In spite of proposed legislation to remove the Q4 Employee Retention Credit, the IRS issued Notice 2021-49 providing guidance on claiming the ERC in Q3 and Q4 of 2021.
- The Employee Retention Credit follows essentially the same rules in Q3 and Q4 of 2021 as set forth for Q1 and Q2.
- Spousal ownership must be considered for purposes of attribution when considering owner wages for the ERC.
- The 2020 wage expense must be reduced by the amount of any 2020 ERC credit claimed, regardless of the period the credit is claimed.
- Tips can be considered qualified wages for purposes of the ERC.
- The IRS provided guidance on recovery startup businesses and severely distressed businesses for Q3 and Q4 of 2021.
On August 4, 2021, the IRS issued Notice 2021-49 to provide additional guidance on claiming the Employee Retention Credit (ERC) in Q3 and Q4, as well as to provide some clarity for very frequently asked questions related to all periods of eligibility.
As in past Notices related to the ERC, the IRS clarified that many of the rules of eligibility remain unchanged for Q3 and Q4. The focus of this Notice was to clarify issues related to the expanded definition of an eligible employer established by the American Rescue Plan and also answer other questions that have arisen over the course of the past year.
In Q3 and Q4, the expanded definition of an eligible employer includes recovery startup businesses and severely distressed organizations.
Essentially, if an organization began after February 15, 2020 and in the preceding three years had less than $1 million in gross receipts, the organization is a recovery startup business and may claim the credit in Q3 and Q4 for up to $50,000 each — regardless of whether it meets the other tests of partial shutdown or significant decline in gross receipts.
If, however, the organization qualifies under those other tests, then it will not be subject to the $50,000 limitation in credit amount.
Large employers, those with over 500 full-time employees in 2019, are generally limited to claiming the ERC for wages paid to employees not performing services. If the employer qualifies as a severely financially distressed employer, however, then all wages paid to employees are eligible to be qualified wages, similar to a small employer. A severely financially distressed employer is a business who has experienced a more than 90% decline in current quarter gross receipts compared to the same quarter in 2019. The lookback election may be utilized to establish eligibility based on the prior quarter’s gross receipts.
The Notice also indicates that tips can be considered as eligible wages for purposes of the ERC as long as they are Medicare wages. In addition, using the same tip wages for both the tip credit and the ERC is allowed.
Additionally, the Notice memorialized some key considerations that were simply understood by interpreting the Internal Revenue Code and associated regulations. The first area that can no longer be argued is that indirect, or attributed ownership, must be considered when determining whether an owner’s wages may be included for purposes of claiming the credit. As a result, anytime an owner or owner’s spouse bears an identified relationship to someone who is considered a greater than 50%, whether independently or by attribution, they may not include their own wages in calculating the credit.
In somewhat disappointing news for many taxpayers who have already filed their 2020 return, the IRS guidance is that if the credit is claimed for 2020 wages, the 2020 wage expense must be reduced by the credit amount, even if this means amending the income tax return. This will also be applicable to 2021 if a taxpayer chooses to amend their payroll tax return to claim the 2021 ERC in a future year.
The Notice further clarified that the rules related to using a prior quarter to qualify for the current quarter will remain in place for Q3 and Q4 of 2021. Unless the Infrastructure Act is signed into law changing the availability of the credit for Q4 of 2021, current guidance exists that a two-quarter decline in gross receipts may actually yield four quarters of available credit in 2021.
The final key point in the Notice is that it generally reinforces the “no double dipping” rule as it relates to using payroll wages for different economic relief provisions.
Because the IRS continues to have five years to examine the ERC claims on the payroll tax returns, it is imperative to document your organization’s eligibility position and calculations contemporaneously with claiming the credit. This can help protect against questions arising five years in the future when data may no longer be available.