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IRS Issues Important New Guidance on ERCs

September 13, 2021

Employers, you’ll want to read up on recent guidance from the IRS on the employee retention credit or ERC.

*Editor’s Note: For the most recent information regarding employee retention credits, please visit our blog- Congress Ends ERC Early, posted November 10, 2021.

The Employee Retention Credit (ERC) was created under the CARES Act to provide financial relief to employers who kept workers on the payroll during the COVID-19 pandemic. Subsequent legislation expanded and extended the ERC through the end of 2021. But beware: Congress is currently considering an infrastructure bill that, if enacted, would end the ERC early.

The IRS recently issued Notice 2021-49 to help employers claim this credit. The original rules have been modified by the Consolidated Appropriations Act (CAA) and the American Rescue Plan Act (ARPA). Here are the highlights of recent IRS guidance on this matter.

Applicable Employment Taxes

The guidance clarifies that employers are entitled to claim the credit against their share of Social Security and Medicare taxes for the third and fourth quarters of 2021. Plus, the excess is refundable. In previous quarters, employers could claim the credit only against Social Security taxes.

Maximum Credit

The CAA made two major changes to the ERC for 2021. First, it increased the overall covered wage ceiling from 50% to 70% of qualified wages paid during the applicable quarter. In addition, it increased the per-employee covered wage ceiling to $10,000 of qualified wages paid during the applicable quarter.

So, for 2021, the maximum ERC is $7,000 per employee per quarter (70% × $10,000) or $28,000 for the tax year. For 2020, the maximum credit was only $5,000 per employee for the entire tax year.

Recovery Startup Businesses

A separate limit applies to recovery startup businesses. The ARPA expanded the definition of “recovery startup business” to include employers that 1) began operating after February 15, 2020, and 2) have average annual gross receipts for the three previous tax years of less than or equal to $1 million. Employers that meet these requirements can now claim the credit without suspended operations or reduced receipts, up to $50,000 total per quarter for the third and fourth quarters of 2021.

The guidance says operations begin once an employer starts functioning as a going concern and performing the activities for which it was organized. The determination of whether an employer is a recovery startup business is made each quarter.

Severely Financially Distressed Employers

When claiming the ERC, large employers with more than 500 employees are generally subject to a more stringent standard when computing the qualified wage base. However, businesses that suffered a decline in quarterly gross receipts of 90% or more compared to the same calendar quarter in 2019 are considered “severely financially distressed employers” under the ARPA. These businesses, regardless of size, may count as qualified wages any wages paid to an employee during any calendar quarter.

Employee Status

The guidance clarifies the definition of a “full-time employee.” Specifically, employers aren’t required to include full-time equivalents when calculating the average number of full-time employees for purposes of determining whether an employer is a large or small eligible employer. In addition, full- or part-time status isn’t relevant for purposes of identifying qualifying wages.

Prohibition on Double-Dipping

The guidance notes that employers can’t claim multiple credits on the same wages. That means you can’t claim the ERC on wages already taken into account when applying for the following business tax credits:

  • The research and development credit,
  • Empowerment zone and work opportunity credits, and
  • Credits for COVID-related paid sick and family leave.

In addition, recipients of a Shuttered Venue Operators grant or a Restaurant Revitalization Fund grant may not treat any amounts taken into account as payroll costs for those programs as qualified wages for ERC purposes. And, when calculating the ERC, the same wages can’t be used when applying for Paycheck Protection Plan (PPP) loan forgiveness. (But, under the CAA, the ERC can be claimed for qualified wages paid with proceeds from PPP loans that aren’t forgiven.)

Other Loose Ends

The guidance addresses other miscellaneous issues related to the ERC, including:

  • The treatment of tips as qualified wages and the interaction with the section 45B credit,
  • The timing of the qualified wages deduction disallowance and whether employers that already filed an income tax return must amend that return after claiming the ERC on an adjusted employment tax return, and
  • Whether wages paid to majority owners and their spouses may be treated as qualified wages.

Important: The family attribution rules could significantly reduce the ERC for family businesses. The guidance also suggests that wages paid to minority owners could be excluded when claiming this credit.

Safe Harbor for Gross Receipts

Additional guidance issued by the IRS — Revenue Procedure 2021-33 — provides a safe harbor that allows employers to exclude certain items from gross receipts when determining eligibility for the ERC. Examples include:

  • Forgiven PPP loan amounts,
  • Shuttered Venue Operators grants, and
  • Restaurant Revitalization Fund grants.

An employer isn’t required to apply the safe harbor when determining eligibility for the ERC. But it must be applied consistently for all quarters in the tax year.

For More Information

Many businesses are unsure about how to calculate or claim the ERC. Our tax specialists understand how the rules have evolved since March 2020 and can help you take advantage of this tax-saving opportunity. We’re also monitoring proposed legislation that would eliminate the ERC for the fourth quarter of 2021 — and can help you plan accordingly if it’s enacted.

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