IRS issues additional ERC guidance
On Aug. 4, 2021, the IRS released Notice 2021-49 (Notice), which amplifies both Notice 2021-20 and Notice 2021-23 by providing additional guidance on the employee retention credit (ERC), applicable to the third and fourth calendar quarters of 2021. Specifically, the Notice addresses changes made to the ERC by the American Rescue Plan Act of 2021 (ARPA). Additionally, the Notice includes guidance on several miscellaneous issues with respect to the credit for both 2020 and 2021.
Before addressing the guidance contained within the Notice, it’s important to note that the Senate, as a means of funding the bipartisan infrastructure bill (see our previous tax alert, Bipartisan infrastructure bill moves forward), has proposed ending the employee retention credit (ERC) program three months early (i.e., eliminating the credit for the fourth quarter of 2021). The House, however, is on recess until Sept. 20, 2021, creating a narrow window for Congress to eliminate the ERC for the fourth quarter of 2021 (without making the change retroactive). The Notice provides that Treasury and the IRS will continue to monitor potential legislation related to the ERC that may impact certain rules it covers. We will continue to monitor updates and issue additional communications as new information becomes available.
Key takeaways
Wages paid to majority owners and their spouses\
The IRS gave much awaited clarification to employers eager for guidance on the ability to treat wages paid to majority owners (more than 50%) and their spouses as qualified. The guidance, however, is very taxpayer unfriendly as it, in effect, provides that majority owners and their spouses can only treat their wages as qualified to the extent they do not have any living related individuals (ancestors, lineal descendants, siblings and step-siblings, aunts and uncles, nieces and nephews, in-laws, or other individuals) sharing the same principal place of abode as the taxpayer.
To clarify, this is not limited to employed related individuals, but to any living related individual considered to have constructive ownership in the business by application of a set of incredibly wide-reaching attribution rules. In short, if the majority owner has any living family other than their spouse (by blood or marriage), their wages cannot be qualified.
The Notice gives the following illustrative examples:
Example 2: Corporation B is owned 100 percent by Individual G. Individual
H is the child of Individual G. Corporation B is an eligible employer with respect to the first calendar quarter of 2021. Individual G is an employee of Corporation B, but Individual H is not. Pursuant to the attribution rules of section 267(c) of the Code, Individual H is attributed 100 percent ownership of Corporation B, and both Individual G and Individual H are treated as 100 percent owners. Individual G has the relationship to Individual H described in section 152(d)(2)(C) of the Code. Accordingly, Corporation B may not treat as qualified wages any wages paid to Individual G because Individual G is a related individual for purposes of the employee retention credit.
Example 3: Corporation C is owned 100 percent by Individual J.
Corporation C is an eligible employer with respect to the first calendar quarter of 2021. Individual J is married to Individual K, and they have no other family members as defined in section 267(c)(4) of the Code. Individual J and Individual K are both employees of Corporation C. Pursuant to the attribution rules of section 267(c), Individual K is attributed 100 percent ownership of Corporation A, and both Individual J and Individual K are treated as 100 percent owners.
However, Individuals J and K do not have any of the relationships to each other described in section 152(d)(2)(A)-(H) of the Code. Accordingly, wages paid by Corporation C to Individual J and Individual K in the first calendar quarter of 2021 may be treated as qualified wages if the amounts satisfy the other requirements to be treated as qualified wages.
Timing of qualified wage deduction disallowance for income tax reporting
Employers receiving the ERC must reduce their deductions for compensation expenses to the extent of the credits received. Prior to this Notice, the timing of that deduction disallowance has been a subject of question, especially in scenarios where the credit is claimed for a quarter in a prior year via Form 941-X. The Notice provides the deduction must be disallowed in the tax year during which the qualified wages giving rise to the credit were paid or incurred.
If a taxpayer has claimed the ERC in 2020 because of the retroactive amendment allowing PPP loan borrowers to claim the ERC or otherwise file an adjusted employment tax return (Form 941-X) to claim the ERC, the Notice makes clear that the taxpayer must file an amended federal income tax return or, if applicable, a partnership subject to the Centralized Partnership Audit Regime must file an Administrative Adjustment Request to reduce the deduction for the wages on which the credits were claimed.
Treatment of restaurant tips and coordination with the § 45B “tip credit”
The Notice provides that cash tips received by an employee in a given calendar month amounting to $20 or more can be treated as qualified wages for ERC purposes assuming the other requirements are met.
Additionally, the guidance clarifies that eligible employers are not prohibited from claiming the ERC and § 45B “tip credit” on the same wages, again, if all other requirements are satisfied.
Recovery Startup Businesses
The ARPA created a new class of eligible employers for Q3 and Q4 of 2021, Recovery Startup Businesses (RSB). An RSB is an employer:
- That began operating a trade or business after Feb. 15, 2020,
- Whose average annual gross receipts over a certain period do not exceed $1M, and
- That is not otherwise eligible under the Gross Receipts or Suspension Tests.
Pursuant to the Notice, for purposes of determining whether the first requirement is met, an RSB is not deemed to have begun 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.” Additionally, the Notice clarifies that tax-exempt entities can be eligible as RSBs, the RSB determination is made on a quarterly basis (regarding whether the employer is otherwise eligible under the Gross Receipts or Suspension Tests), and the aggregation rules that otherwise apply to the ERC apply when making that determination.
Severely financially distressed employers
The ARPA additionally provides that for Q3 and Q4 an employer whose gross receipts declined more than 90% from the corresponding quarter in 2019 is a Severely Financially Distressed Employer (SFDE). An SFDE may treat all wages it paid during such quarter as qualified, regardless of their status as a large or small employer. Pursuant to the Notice, the same rules under the Gross Receipts Test per Notices 2021-20 and 2021-23 apply for purposes of determining whether an employer is an SFDE, to include:
- An employer that was not in existence during 2019 can use the relevant quarter in 2020 for the reference period, and
- An employer can elect to use its gross receipts from the immediately preceding calendar quarter to determine whether it is an SFDE.
Additional items
Lastly, the Notice makes clear that full-time equivalent (FTE) employees are not included when determining whether an employer is large or small, but wages paid to FTEs can be qualified, and the election to use the gross receipts from the previous quarter to determine eligibility in 2021 is not irrevocable.
We encourage you to reach out to your Baker Tilly advisor regarding how any of the above may impact your situation.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
