In March 2020, the Employee Retention Credit (ERC) was enacted as part of the CARES Act to benefit companies impacted by government orders due to COVID-19 or that experienced a significant decline in gross receipts compared to 2019. It was also designed to reward those companies who kept employees on the payroll. For 2020 and the first two quarters of 2021, many companies have been evaluating their eligibility for the ERC.
The ERC is a refundable payroll tax credit against an employer’s share of FICA taxes. When enacted by the CARES Act, the ERC was equal to 50 percent of the qualified wages paid by an eligible employer to employees after March 12, 2020, and before January 1, 2021, up to $10,000. The maximum ERC for 2020 was $5,000 per employee.
The Consolidated Appropriations Act, 2021 extended the ERC to the first and second quarters of 2021. Along with that extension, the credit percentage (increased to 70 percent of qualified wages), definition of significant decline in gross receipts (20 percent reduction as compared to the same quarter in 2019), and definition of small employer (adjusted to be less than 500 FTEs) were all modified. As a result, the maximum ERC for 2021 was increased to $7,000 per employee per quarter.
Previous notices from the Treasury Department and Internal Revenue Service (IRS) provided answers to some pertinent questions on the application of the ERC rules through the second quarter of 2021. Then, on August 4, 2021, the Treasury Department and IRS released further and much-anticipated guidance on the ERC. This guidance, Notice 2021-49, clarifies the treatment of certain new provisions added by the American Rescue Plan Act of 2021 and applicable for the third and fourth quarters of 2021, as well as on issues applicable to the ERC for both 2020 and 2021.
Guidance related to the American Rescue Plan Act of 2021
Some of the new provisions applicable to the third and fourth quarters of 2021 are as follows:
- Recovery startup business: For a business that began its operations after February 15, 2020, had average annual gross receipts of less than $1 million and did not otherwise qualify for the credit, a credit of up to $50,000 for each of the third and fourth quarters is available. The qualified wages are determined as if the recovery startup business is a small employer.
- Determination of qualified wages for a severely distressed employer: Notice 2021-49 defines a severely distressed employer as one that the gross receipts for a calendar quarter are less than 10 percent of the gross receipts from the same quarter in 2019. If an employer is severely distressed, it may claim all wages paid during the quarter as qualified wages, even if it is a large employer.
Guidance related to issues applicable to the ERC for both 2020 and 2021
Since the enactment of the ERC, there have been many questions around certain aspects of qualifying for, calculating, and claiming the credit. The following are issues that have been addressed via Notice 2021-49:
- Determination of the number of full-time employees (FTEs) in determining qualified wages: In computing the number of FTEs, you are not required to include full-time equivalents in the calculation. Instead, you look at the number of employees that had an average of 30 hours per week or 130 hours in the month of services provided as laid out in IRC 4980H.
- Treatment of tips: Notice 2021-49 has clarified that tips earned by employees, if the total tips in a calendar month are more than $20, are considered qualified wages up to the maximum eligible wages based on the applicable year’s rules, as long as all other requirements to treat the amounts as qualified wages are satisfied. Additionally, tips that are used to compute the section 45B credit may also be used to claim the ERC.
- Timing of disallowance of wage deduction: The amount of the reduction to the deduction for qualified wages caused by the ERC must be taken in the year the qualified wages were paid or incurred. This means that companies that filed their 2020 income tax returns prior to claiming the ERC must amend their returns.
- Determination of qualified wages for related individuals: The provisions of section 267(c) must be considered when determining whether the owner and his or her spouse’s wages are qualified wages. In certain situations, through attribution of stock ownership, the owner and his or her spouse’s wages will not be qualified wages eligible for the ERC.
- Use of alternative quarter election: The election to use the alternative quarter election is available on a quarterly basis. It is not required to be used in a later quarter if previously elected.
- Significant decline in gross receipts: Notice 2021-49 allows companies to continue using the safe harbor laid out in Notice 2021-20 to determine if there is a significant decline in gross receipts where a company acquires a business in 2021.
Even though the ERC was extended through the end of 2021, the recently released draft of the Infrastructure Bill being considered in Congress will end the ERC after the third quarter of 2021. We continue to monitor this legislation and the impacts it may have on the ERC.
Article written by:
Sara Goldhardt, CPA
Director, State & Local Tax Services
Kevin Dunn, CPA
Director, Tax & Business Advisory Services