On August 4, 2021, the Internal Revenue Service (IRS) released Notice 2021-49 which provided additional guidance and clarification for the Employee Retention Credit (ERC) for quarters 3 and 4 of 2021.
For all quarters of 2021, the employee retention credit can be claimed against “applicable employment taxes.” For the third and fourth quarters of 2021, the definition of “applicable employment taxes” has been expanded to include the employer’s portion of Medicare tax (or equivalent portion of Tier 1 tax under the Railroad Retirement Tax Act in addition to the employer’s portion of Social Security tax which has been allowed since the inception of the ERC.
There have been no changes to the limit of $10,000 of eligible wages, including allocable qualified health plan expenses per employee per quarter (same as the 1st and 2nd quarters of 2021). The credit is calculated as 70% of the eligible wages for the quarter, which would be a maximum credit amount of $7,000 per employee per quarter. For the 3rd and 4th quarters of 2021, there is another limit imposed for recovery startup businesses that does not allow the credit for either quarter to exceed a total credit of $50,000 per quarter after the application of the $10,000 wage limit.
The definition of an eligible employer has been expanded for quarters 3 and 4 to include a new category of “recovery startup business”. An eligible employer is now defined as an employer carrying on a trade or business (1) whose trade or business’s operations is fully or partially suspended due to orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19; (2) that experiences a decline in gross receipts (50% or more for quarters in 2020 and 20% or more for quarters in 2021); or is a recovery startup business.
A recovery startup business is defined as an employer that is not otherwise an eligible employer under conditions (1) or (2) of the preceding paragraph, that began carrying on any trade or business after February 15, 2020, and for which the average annual gross receipts of the employer for the three-taxable-year period ending with the taxable year that precedes the calendar quarter for which the credit is determined does not exceed $1,000,000.
Tax-exempt organizations may also qualify for ERC if they meet the requirements for an eligible employer as described above. While the extension of the ERC given under the American Rescue Plan Act of 2021 did not specifically provide that these types of organizations can be an eligible employer due to being a recovery startup business, the IRS and Treasury have determined it is appropriate to treat them as eligible employers if they can meet the requirements of a recovery startup business. The law also did not specifically state that the recovery startup business may be treated as small eligible employers (those with 500 full-time employees or fewer). This notice provides that the IRS and the Treasury have concluded it is appropriate to apply the small eligible employer rule as is it applies to recovery startup businesses.
For the 3rd and 4th quarters of 2021, there is also some relief from the large and small employer determination when calculating full-time employees to determine what wages are eligible for the calculation of the credit for those employers who are considered “severely financially distressed employers.” “Severely financially distressed employer” is defined as an employer that is an eligible employer based on a decline in gross receipts, but the gross receipts for the eligible employer for the calendar quarter are less than 10 percent of the gross receipts as compared to the same calendar quarter in the calendar year 2019 (or 2020 if the employer was not in existence in 2019), instead of less than 80 percent. If an employer is eligible as a “severely financially distressed employer,” they are able to calculate the ERC for that quarter using wages paid during the quarter regardless of if the employee worked or did not work, to figure out the eligible wages (subject to the $10,000 limit) regardless of how many full-time employees they have. Normally large employers are only allowed to pick up wages as eligible if they are paid in order for employees to not work. This new rule allows them to pick up all wages paid as eligible, allowing them a larger credit if they can meet the requirements of a “severely financially distressed employer.”
As mentioned previously, the notice again clarified that wages used for the ERC cannot be used for any other credit or relief program. The IRS wants to avoid any double-dipping of benefit. Any wages used for the ERC cannot be wages used for first or second draw Paycheck Protection Program loan forgiveness, Restaurant Revitalization Grant, Shuttered Venues Operators Grant, Paid Sick and Family Leave, Work Opportunity Credit, Research & Development Credit, or any other credit or grant that is calculated based on wages paid.
The notice also provided clarification and guidance on several miscellaneous ERC concerns for both 2020 and 2021 credits, including the following:
- Whether wages paid to an employee who is a majority owner of a corporation or noncorporate entity and/or that individual’s spouse may be treated as qualified wages for the purpose of the credit,
- Definition of full-time employees
- Treatment of tips as qualified wages
- The timing of the disallowance of a deduction for wages by the amount of the ERC
- The alternative quarter election in determining whether there has been a decline in gross receipts
- How to calculate gross receipts of employers that came into existence in the middle of a calendar quarter for the purposes of the gross receipts safe harbor under Notice 2021-20.
Majority-Owner Wages
Notice 2021-49 went further into detail on whether wages paid to an employee who owns more than 50% (majority owner) of the value of a corporation may be treated as qualified wages, as well as wages paid to a spouse of a majority owner may be treated as qualified wages. Wages are not considered with respect to an individual who bears any of the relations described in section 152(d)(2)(A)-(H) of the Code to the following:
- The taxpayer, or
- If the taxpayer is a corporation, to an individual who owns, directly or indirectly more than 50% in value of the outstanding stock of the corporation (majority owner of a corporation), or
- If the taxpayer is an entity other than a corporation, to any individual who owns, directly or indirectly, more than 50% of the of the capital and profits interests in the entity (majority owner of a noncorporate entity).
The IRS and Treasury have concluded that ownership attribution rules apply for the purpose of determining both an individual’s capital and profits interests in a partnership or other entity. Wages paid to employees with the following relationships to a majority owner of a corporation or of a partnership or other entity are not qualified wages:
- A child or a descendant of a child
- A brother, sister, stepbrother, or stepsister
- The father or mother, or an ancestor of either
- A stepfather or stepmother
- A niece or nephew
- An aunt or uncle
- A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
- An individual (other than a spouse, determined without regard to section 7703, of the taxpayer) who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household)
It’s important to determine whether an individual has constructive ownership of stock of a corporation by using the following factors:
- Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust is considered as being owned proportionately by or for its shareholders, partners, or beneficiaries
- An individual is considered to own the stock owned, directly or indirectly, by or for the individual’s family
- An individual owning (otherwise than by the application of (2)) any stock in a corporation is considered to own the stock owned, directly or indirectly, by or for his partner
- The family of an individual includes only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants, and
- Stock constructively owned by a person by reason of the application of (1) will be treated, for the purpose of applying (1), (2), or (3), as actually owned by the person. Stock constructively owned by an individual by reason of the application of (2) or (3) will not be treated as owned by the individual to again apply either rule to reattribute and make another individual the constructive owner of the stock.
By applying all these rules, a majority owner of a corporation is a related individual for the purpose of the employee retention credit. Any related individual to the majority owner of the corporation would also be considered as having an indirect majority ownership in the corporation as well. This makes any wages paid to the majority owner not eligible for ERC.
A spouse of a majority owner is a related individual for purposes of the employee retention credit, whose wages are not qualified wages if the majority owner has a family member who is a brother or sister (whether by whole or half-blood), ancestor, or lineal descendant (and thus deemed to own the majority owner’s shares) and the spouse bears a relation described above to the family member. If the majority owner of a corporation has no brother or sister (whether by whole or half-blood), ancestor, or lineal descendant, then neither the majority owner nor the spouse is a related individual, and the wages paid to the majority owner and/or the spouse are qualified wages for the purpose of the employee retention credit, assuming the other requirements for qualified wages are satisfied. The IRS and Treasury provided the following examples to illustrate the application of these rules:
Example 1:
Corporation A is owned 80 percent by Individual E and 20 percent by Individual F. Individual F is the child of Individual E. Corporation A is an eligible employer with respect to the first calendar quarter of 2021. Both Individual E and Individual F are employees of Corporation A. Pursuant to the attribution rules of section 267(c) of the Code, both Individual E and Individual F are treated as 100 percent owners of Corporation A. Individual E has the relationship to Individual F described in section 152(d)(2)(C) of the Code, and Individual F has the relationship to Individual E described in section 152(d)(2)(A). Accordingly, Corporation A may not treat as qualified wages any wages paid to either Individual E or Individual F because both Individual E and Individual F are each related individuals for purposes of the employee retention credit.
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.
Example 4:
Corporation D is owned 34 percent by Individual L, 33 percent by Individual M, and 33 percent by Individual N. Individual L, Individual M, and Individual N are siblings. Corporation D is an eligible employer with respect to the first calendar quarter of 2021. Individual L, Individual M, and Individual N are employees of Corporation D. Pursuant to the attribution rules of section 267(c) of the Code, Individual L, Individual M, and Individual N are treated as 100 percent owners. Individual L, Individual M, and Individual N have the relationship to each other described in section 152(d)(2)(B) of the Code. Accordingly, Corporation D may not treat as qualified wages any wages paid to Individual L, Individual M, or Individual N.
Definition of Full-Time Employees
For the purposes of the Employee Retention Credit, the definition of a “full-time employee” means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month. Full-time equivalents do not play any role in determining whether an eligible employer is a large eligible employer or a small eligible employer. It’s important to note that for the purposes of identifying qualified wages, an employee’s status as a full-time employee is irrelevant, and wages paid to an employee who is not full-time may be treated as qualified wages if all other requirements to be able to treat the amount as qualified wages are satisfied.
Tips as Qualified Wages
Section 3121(a)(12) of the Internal Revenue Code excludes from the definition of “wages” tips paid in any medium other than cash and cash tips received by an employee in any calendar month in the course of employment by an employer unless the amount of cash tips is $20 or more. If cash tips received by an employee in a calendar month amount to $20 or more, all the cash tips received by the employee in that calendar month are included in wages. Therefore, any cash tips treated as wages within the definition of Section 3121(a) of the Code are treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied. If cash tips are more than $20 in a calendar month, they are eligible to be included in the ERC calculation for that quarter.
This notice also discusses that due to the wording of the laws that this provision does not prevent the receipt of both the employee retention credit and the FICA Tip credit (Section 45B credit) for the same wages. Therefore, eligible employers are not prevented from receiving both the employee retention credit and the FICA Tip credit (Section 45B credit) for the same wages.
Timing of Disallowed Deduction for Wages by the Amount of ERC
Under Notice 2021-20, a reduction in the amount of the deduction allowed for qualified wages, including qualified health plan expenses, caused by receipt of the employee retention credit occurs for the tax year in which the qualified wages were paid or incurred. If an amendment is made to claim ERC for a prior period, the taxpayer should file an amended federal income tax return or administrative adjustment request (AAR), if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken with respect to those same wages on the original federal tax return. Notice 2021-49 again reiterated that to satisfy the tracing requirement, the taxpayer must file an amended return or AAR, as applicable.
Alternative Quarter Election
The alternative quarter election under Notice 2021-23 for the 1st and 2nd quarter of 2021 have been extended to the 3rd and 4th quarters of 2021. This election can be used when determining eligibility for the ERC based on gross receipts. The employer does not need to consistently apply or use the alternative quarter election once it has been made.
For example, an employer may be an eligible employer due to a decline in gross receipts for the second quarter of 2021 if its gross receipts for the second quarter are equal to 75% of its gross receipts in the second quarter of 2019 (i.e., the employer does not rely on the alternative quarter election for the second quarter); the employer could then use the alternative quarter election to be an eligible employer for the third quarter of 2021.
Gross Receipt Calculation for Employers That Came into Existence in the Middle of a Calendar Quarter
Notice 2021-20 provided a safe harbor for employers that acquired businesses in 2020 to include the gross receipts of the acquired business in its gross receipts for 2019 to determine whether the employer experienced a significant decline in gross receipts regardless of the fact the employer did not own the acquired business during a calendar quarter in 2019. This rule continues to apply to employers that acquired businesses in 2021.
The IRS and Treasury also clarified how to calculate gross receipts of employers that came into existence in the middle of a calendar quarter in 2020. Notice 2021-20 provided rules for determining gross receipts for an employer that came into existence in 2019. That same rule continues to apply to 2021. For example, an employer that came into existence in the third quarter of 2020 should use that quarter as the base period to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2021 and should use the fourth quarter 2020 for comparison to the fourth quarter of 2021 to determine whether it experienced a significant decline in gross receipts.
Notice 2021-20 can be found here.
Notice 2021-23 can be found here.
Notice 2021-49 can be found here.
If you have any questions, please reach out to your personal Sciarabba Walker contact or email us at info@swcllp.com.