The Internal Revenue Service (IRS) offers further ERC guidance on computations for enterprises that are very new, the wages of majority owners, the treatment of PPP debt forgiveness as gross receipts, and more.
In the form of a Notice and a Revenue Procedure, the Internal Revenue Service (IRS) has released more relevant guidance about the Employee Retention Credit (ERC).
Notice 2021-49, which was published on August 4, clarifies and expands upon previous IRS guidance for the purposes of ERCs that are available for the third and fourth quarters of 2021 (in accordance with the newly enacted IRC Section 3134). (It is important to note that if the Bipartisan Infrastructure Investment and Jobs Act were to be passed in its current proposed form, it would generally stop the availability of the ERC for the fourth quarter of 2021; we are monitoring the progress of the legislation and will give updates.)
The Notice also includes responses to several seemingly common taxpayer and taxpayer representative ERC-related questions, some of which have been deemed unresolved until now and which are of considerable importance. The most prominent of these questions are listed below. Take note that all comments are applicable to all years, not just the third and fourth quarters of 2021.
An employer is able to exclude from their gross receipts the amount of loan forgiveness they received from the Paycheck Protection Program (PPP) as well as grant amounts from other pandemic relief programs thanks to Revenue Procedure 2021-33, which was issued on August 10th. This is done so that ERC eligibility can be determined.
Continue reading for further information on these two recent releases, or jump forward to Revenue Procedure 2021-33.
Public Notices 2021-49
Regarding employers who will not be present in 2022
Regarding qualified wages, the distinction between “small employer” and “large employer” status is important.
In general, an employer can qualify for an ERC if it either 1) completely or partially suspends its operations as a result of a government order limiting commerce, travel, or group meetings as a result of COVID-19 or 2) experiences a decline in gross receipts in comparison to a certain quarter in 2019. This is despite the fact that the specific rules for 2020 and 2021 will be different. Subject to a number of restrictions, the amount of the ERC is calculated as a percentage of the “Qualified Wages” that were paid to each employee during the appropriate suspension period or quarter. Details may be found in our comprehensive overview of the ERC.
The ERC amount that applies to a “Small Employer” can be calculated by taking into account all of the Qualified Wages and/or Qualified Health Plan Expenses paid during an applicable quarter or suspension period (subject to the applicable $10,000 limit and the requirement that there be no double-dipping). On the other hand, a “Large Employer” can only calculate its ERC based on Qualified Wages and/or Qualified Health Plan Expenses paid to or for employees during an applicable quarter or suspension period for periods that they were not providing services. In other words, a “Large Employer” cannot determine its ERC based on any other factors (e.g., furloughed employees). The number of full-time employees that an employer has on average in their controlled group for the calendar year 2019 is the test that determines whether or not the employer is considered a small or large employer.
The Notice restates previously issued guidance by confirming that the test is to be based on the number of full-time employees in the controlled group of the employer for the calendar year 2020 even if the employer did not exist in 2019. This is because the Notice is intended to reinforce the existing guidance.
Significant reduction in gross receipts
An employer can generally be eligible for ERC status by virtue of the fact that its controlled group has experienced a “significant decline” (greater than 50 percent for a 2020 ERC or greater than 20 percent for a 2021 ERC) of its gross receipts for a calendar quarter in 2020 or 2021 as compared to the same quarter in 2019. This is an alternative to the employer having experienced a partial suspension of its business operations. (The employer also has the option of testing on the basis of the quarter that immediately before the most recent quarter in order to test eligibility for a 2021 ERC.)
The notice makes reference to the existing guidance that states that the test must be based on the employer’s gross receipts for the calendar year 2020 if the employer did not exist in 2019. Additionally, the notice makes reference to the existing guidance that is applicable to an employer that came into existence for the first time in 2019.
Full-time employees vs. full-time equivalent employees
The Notice specifies that for the purpose of determining an employer’s status as a Large Employer or Small Employer, in determining a controlled group’s full-time employees for 2019 (or 2020 for employers not in existence in 2019), the test is based on the number of “full-time employees” (130 hours or more per month or on average, 30 hours or more per week), as opposed to the number of “full-time equivalent employees” (the applicable standard for Affordable Care Act purposes).
ERC no double-dipping rule
The Notice makes it very clear that the same wages of an employee cannot be utilized both to produce an ERC and as payroll expenditures for the purposes of the following government programs:
- Waiver of a portion of the loan for the first or second draw under the Paycheck Protection Program
- Operators of Closed Venues are Eligible for a Grant
- Restaurant Revitalization Fund grant
In a manner that is analogous to the existing guidance that is applicable to PPP loans, the Notice stipulates that an ERC-eligible employer that receives a grant from the Restaurant Revitalization Fund or the Shuttered Venue Operators Grant is required to keep in its ERC records documentation supporting the fact that it did not “double-dip” wages under the ERC and under either of the grants.
The Use of Gratuities as Qualified Wages
The Notice clarifies that tips that are considered wages for the purpose of FICA taxes are eligible to be Qualified Wages, and that it is possible to claim both the FICA tip credit (IRC Section 45B) and an ERC with regard to the same wages.
Deduction for amount retirement contributions taken out of the federal income tax withheld by the employer
According to the guidance that is currently in place, the amount of an employer’s ERC for a given year is supposed to have a dollar-for-dollar impact on the employer’s ability to deduct compensation expenses from their federal income tax return. When an employer amends an employment tax return (Form 941) from a prior year by filing Form 941-X to claim a retroactive ERC, the question has arisen as to whether or not the employer is required to amend its federal income tax return to reduce the compensation deduction taken on that return if it has already filed its income tax return for the tax year for which it claims the ERC. This is the case if the employer has already filed its income tax return for its tax year for which it claims the E
The Notice specifies that in the event that an ERC is claimed on a retroactive basis for a tax year of the employer for which the employer’s federal income tax return has already been filed, the employer is required to file an amended income tax return in order to reduce its compensation deduction by the amount of the ERC claimed for that year.
Exclusion from the calculation of qualified wages of wages earned by related people
According to the current guidance, wages that are provided to employees who have any of the following ties to a majority owner of a business or partnership are not considered to be qualified wages.
- A child or someone who is a child’s descendent
- A biological or step sister, including a stepbrother or stepsister
- A parent, a parent’s ancestor, or either parent’s ancestor
- Either an adoptive father or adoptive mother
- A niece or an uncle’s son
- Aunt or uncle
- Your son-in-law, your daughter-in-law, your father-in-law, your mother-in-law, your brother-in-law, or your sister-in-law
- A person (other than a spouse) who resides in the same dwelling as the head of the home and is considered to be a member of the family
In addition, in accordance with the current guidance, the rules of constructive ownership outlined in IRC Section 267(c) apply.
The combination of the aforementioned rules has resulted in uncertainty over the question of whether or not it is possible for the wages of a majority owner of a firm and/or the members of the owner’s family to be qualified wages that are eligible for the ERC. (As a reminder, the earned income of a partner or any other individual who is self-employed does not constitute “Qualified Wages” for the purposes of the ERC.) The Notice states the following with reference to this matter:
If a majority owner of a corporation does not have a brother or sister (either by whole or half-blood), an ancestor, or a direct descendant, then the owner’s wages and/or the wages of the owner’s spouse are eligible to be Qualified Wages. This applies even if the owner is related to the other person through a different line of ancestry.
The wages of a majority owner of a corporation who has a brother or sister (by whole or half-blood), ancestor, or lineal descendant are not eligible to be Qualified Wages since they are considered to be related to the majority owner in some way.
If the majority owner has a brother or sister (whether by whole or by half-blood), ancestor, or lineal descendant, and the spouse and family member share one of the familial ties specified above, then the wages of the majority owner’s spouse are not eligible to be Qualified Wages.
Even if the relative is not an employee of the business, these rules still apply. For instance, if a majority owner has a brother, even though the brother is not an employee of the firm, the majority owner’s wages are not eligible to be considered ERC-eligible Qualified Wages.
Specific rules are provided for computing the total gross receipts of a business purchased in the year 2021.
The current guidance allows an employer that bought a business in 2020 to include the 2019 gross receipts of the acquired business as part of the employer’s 2019 gross receipts. This is done for the purpose of passing the “substantial fall in gross receipts” test (i.e., even though the employer did not own the business in 2019). According to the Notice, an employer who bought a business in 2021 will also be entitled to use the 2019 gross receipts of the acquired business as part of the employer’s 2019 gross receipts for the purposes of the ERC.
Procedure Regarding Revenue 2021-33
The cancellation of PPP receipts and gross revenue
As was discussed earlier, the “substantial fall in gross receipts” test is one of the two potential pathways that an employer can take in order to become eligible to claim an ERC for a calendar quarter that is available in either 2020 or 2021. An employer’s Paycheck Protection Program (PPP) loan forgiveness amount (as well as other pandemic relief program grant amounts) was required to be included in the employer’s gross receipts for this purpose for the quarter in which the loan was forgiven. This often had an impact on the test result and could have made it impossible for the employer to pass the test. However, as of right now, this requirement has been lifted.
An employer has the ability, under the provisions of Revenue Procedure 2021-33, to omit the following amounts from its gross receipts for the purposes of the test:
- Amount of the PPP loan that was forgiven
- Amount of the Grant for Shuttered Venue Operators
- Restaurant Revitalization Fund grant amount
To take advantage of this opportunity, the employer and all members of its ERC controlled group may choose to exclude these amounts from the controlled group’s gross receipts for the purposes of the test; however, in order to take advantage of this opportunity, all members of the controlled group are required to do so for all such amounts for all such tests.
What are CohnReznick’s Opinions on the Matter?
The guidance provided in the Notice does not include any genuine surprises and is, for the most part, consistent with what we believed to be the rules. The only exception to this is the exclusion of wages earned by related people from the definition of qualified wages. However, the clarification in the Notice that the application of double attribution applies for the purposes of the related individuals’ wages exception is disappointing. This is due to the fact that the mere fact that a majority owner of a corporation has a sibling, parent, child, or grandchild, even in the case where that individual does not work for the corporation, will prevent the wages of both the owner and the owner’s spouse from being considered Qualified Wages.
If an employer would have otherwise failed the ERC significant decline in gross receipts test but now has the ability, under Revenue Procedure 2021-33, to exclude the amount of a forgiven PPP loan, as well as the amounts of any grants received from the Shuttered Venue Operators and Restaurant Revitalization Funds, this new ability may allow them to pass the test.
As was mentioned earlier, it is also essential to keep in mind that the infrastructure legislation that is currently being considered in Congress would, for the purpose of raising additional revenue, note it impossible for the majority of employers to qualify for the ERC beginning in the fourth quarter of 2021. Keep an eye out for any updates on our website.
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