There is still time for employers to claim the Employee Retention Credit (ERC) in the third and fourth quarters of 2021, though those employers who wish to take advantage would be wise to weigh their options now. In order to offset the prohibitive costs associated with the forthcoming infrastructure bill currently on the table, Congress is contemplating the elimination of the ERC which was originally created in March 2020 as a means of incentivizing employers to keep their workforces intact during the pandemic. The elimination of the provision could go into effect as early as the start of the 4th quarter of 2021.
The IRS recently released Notice 2021-49 which offers new guidance on the ERC and issues related to the extension of the credit through 2021 by the American Rescue Plan Act (ARPA).
A Primer in Employee Retention Credit Specifics
Because the elements of the ERC changed multiple times over the course of 2020 and because so many other pandemic-related programs were simultaneously being put into place (some of which conflicted with the ability of employers to claim the ERC), employers may not yet have tapped into the benefits of the credit.
Initially, the ERC was made available to employers whose businesses experienced a full or partial cessation in operations as a direct result of a COVID-related government closure order. It was also open to those employers who experienced a decline of more than 50% in gross receipts when compared to the same quarter of the prior year (and until gross receipts exceeded 80% of gross receipts in the earlier quarter).
From March 13, 2020 through December 31, 2020, the per eligible employee ERC equaled 50% of qualified wages (including the cost of health benefits) up to $10,000 per employee per year, with a maximum benefit of $5,000 per employee.
Further complicating matters, business owners who wished to enroll in the Paycheck Protection Program (PPP) which was designed to keep struggling businesses afloat during the pandemic and which offered a greater monetary payout than the ERC, were not permitted to claim the Employee Retention Credit credit while participating in the PPP program. In December 2020, the Consolidated Appropriations Act (CAA) changed the landscape by altering the preliminary rule to allow employers to participate in both initiatives, provided they didn’t use forgiven PPP loan funds to pay for qualified wages.
The CAA also extended the ERC through June 30, 2021 and raised the credit’s amount from 50% to 70% of qualified wages, starting on January 1, 2021. At the same time, the limit on per-employee qualified wages jumped from $10,000 per year to $10,000 per quarter, giving employers the opportunity to claim an Employee Retention Credit of up to $7,000 per quarter for each eligible employee.
Expanded eligibility was another helpful advantage provided by the changes the CAA implemented, accomplished through the requisite year-over-year gross receipt reduction from 50% to only 20%. At the same time, the CAA increased the threshold for classifying a business as a “large employer” –subject to more stringent standards when calculating the qualified wage base – from 100 to 500 employees.
IRS Guidance on Changes Enacted by ARPA
The ARPA extended employers’ ability to claim the Employee Retention Credit through the end of 2021 while simultaneously making some changes that apply only to the 3rd quarter and 4th quarter of 2021. The IRS guidance recently issued focuses primarily on ARPA’s ERC-related aspects, including:
Employment Taxes – Under the CARES Act, employers could claim the ERC only against Social Security taxes. The IRS guidance revises that provision for the 3rd quarter and 4th quarter, only, allowing employers to claim the ERC against their share of Medicare taxes, with the excess refundable.
Revisions to Maximum Amounts – In 2021, the credit is worth up to $28,000 per eligible employee, or $7,000 per eligible employee, per quarter, for employers who wish to claim the ERC, though a different limit is applied to “recovery startup businesses”.
Recovery Startup Businesses –The pool of ERC-eligible employers was expanded by the ARPA to include those which have average annual gross receipts totaling $1 million or less for the three prior tax years and which began operating after February 15, 2020. A business is not considered to be fully operational, however, until it’s started functioning as a going concern and executing the activities it was established to perform.
These employers can claim the ERC without suspended operations or reduced receipts, up to $50,000 total per quarter for the 3rd quarter and 4th quarter of 2021.
It’s important to note that a new determination must be made each quarter in order for a taxpayer to continue to qualify as a recovery startup business.
Qualified Wages – Extra relief is granted, through the ARPA, to “severely financially distressed employers” with less than 10% of gross receipts for 2021 as compared to the same calendar quarter in 2019. Severely financially distressed businesses are permitted to count any wages paid to an employee during any quarter as qualified wages, regardless of employer size. However, wages that are utilized for business tax credits such as research, work opportunity, and COVID-related employee leave, cannot also be used for ERC. The employer will have to choose which benefit yields the best result when claiming credits.
Defining Full Time Employment
The IRS guidance also more accurately defines the term “full-time employee.” According to this new guidance, employers no longer need to struggle with determining whether they will be considered a large or small employer so do not need to include full-time equivalents when calculating the average number of full-time employees. Since an employee’s full- or part-time status is not required when determining qualifying wages, wages paid to non-full-time workers can be treated as qualified wages (given that all other requirements are met).
There are several other issues that the IRS guidance clarifies including the timing of qualified wage deduction disallowance, gross receipts safe harbor, alternative quarter election for 2021, treatment of tips and the Section 45B credit, and exclusion of wages paid to the majority owners of corporations.
The rules regarding the exclusion of wages paid to the majority owners of corporations, which attribute ownership to owners’ family members, could significantly reduce the amount of the ERC for family-owned corporations. In fact, even the wages paid to minority owners might end up excluded from the ERC computation.
Although the Senate has passed legislation that could eliminate the ERC starting in the 4th quarter of 2021, the House of Representatives is on recess until the fall, so the timing on the expiration of the credit remains to be seen. If you have questions regarding the IRS’ guidance on claiming the Employee Retention Credit for your business, please contact your Untracht Early advisor.