The employee retention credit (ERC) is turning into the gift that keeps on giving.
It was enacted on March 27, 2020 as part of the CARES Act, and then was expanded greatly on December 27, 2020 by the Consolidated Appropriations Act, 2021, which among other things eliminated the ban on the ERC if a taxpayer received a paycheck protection program (PPP) loan. We summarized those changes here. Congress then expanded the ERC to the last two quarters of 2021 in the American Rescue Plan Act of 2021, enacted on March 11, 2021, and added a new section to the Internal Revenue Code, §3134. We summarized those changes here.
The IRS has weighed in on the ERC too. It issued 94 frequently asked questions (FAQs) on its website and a 102-page notice, Notice 2021-20, on March 1, 2020, explaining the workings of the 2020 ERC.
Most recently, on April 2, 2021, the IRS issued Notice 2021-23 (Notice) concerning the ERC for the first two quarters of 2021. At 17 pages, it is a light read compared to the previous 102-page notice. According to the IRS press release accompanying Notice 2021-23, the Notice explains the changes to the ERC for the first two quarters of 2021, including:
- the increase in the maximum credit amount,
- the expansion of the category of employers that may be eligible to claim the credit,
- modifications to the gross receipts test,
- revisions to the definition of qualified wages, and
- new restrictions on the ability of eligible employers to request an advance payment of the credit.
The IRS also stated that it will provide further guidance regarding the ERC for the third and fourth quarters of 2021.
Let’s now discuss the details and practical implications of Notice 2021-23.
- Eligible employers –
- The Notice states that tax-exempt organizations qualify for the ERC, and adds that public colleges and universities qualify, as well as governmental entities whose principal purpose or function is to provide medical or hospital care, provided they satisfy the other requirement of an eligible employer. This is good news for these organizations, but it is also welcome news for tax-exempt elementary and secondary schools. While it is unclear exactly how the partial shutdown rules apply to these organizations, at least the IRS acknowledges that educational organizations can qualify.
- Decline in gross receipts –
- Decline in gross receipts threshold is reduced from 50% for the 2020 ERC to 20% for the 2021 ERC.
- Comparison is 2021 v. 2019, so Q1 2021 v. Q1 2019, and Q2 2021 v. Q2 2019.
- Businesses can elect to qualify using gross receipts from the immediately-preceding calendar quarter.
- For Q1 2021, the election involves a comparison of Q4 2020 v. Q4 2019. If a business was not in existence as of the beginning of Q4 2019, then the election cannot be made.
- For Q2 2021, the election involves a comparison of Q1 2021 v. Q1 2019. If a business was not in existence as of the beginning of Q1 2019, then the election involves a comparison of Q1 2021 v. Q1 2020.
- Most helpful is that the election can be made for either quarter and it does not need to be made for both quarters. This allows a taxpayer that meets the test for one quarter to qualify for two quarters of the 2021 ERC. For example, if a business has a Q1 2021 decline in gross receipts of more than 20%, then it can claim the ERC for Q1 2021, and Q2 2021 using the election. There was concern that the IRS would require an all-or-nothing approach to the election, but it did not and this is great news for businesses.
- Businesses can elect to qualify using gross receipts from the immediately-preceding calendar quarter.
- If a business was not in existence at the beginning of any calendar quarter in 2019, then the comparison is to the same quarter in 2020.
- Amount of the ERC –
- The ERC is 70% of eligible wages and healthcare costs up to $10,000 per employee for the relevant calendar quarter. This means that the ERC resets each quarter; thus, the maximum credit per employee is $14,000 for the first two quarters of 2021.
- Qualified wages –
- As expected, the amount depends on the monthly average of full-time employees during 2019. Thus, if a business had on average 500 or less full-time employees in 2019 (a “small eligible employer”), then eligible wages include wages paid to all employees (i.e., for time providing services and for time not providing services) even if the employer has more than 500 employees in 2021. Recall this threshold is 100 employees for the 2020 ERC.
- If a business had more than 500 full-time employees in 2019 (a “large eligible employer”), then qualified wages are limited to those wages paid to employees for time they did not perform services.
- It remains unclear whether part-time employees are included in the determination of the number of “full-time employees.” The Bluebook to the CARES Act, prepared by the Joint Committee on Taxation, states at footnote 145 that part-time employees are included in the calculation, but the IRS has addressed the issue multiple times and refuses to state with clarity whether part-time employees are included, referring generally to §4980H. In Notice 2021-23, however, the IRS went further than it has previously – it referenced §4980H(c)(4), the section that includes full-time employees, instead of providing a generic reference to §4980H, which includes a provision that seems to require the inclusion of part-time employees. Although not entirely clear, this suggests that part-time employees should not be included in the calculation.
- The exclusion of part-time employees would expand the 2020 and 2021 ERCs dramatically. For example, if a business had 450 full-time employees and 800 part-time employees in 2019, and the same number of employees in 2021, then it could qualify for the 2021 ERC with respect to all the wages of its 1,250 employees.
- The aggregation rules apply for purposes of determining the number of employees in 2019, and presumably for the eligibility determination and the determination of the maximum amount of credit per employee too.
- The 2020 wage limitation for large eligible employers does not apply to the 2021 ERC. Recall this rule limits wages paid by large eligible employers to the amount paid during the 30 days preceding the period of the shutdown or the first day of the quarter in which there was a decline in gross receipts.
- Just like with the 2020 ERC, wages used to support the 2021 ERC may not be used to claim credits under §§45S, 41, 45A, 45P, 51, and 1396; however, an employer can use the same wages to claim the 2021 ERC and the work opportunity credit under §51.
- Claiming the credit
- Businesses can access the 2021 ERC by withholding required deposits of federal income and payroll taxes. The IRS provided penalty relief in Notice 2020-22 for businesses that take this route.
- If the amount of the ERC exceeds the quarterly withholding, then small eligible employers may request an advance on the credit by filing the Form 7200 or the new Form 941 (Rev. 3-2021). Note the amount of the advance generally is limited to 70% of the average quarterly wages paid in calendar year 2019, determined after applying the aggregation rules. Advance payments are not available to large eligible employers.
- Reports of delays in the refund process suggest that reductions in withholding may provide quicker access to ERC funds.
Finally, although not mentioned in the Notice, recall that the amount of the 2021 ERC will be taxable in 2021 by virtue of expense disallowance, so businesses should keep this in mind when preparing quarterly estimates. You can read more about the taxation of the ERC here.
Withum tax advisor.