The IRS Releases New Guidance on the Employee Retention Tax Credit: Here’s What You Need to Know

The coronavirus caused many businesses to suffer financially. Many were forced to fire or lay off employees.

The government put the employee retention tax credit into effect to counter the economic damage of employee layoffs. The credit was created to encourage businesses to keep employees on the payroll in return for a credit on their tax return.

Recently, the IRS issued further guidance for employers who pay qualified wages after June 30, 2021, and before Jan. 1, 2022, and on miscellaneous issues regarding businesses that qualified for credit for payments made in 2020 and 2021.

Notice 2021-20 was originally released to provide guidance on the ERTC, but at the beginning of the month, the organization published Notice 2021-49 which offers more clarity and explains updates that have been made.

For example, more detailed guidance was provided for newly added ERTC related categories the American Rescue Act has put into effect. It addresses the following changes:

  • Making the credit available to eligible employers that paid qualified wages after June 30,2021 and before Jan. 1, 2022
  • Expanding to definition of eligible employer to include ‘recovery startup business’
  • Modifying the definition of qualified wages for ‘severely depressed employers’
  • Providing that the employer retention credit does not apply to qualified wages that are considered payroll costs in connection with a shuttered venue grant or restaurant revitalization grant

It also addressed the following miscellaneous issues:

  • The definition of full-time employee
  • Whether tips are considered qualified wages
  • The timing of qualified wages deduction disallowance and whether taxpayers that already filed their tax returns must amend them after claiming the credit on an adjusted return
  • Whether wages paid to majority owners and their spouses may be treated as qualified wages

What is the Employee Retention Credit?

The employee retention credit is a credit that employers can claim for retaining employees throughout the pandemic. It comes into play in various pieces of legislation including the following:

CARES Act 2020

Employees who qualify including those who took an PPP loan, can claim 50% of wages up to $10,000 per employees per year for wages paid between March 13 and December 31 of 2020.

Consolidated Appropriations Act 2021

Employers who qualify can claim a credit for 70% of qualified wages paid for up to $10,000 per employee. This applies to the first two quarters of 2021.

American Rescue Plan Act 2021

This is a 70% credit up to a $10,000 limit per quarter meaning employers can claim up to $7,000 per employee per quarter for all of 2021 making for a total of up to $28,000 for the year. Startup businesses started after Feb. 15, 2021, that had an average of $1 million or less in gross receipts and would not have otherwise been eligible may be allowed a credit of up to $50,000 per quarter.

What Employers Qualify for the ERTC?

Most employers qualify for the ERTC including hospitals, universities and organizations who are now eligible under the American Rescue Plan Act. Those who took a loan under the Paycheck Protection Program are also now eligible under the Consolidated Appropriations Act.

In order to qualify, the business must have been forced to reduce business hours due to the government order. The credit would only be applied for the time the business was operating at partial capacity.

Essential businesses who were not forced to close as well as those who continued working through telework would not be eligible unless the employer had a significant decline in gross receipts.

On Aug. 10, 2021. The IRS released Revenue Procedure 2021-33 which allows an employer to exclude the amount of their PPP loan as well as their Shuttered Venue Operators Grant or Restaurant Revitalization Fund grant from the definition of gross receipts solely for the purpose of determining ERTC eligibility.

Here’s how eligibility is seen under various acts of legislation:

CARES Act 2020

If gross receipts are more then 50% lower in 2020 as compared to the same quarter of 2019, the employer would quality for an ERTC. However, they will become disqualified if the next quarter shows an 80% or more improvement over the same quarter of 2019.

Consolidated Appropriations Act 2021

Qualifying businesses must be impacted by forced closures and see a 20% drop in gross receipts as compared to the same quarter in 2019 in order to qualify. New businesses who were not open in 2019 may be eligible based on a 20% drop as compared to any quarter they were open.

American Rescue Plan Act 2021

In addition to meeting the eligibility requirements under the Consolidated Appropriations Act, businesses also have the option of determining eligibility based on gross receipts of the immediately preceding calendar quarter compared to the corresponding quarter in 2019.

Recovery Startup Businesses

The American Rescue Plan has added the category of a Recovery Startup Business for the 3rd and 4th quarter of 2021 only. These entities may qualify for a credit of up to $50,000 per quarter.

To qualify as a Recovery Startup Business you must:

  • Have begun operating as a business after Feb. 15, 2020
  • Have annual gross receipts of a $1 million or less
  • You must not be eligible for the ERTC under the other two categories including the partial or full suspension of operations or the decline in gross receipts

Recovery Startups may use all qualified employee wages for the purpose of claiming a credit. Their status as a Recovery Startup will be determined per quarter. So if, they were fully or partially suspended for one quarter, they would not be considered a Recovery Startup for that quarter.

What Wages Qualify for Retention Credit?

Most wages that are subject to FICA taxes and qualified health expenses may qualify for a retention credit if they were paid after March 12,2020 through Dec. 31, 2021. The credit can only apply to wages that are not forgiven or expected to be forgiven on the PPP.

For an employer to figure out what payments are eligible, they must determine their number of full time employees, that being those who worked at least 30 hours a week or 130 hours a month in 2019. Employers would then figure the credit as follows:

  • Employers in business for the entire calendar years of 2019 or 2020 would take the number of their total full-time employees in each calendar month and divide that by 12.
  • Employers who started the business in the middle of 2019 or 2020 would take the number of full-time employees in each calendar month and divide it by the number of months the business was operating within the year.
  • Employers who started their business in 2021 would take their number of full-time employees in each calendar month and divide it by the number of months the business was operating.

Accounting professionals should be aware that the full time equivalent (FTE) used for the PPP forgiveness report is not calculated the same way as a full-time employee for the retention credit. Therefore, you should not be providing your clients with PPP Forgiveness FTE information.

Also, if your client has taken a PPP loan that they will be forgiven for, they may still be eligible for the ERTC on certain wages.

Here are how wages may qualify under different legislations:

CARES Act 2020

Companies with over 100 full time employees can only take credit for payments made to employees who were not working due to a suspension or decline in business. Wages paid for vacation or sick leave will not be included.

Companies with fewer than 100 full time employees can use all wages including those paid to workers that were and were not actively working as well as sick pay and vacation pay. Only paid leave provided under the Families First Coronavirus Response Act would be excluded.

Consolidated Appropriations Act 2021

This legislation increased the employee limit to 500 when it comes to determining which wages may be credited.

American Rescue Plan 2021

This legislation allows certain hard-hit businesses to claim credit against all employee qualified wages whether they were providing services or not. Hard hit businesses are defined as those whose gross wages are less then 10% of what they were in 2019 and 2020 as compared to where they are in 2021.

The IRS has guardrails in place to prevent wage increases that may occur if the employee is eligible for the credit.

Are Tipped Wages Included in the Credit?

Tipped wages may be included in the credit if they were subject to FICA. They would be subject to FICA if they were over $20 per month plus employee.

Are Owner/Spouse Wages Included in the Credit?

Wages paid to those related to a majority owner would not be eligible for a credit. The new guidance clarifies what related individuals would be excluded. These including:

  • Children and grandchildren
  • Siblings including stepbrothers and stepsisters
  • Fathers, mothers and grandparents
  • Stepmothers and stepfathers
  • Nieces and nephews
  • Aunts and uncles
  • In-laws

What is the Interaction with Other Credits and Funding Sources?

  • Employers who take the employee retention credit cannot take credit on the same wages for paid family medical leave.
  • Employees included in the Work Opportunity Tax Credit may not be included in the employee retention credit.
  • Credit can only be applied to wages that will not be forgiven under the PPP.
  • Businesses covered under the Shuttered Venue Operators Grant or the Restaurant Revitalization Grant may not use the money they take in under the grant as employee wages eligible for the ERTC. They must retain records stating how the money was used to avoid any confusion.

How Do the Credits Work?

The American Rescue Plan states that nonrefundable pieces of the employee retention tax credit will be claimed against Medicare taxes instead of against Social Security taxes as they were in 2020. However, this will only apply to wages paid after June 30, 2021. It will not affect the total credit amount.

If the credit exceeds the employer’s total liability of the portion of Social Security or Medicare, the excess will be refunded to the employer. At the end of the quarter, the credit amounts will be reconciled on the employers Form 941.

How Does an Employer Claim the ERTC Retroactively?

Notice 2021-20 provided guidance for employers claiming the ERTC relevant to wages paid between March 12, 2020, and Jan. 1, 2021. It includes guidance on how employers who received a PPP loan can retroactively claim the ERTC.

In order to claim it, employers must file a Form 941-X Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund for the applicable quarter. The IRS provides three examples that highlight the process and includes several examples of how an employer determines which wages are eligible for the credit.

The number of wages eligible are largely dependent on what was reported on the PPP loan forgiveness application. Payroll costs reported on the application may be utilized in certain conditions where more expenses than necessary were used to justify loan forgiveness. In these cases, the IRS will take the minimum wage cost necessary combined with other eligible expenses to justify loan forgiveness.

However, the IRS mandates that expenses eligible for PPP loan forgiveness that were not included in the application can not be factored in after the fact. Therefore, it’s important to ensure all eligible expenses are included from the PP loan to get the most out of the credit.

How Does a PEO Client Employer Reconcile?

Employers that use a Professional Employer Organization (PEO) or a Certified Professional Employer Organization (CPEO) do not have an individual 941 on file so it will be important for them to understand how to reconcile this information and receive credit. The IRS posted guidance in their latest update to clarify how the process will work. Basically, the retention credit is reported on the PEO-CPEO aggerate Form 941 and Schedule R.

The ERTC has helped and will continue to help many businesses and employees stay afloat during pandemic times. The new guidance the IRS released provides a better understanding of how the credit works. If you have any more questions, do not hesitate to discuss them with your accountant or tax preparer.