or lineal descendant. The spouse of a majority owner is also a related individual for purposes of the ERC if the majority owner has a family member who is a brother or sister (whether by whole or half-blood), ancestor or lineal descendant.

Insight

Wages paid to a sole owner or majority owner will rarely qualify for the ERC, according to the guidance provided in Notice 2021-49, because of the way the ownership attribution rules are applied. The owner must have no family other than a spouse in order to treat his or her wages as qualified wages. Members of Congress have voiced their disagreement with this guidance. It is possible the IRS will revise their position regarding related individuals in future guidance.

Alternative Quarter Election for Calendar Quarters in 2021

The Treasury Department and the IRS have been asked whether an eligible employer must consistently use the alternative quarter election once it has been made. The Notice 2021-49 confirms that 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 using the standard quarter comparison; 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

Notice 2021-49 confirms that the safe harbor rule that allows an employer to include the gross receipts of an acquired business that it did not own during a calendar quarter in 2019 continues to apply to employers that acquire businesses in 2021 for purposes of measuring whether there was a decline in gross receipts. In addition, an employer that came into existence in 2020 (e.g., the third quarter of 2020) should use that quarter to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2021 and should determine whether it experienced a significant decline in gross receipts by comparing the fourth quarter of 2020 to the fourth quarter of 2021.

Insights

Guidance provided in Notice 2021-49 has created several opportunities for certain employers to obtain additional ERCs. For example, some restaurant employers may not have included cash tips as qualified wages for their previous ERC claims. Under the notice, those employers can now file amended returns to claim additional ERCs or employers who did not count amounts paid to full-time equivalent employees as qualified wages for the ERC may now do so. Revenue Procedure 2021-33 has also created an opportunity for certain employers that received PPP loan forgiveness, shuttered venue operator grant or restaurant revitalization grant to obtain additional ERC. Employers should review the contents of the notice and the revenue procedure with their tax advisor to determine if additional ERCs may be available, and if so, employers may file Form 941-X to request the additional credit or refund.

Employers should also determine if they may have claimed more ERC than they were entitled to based on the guidance in Notice 2021-49. For example, some small business owners may not have applied the ownership attribution rules correctly. If necessary, Form 941-X may be filed to correct the error. According to the notice, the IRS will not assess penalties for failure to timely pay or deposit tax if the taxpayer can show reasonable cause and not willful neglect for the failure.

​

H.R. 3684, the Infrastructure Investment and Jobs Act, proposes to end the ERC on September 30, 2021 rather than December 31 (but recovery startup businesses would remain eligible through year-end). That provision may or may not be included in the infrastructure bill that is eventually signed into law (which is expected in the next month or so).

Tax & Audit Internships

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Are you looking to gain valuable experience to complement your education? Urish Popeck’s internship program will help launch your career as you will be exposed to real-world experience and be responsible for accounting specific tasks. We provide a balanced work-life schedule so that you can effectively gain industry experience while continuing your education.

Responsibilities of Position:

  • Hands-on experience preparing tax returns and/or audit engagements
  • Develop working knowledge of audit and/or tax software and research tools
  • Develop relationships with team members
  • Participate in engagement planning and written client communications
  • Financial statement preparation assistance

Qualifications:

  • Pursuing a Bachelor’s in accounting
  • On track to obtain 150 credit hours
  • Working knowledge of Microsoft Office programs  
  • Possess strong interpersonal, analytical, and research abilities

What We Offer:

  • Opportunity to participate in engagements often found in much larger firms
  • Hands-on training
  • Flexible part-time work hours to accommodate class schedules
  • Employee events

Individuals Affected By COVID-19 Helped By Federal Aid Package

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The Families First Coronavirus Response Act (H.R. 6201),  became law on March 18, 2020. The Act guarantees free testing for the novel coronavirus (COVID-19), establishes emergency paid sick leave, expands family and medical leave, enhances unemployment insurance, expands food security initiatives, and increases federal Medicaid funding.

The Act includes up to 80 hours of emergency paid sick leave for workers who are unable to work while they are sick or complying with COVID-19 restrictions or caring for school age children due to the closure of schools or child care facilities, as well as paid family and medical leave that employees will be able to use to care for family members (not for personal illness) for up to 12 weeks. The first 10 days of emergency family and medical leave may be unpaid, unless employees opt to use accrued paid time off for those days.

The mandatory paid leave provisions apply to employers with fewer than 500 employees and government employers, with exceptions for health care workers and first responders. Self-employed individuals would be eligible for the new benefits provided under the Act. It is not clear if individuals who have self-employment income from their partnership or limited liability company would be eligible for the new self-employed benefits, as the Act does not specifically address those situations. Employers with 500 or more employees would not be subject to those rules.  Employers who are required to provide paid time off would need to initially bear the costs of paying their employees, but the federal government would provide payroll tax credits to help cover those costs.

Background. Currently, the federal Family Medical Leave Act of 1993 (FMLA) provides eligible employees up to 12 work weeks of unpaid leave a year and requires group health benefits to be maintained during the leave as if employees continued to work instead of taking leave. Employees are also entitled to return to their same or an equivalent job at the end of their FMLA leave. Special rules apply to military personnel.

To be eligible for FMLA, an employee is required to have been employed by their employer for a year, worked for 1,250 hours, and worked in a location where there are 50 other employees within a 75-mile radius. The FMLA applies to all private sector employers who employ 50 or more employees for at least 20 workweeks in the current or preceding calendar year (including joint employers and successors of covered employers). Many states have enacted laws that are similar to federal FMLA, which apply to smaller employers who may be exempt from federal FMLA. The FMLA also applies to federal, state and local employers. These current provisions remain available for qualifying employees.

Employer Mandates

Emergency Paid Sick Leave. Through December 31, 2020, the Act requires employers with fewer than 500 employees and government employers to provide all employees (including union employees and regardless of how long the individual worked for the employer, but excluding health care workers and first responders) with 80 hours (e.g, 10 business days) of emergency paid sick leave for full-time workers (pro-rated for part-time employees or employees with varying work schedules) for employees who are unable to work or telework because the employee:

  • Is subject to a federal, state, or local COVID-19 quarantine or isolation order;
  • Has been advised by a health care provider to self-quarantine because of COVID-19;
  • Is experiencing COVID-19 symptoms and is seeking a medical diagnosis;
  • Is caring for an individual subject to or advised to quarantine or isolation;
  • Is caring for a son or daughter whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 precautions; or
  • Is experiencing substantially similar conditions as specified by the Secretary of Health and Human Services, in consultation with the Secretaries of Labor and Treasury.

Generally, employers would pay employees at their regular rate of pay for emergency sick leave, capped at $511 per day ($5,110 in the aggregate) if the leave is taken for an employee’s own illness or quarantine (i.e., for the first three bullets above). Employers would pay employees two-thirds of their regular rate of pay for emergency sick leave, capped at $200 per day ($2,000 in the aggregate) if the leave is taken to care for others or due to school closures (i.e., for the last three bullets above).

An employer cannot require an employee to use other paid leave before using this paid leave. Employers would not be able to require employees to find replacement workers to cover their shifts if employees use emergency paid sick leave. The federal government is supposed to provide a model notice within seven days after enactment, which employers would be required to post at their workplace, informing employees of their right to emergency paid sick leave. The U.S. Department of Labor is directed, within 15 days after enactment, to issue guidelines on how to calculate the amount of emergency paid sick leave. The Department of Labor also has the authority to issue regulations to exempt small businesses with fewer than 50 employees from having to provide emergency paid sick leave to employees who need to care for a son or daughter whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 precautions if the imposition of such requirements would jeopardize the viability of the business as a going concern.

Employers would face penalties for failing to comply with the new emergency paid sick leave rules and are prohibited from discriminating against employees who take emergency paid sick leave. Eligible employees could use emergency paid sick leave before using new, emergency paid family and medical leave created by the Act.

FMLA Amendments. The Act would add provisions to the FMLA to provide employees (including union employees) who have been employed for at least 30 days by employers with fewer than 500 employees or government employers, with the right take up to 12 weeks of job-protected leave through December 31, 2020, if the employee is unable to work or telework due to having to care for a child under age 18 if the child’s school or place of child care has been closed (or the child care provider is unavailable), due to the COVID-19 public health emergency.  Employers may elect to exclude health care workers and first responders from taking this public health emergency FMLA.

The first 10 days of FMLA under these new provisions may be unpaid. Employees can use other paid time off such as vacation, sick days, sabbatical, or emergency paid sick leave to cover that gap, but employers cannot require employees to use their accrued paid time off before using these 12 weeks of extended FMLA leave. Employers would pay employees two-thirds of their regular rate of pay for this emergency FMLA leave, capped at $200 per day ($10,000 in the aggregate per employee). Adjustments would be made to the amount of paid time off for employees with varying schedules.

The Act gives the U.S. Department of Labor authority to issue regulations that would exclude certain health care providers and emergency responders from being able to take emergency family and medical leave. The Department of Labor also has the authority to issue regulations to exempt small businesses with fewer than 50 employees from the emergency family and medical leave requirements if the imposition of such requirements would jeopardize the viability of the business as a going concern. The Act would also exempt employers with fewer than 50 employees in a 75-mile radius from civil damages in an FMLA lawsuit.

Under the Act, covered employers (those with less than 500 employees) are required to hold an employee’s job open for them until the end of the leave period. However, an exception applies to employers with fewer than 25 employees if the employee’s position no longer exists due to economic conditions or other changes in the employer’s operations that affect employment and are caused by the COVID-19 crisis, and the employer made reasonable efforts to restore the employee’s job. And, if those efforts failed, the employer agrees to reinstate the employee if an equivalent position becomes available within a year.

The Act creates new, refundable payroll tax credits for employers to help cover the costs of this new paid sick and family leave.

Payroll Tax Credits

To assist employers who are required to provide emergency paid sick leave or FMLA leave under the programs described above, the Act provides for a refundable tax credit applicable against the employer’s portion of Social Security or Railroad Retirement Tax Act (RRTA) tax for amounts paid under those programs. The credit is equal to 100% of the compensation paid in each calendar quarter to employees who are not working for the reasons enumerated above, subject to the following limitations:

For payments to an employee who needs time off for self-isolation, diagnosis, or care of a COVID-19 diagnosis, or compliance with a health care provider’s recommendation or order, the credit is capped at $511 of eligible wages per employee per day. For payments to an employee who needs time off to care for a family member who has been exposed to or diagnosed with the COVID-19, or a child under age 18 whose school or place of care has been closed, the credit is capped at $200 of eligible wages per employee per day. The credit for emergency paid sick leave wages is only available for a maximum of 10 days per employee over the duration of the program. For expanded FMLA, the credit is capped at $200 of eligible wages per employee per day and $10,000 for all calendar quarters.

Both of the credits are increased by any amounts paid or incurred by the employer to maintain a group health plan, to the extent those expenses are (1) excluded from the employee’s gross income under the tax code and (2) “properly allocable” to the respective qualified sick or FMLA wages required to be paid under the Act. The exact method of allocation will be provided by regulation at a later date, but the Act provides that the allocation will be treated as properly made if done “on the basis of being pro rata among covered employees and pro rata on the basis of periods of coverage.”

If the credit exceeds the employer’s total liability for Social Security or RRTA tax for all employees for any calendar quarter, the excess is refundable to the employer. The employer may choose not to apply the credit. Further, to prevent a double benefit, the employer cannot obtain a deduction for the amount of the credit. In addition, employers may not receive the credit in connection with wages for which a credit is allowed under Section 45S (credit for paid family and medical leave).         

Similar rules apply to a self-employed individual that allow a refundable tax credit against the individual’s self-employment tax. The credit is capped at the lesser of the amounts that apply to eligible wages per employee or the individual’s lost self-employment income. The House-passed version of the Act provides guidance on how to determine the individual’s lost income due to the corona virus.

Notably, required payments for emergency paid sick leave or FMLA under the Act will not be considered wages for purposes of calculating the employer’s portion of the Social Security or RRTA tax. In addition, the tax credits available to an employer are increased by the amount of the employer’s liability for Medicare tax on wages paid under the Act, effectively exempting the emergency sick leave and FMLA payments from that tax as well. In this way, the Act provides employers with two tax benefits: (1) refundable credits against the employer’s portion of Social Security or RRTA tax; and (2) an exemption from, or credit against, the employer’s portion of Social Security or RRTA and Medicare taxes on the wages required to be paid under the Act.

However, the law does not exempt these payments from the definition of wages for the purpose of other taxes (including the employee’s portion of Social Security, RRTA and Medicare taxes).

The Act ensures there is no negative impact to the Social Security program caused by the tax credit or the exemption of sick pay and family leave pay from Social Security tax by authorizing a transfer of funds from the General Fund to the Social Security and disability insurance trust funds to replace the lost employer contributions. The tax provisions discussed herein will apply beginning on a date to be determined by the Secretary of the Treasury after the enactment of the Act and ending on December 31, 2020.