Note: The ERC has ended as of 9/30/2021 for most companies.
On August 4, 2021, the Internal Revenue Service (IRS) issued its third round of guidance on the Employee Retention Credit (ERC)—IRS Notice 2021-49. The guidance addresses changes to the ERC included in the American Rescue Plan Act (ARP) of 2021 and also answers longstanding questions that have lingered since the ERC was expanded in the CARES Act in April of 2020. On August 10, 2021, the IRS then issued Revenue Procedure 2021-23, which provided some clarity around the definition of gross receipts.
During this same week, Congress signaled that as part of its $1 trillion infrastructure bill, the ERC will end one quarter early in an effort to fund some of that spend, even while Covid-19 cases are rising nationwide.
As a reminder, the ERC under the CARES Act encourages businesses to keep employees on their payroll. For eligible employers financially impacted by Covid-19, the refundable tax credit is 50% of up to $10,000 in wages paid. For background context on the ERC, interaction with Paycheck Protection Program (PPP), and related legislation, consider reading Employee Retention Credit – IRS Updates Guidance on PPP Coordination Issues and More before reviewing the latest guidance. We encourage you to also explore the IRS’ ERC FAQs, which have also been updated for IRS Notice 2021-49.
This update serves to help employers understand the latest guidance regarding business size and associated definitions, wage deduction disallowances, and other related legislature.
Full-Time Employee Defined
Your employee count is what determines if you are a small (100 or fewer employees in 2019) or large (more than 100 employees in 2019) for purposes of the ERC. To that affect, the new guidance specifies that eligible employers are not required to include full-time equivalents when determining the number of full-time employees. As a result, this should allow more employees to fall under the favorable treatment afforded eligible small employers.
Wage Disallowance Timing
Similar to how the wage deduction related to other employment tax credits, like the Work Opportunity Tax Credit (WOTC), an employer receiving benefits from the ERC must reduce the deduction for those same wages by the amount of the credit. This deduction decrease also applies to any qualified health plan expenses that generate an ERC. This reduction of wage expense is often overlooked and differs from the way the PPP operated. After receiving many questions about the timing of the deduction disallowance, the Treasury and the IRS provide for the following:
- The wage and benefit reduction occurs for the year in which the wages and benefits were paid or incurred, not in the year the ERC benefit is received. This is in line with how the rules work for similar credits (WOTC, R&D).
- If an employer receives an ERC benefit in 2021, or even 2022, from amending previously filed payroll tax returns and the related wages were deducted on their 2020 income tax return, the employer must amend their 2020 income tax return. Employers structured as pass through entities would then provide amended Schedule K-1s to its members, who would also need to amend their 2020 income tax returns.
Related Party Wages
For months, employers and their advisors had wondered and asked about various forms of related party wages and how those wages would be treated for purposes of the ERC. While the statute provided some guidance, questions regarding owner spouses and other relationships have remained since the CARES Act became effective. In Notice 2021-49, the IRS provides some assistance:
- Wages paid to majority owners of a corporation, and their spouses, are generally not eligible wages for purposes of the ERC.
- However, if the majority owner and their spouse do not have siblings or children, their wages would otherwise qualify.
- It is possible that a minority owner’s wages could be excluded under certain circumstances.
- See examples 3 and 4 in Notice 2021-49 (page 31) for more details.
- One may choose an “alternative quarter” to determine if they are an eligible employer for purposes of the revenue declination rules for Q3 of 2021, then use a different benchmark for Q4 of 2021. See page 32 of the notice for details.
- Recovery Startup Businesses are defined within the notice to essentially be small businesses with less than $1 million in revenue.
- IRS Revenue Procedure 2021-23 clarified that for purposes of the test that one needs to meet to be eligible for the ERC, PPP loan forgiveness income and grants from the Shuttered Venue and Restaurant Revitalization programs can be excluded from the definition of gross receipts.
- Employers receiving benefits from the Shuttered Venue and Restaurant Revitalization programs may not utilize that same wage spend to generate ERC benefits, just like the rules in place for PPP loans.
- There will be a 5-year statute of limitations on ERC claims made for the third and fourth quarters of 2021
Employers should thoroughly review the provisions above to take advantage of all potential credits. Careful attention should be paid to the ERC to determine potential qualifying wages considering the latest guidelines. If you have any questions on any of the credits discussed above, please contact the SC&H Tax Team.