IRS provides additional ERC guidance on calculations for newer businesses, majority owners’ wages, PPP loan forgiveness as gross receipts, and more
The IRS has provided additional important guidance on the Employee Retention Credit (ERC) in the form of a Notice and a Revenue Procedure.
Notice 2021-49, issued Aug. 4, amplifies prior IRS guidance for purposes of ERCs available for the third and fourth quarters (per new IRC Section 3134) of 2021. (Note that if enacted as currently proposed, the Bipartisan Infrastructure Investment and Jobs Act would generally end the availability of the ERC for the fourth quarter of 2021; we are watching the development of the legislation and will provide updates.)
Of great interest, the Notice also includes answers to various apparently popular taxpayer and taxpayer representative ERC-related inquiries (some of which have been considered unsettled until now), the most significant of which are as follows. Note that these responses apply to all years, not just 2021 Q3/Q4.
Revenue Procedure 2021-33, issued Aug. 10, permits an employer to exclude its Paycheck Protection Program (PPP) loan forgiveness amount (as well as other pandemic relief program grant amounts) from its gross receipts for purposes of determining its ERC eligibility.
Read on for more about these two new releases, or skip straight to Revenue Procedure 2021-33.
For employers not in existence in 2019
Qualified Wages – ‘Small Employer’ vs. ‘Large Employer’ status
While the exact rules differ for 2020 and 2021, recall that in general, an employer can qualify for an ERC if it 1) fully or partially suspends its operations due to a governmental order limiting commerce, travel, or group meetings due to COVID-19 or 2) experiences a decline in gross receipts compared with a certain quarter in 2019. The ERC amount is a percentage of “Qualified Wages” paid per employee during an applicable suspension period or quarter, subject to certain limitations. See our full ERC overview for details.
A “Small Employer” can determine its ERC amount based on all Qualified Wages and/or Qualified Health Plan Expenses paid during an applicable quarter or suspension period (subject to the applicable $10,000 and no double-dipping limitations). Conversely, a “Large Employer” can only determine its ERC based on Qualified Wages and/or Qualified Health Plan Expenses paid to or for employees during an applicable quarter or suspension period for periods that they were not providing services (e.g., furloughed employees). The test for Small Employer versus Large Employer status is based on the number of full-time employees on average in the employer’s controlled group for calendar year 2019.
The Notice reiterates existing guidance by confirming that if the employer was not in existence in 2019, the test is to be based on the number of full-time employees on average in the employer’s controlled group for calendar year 2020.
Significant decline in gross receipts
As an alternative to having experienced a partial suspension of its business operations, an employer can generally be ERC-eligible by virtue of its controlled group having experienced a “significant decline” (greater than 50% for a 2020 ERC or greater than 20% for a 2021 ERC) of its gross receipts for a 2020 or 2021 calendar quarter as compared to the same quarter in 2019. (For purposes of a 2021 ERC, the employer can also test on the basis of the immediately preceding quarter.)
The Notice refers to the existing guidance that if the employer was not in existence in 2019, the test is to be based on calendar year 2020 gross receipts, and also refers to the existing guidance applicable to an employer that first came into existence during 2019.
Full-time employees vs. full-time equivalent employees
The Notice specifies that for the purpose of determining an employer’s status as a Large Employer or Small Employer, in determining a controlled group’s full-time employees for 2019 (or 2020 for employers not in existence in 2019), the test is based on the number of “full-time employees” (130 hours or more per month or on average, 30 hours or more per week) rather than the number of “full-time equivalent employees” (the applicable standard for Affordable Care Act purposes).
ERC no double-dipping rule
The Notice clarifies that the same wages of an employee cannot be used both to generate an ERC and as payroll costs for purposes of the following government programs:
- Forgiven portion of a first- or second-draw Paycheck Protection Program loan
- Shuttered Venue Operators Grant
- Restaurant Revitalization Fund grant
Similar to the existing guidance applicable to PPP loans, the Notice specifies that an ERC-eligible employer that receives a Shuttered Venue Operators Grant or Restaurant Revitalization Fund grant is required to retain in its ERC records documentation supporting that it did not “double-dip” wages under the ERC and under either grant.
Tips as Qualified Wages
The Notice specifies that tips that are wages for purposes of FICA taxes are eligible to be Qualified Wages, and that the FICA tip credit (IRC Section 45B) and an ERC may both be taken with respect to the same wages.
Reduction of employer federal income tax compensation deduction by ERC amount
The existing guidance has provided that the amount of an employer’s ERC for a year reduces the employer’s federal income tax compensation deduction on a dollar-for-dollar basis. The question has arisen whether, where an employer amends a prior year’s employment tax return (Form 941) by filing Form 941-X to claim a retroactive ERC, if it has already filed its income tax return for its tax year for which it claims the ERC, it must amend its federal income tax return to reduce the compensation deduction taken on that return.
The Notice specifies that where an ERC is claimed on a retroactive basis for a tax year of the employer for which the employer’s federal income tax return has already been filed, the employer must file an amended income tax return to reduce its compensation deduction by the amount of the ERC claimed for that year.
Exclusion of related individuals’ wages as Qualified Wages
Under the existing guidance, the wages paid to employees with the following relationships to a majority owner of a corporation or partnership are not Qualified Wages:
- Child or descendant of a child
- Brother, sister, stepbrother, or stepsister
- Father, mother, or ancestor of either
- Stepfather or stepmother
- Niece or nephew
- Aunt or uncle
- 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) who has the same principal place of abode and is a member of the household
Further, under the existing guidance, the constructive ownership rules of IRC Section 267(c) apply.
The combination of the above rules has led to confusion as to whether the wages of a majority owner of a corporation and/or the members of the owner’s family can be ERC-eligible Qualified Wages. (Reminder: The earned income of a partner or other self-employed individual does not constitute ERC-eligible Qualified Wages.) In this regard, the Notice provides as follows:
If a majority owner of a corporation has no brother or sister (by whole or half-blood), ancestor, or lineal descendant, the wages of the owner and/or the owner’s spouse are eligible to be Qualified Wages.
The wages of a majority owner of a corporation who has a brother or sister (by whole or half-blood), ancestor, or lineal descendant, are not eligible to be Qualified Wages.
The wages of the spouse of a majority owner are not eligible to be Qualified Wages if the majority owner has a brother or sister (whether by whole or by half-blood), ancestor, or lineal descendant, where the spouse and family member have one of the family relationships described above.
These rules apply even if the relative is not an employee of the corporation; for example, if a majority owner has a brother, even if the brother is not an employee of the corporation, the majority owner’s wages are not ERC-eligible Qualified Wages.
Special rules for determining gross receipts of a business acquired in 2021
For purposes of the “significant decline in gross receipts” test, the existing guidance permits an employer that acquired a business in 2020 to include the 2019 gross receipts of the acquired business as part of the employer’s 2019 gross receipts (i.e., even though the employer did not own the business in 2019). The Notice specifies that an employer that acquired a business in 2021 will also be able to include the 2019 gross receipts of the acquired business as part of the employer’s 2019 gross receipts for ERC purposes.
PPP loan forgiveness and gross receipts
As mentioned above, the “significant decline in gross receipts” test is one of the two available avenues for an employer to become eligible to claim an ERC for a 2020 or 2021 available calendar quarter. Until now, an employer’s Paycheck Protection Program (PPP) loan forgiveness amount (as well as other pandemic relief program grant amounts) was required to be included in the employer’s gross receipts for this purpose for the quarter in which the loan was forgiven, often impacting the test result and possibly causing the employer to be unable to pass the test.
Revenue Procedure 2021-33 permits an employer to exclude the following amounts from its gross receipts for purposes of the test:
- PPP loan forgiven amount
- Shuttered Venue Operators Grant amount
- Restaurant Revitalization Fund grant amount
In order to avail itself of this opportunity, the employer and all members of its ERC controlled group may exclude these amounts from the controlled group’s gross receipts for purposes of the test, but all controlled group members must do so for all such amounts for all such tests.
With the exception of the related individuals’ wages exclusion from Qualified Wages, the guidance under the Notice provides no real surprises and is generally consistent with what we thought to be the rules. However, the clarification under the Notice that the application of double attribution applies for purposes of the related individuals’ wages exception is disappointing, as the mere fact that a majority owner of a corporation has a sibling, parent, child, or grandchild, even where that individual does not work for the corporation, will prevent the wages of the owner and the owner’s spouse from being considered Qualified Wages.
An employer’s new ability under Revenue Procedure 2021-33 to exclude its forgiven PPP loan amount – as well as the amounts of its Shuttered Venue Operators and Restaurant Revitalization Fund grants – as gross receipts may permit them to pass an otherwise failed ERC significant decline in gross receipts test.
As mentioned above, it is also important to note that for revenue-raising purposes, the infrastructure legislation currently before Congress would eliminate the availability of the ERC for the fourth quarter of 2021 for most employers. Watch our website for updates.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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