The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) provided a number of changes to the Employee Retention Tax Credit (ERTC). Most of these changes are only applicable starting Jan. 1, 2021 and (at the time) only applied to the first two quarters of 2021. Congress has since extended the ERTC from June 30, 2021 to Dec. 31, 2021.    

We discussed many of the Relief Act changes in our article on the IRS’s initial guidance in Notice 2021-20. The IRS has now issued Notice 2021-23 with some additional guidance on the Relief Act changes that are effective in 2021.

• The Relief Act provisions allow governmental colleges or universities (such as state universities) to apply for the credit (if otherwise eligible) for 2021.   
  • The Notice provides that the IRS will use section 1.170A-9(c) for the definition of governmental college or university and use 1.170A-9(d) for determining a governmental entity providing medical or hospital care.   
  • A related rule provides that the wages used in determining the ERTC qualified wages for a governmental college or university or entity providing medical/hospital care includes most, but not all, wages paid to governmental employers that would otherwise be exempt from FICA/Medicare (for example, certain employees of state governments under sections 3121(b) (7)).
• The Relief Act provisions changed the ERTC gross receipts eligibility test from a “more than 50% decline in gross receipts” to a “more than 20% decline in gross receipts” for 2021.  
  • The Notice confirms that the gross receipts test for the first two quarters of 2021 is NOT under the special two-quarters rule allowable in 2020. Under the two-quarters rule, once a company had a more than 50% reduction in gross receipts for a quarter, the company was also treated as meeting the ERTC eligibility rule for the following quarter, even if the company’s gross receipts rebounded in that next quarter. With this change, in 2021 the company must satisfy the “more than 20% decline in gross receipts” on a quarter-by-quarter basis.   
  • The Notice also discusses the Relief Act provision allowing a company to elect to use a look-back rule (applying the gross receipts numbers from the previous quarter, rather than the current quarter, in showing a more than 20% decline in gross receipts). While not completely clear, it appears that the employer makes this election on a quarter-by-quarter basis.
• The Notice provides special rules for companies that were not in existence in 2019. Generally, the company can use the first or second quarter of 2020 (as applicable) to show the more than 20% decline in gross receipts.
• The Notice discusses the Relief Act change for 2021 that allows an employer using the section 51 Work Opportunity Credit for a given employee to nevertheless claim an employee retention credit based on wages paid to that employee (if otherwise eligible under the ERTC rules). However, the employer cannot use the same wages for both the Employee Retention Credit and the Work Opportunity credit. 
• The Notice provides more guidance on the rules around advanced credits under the ERTC. Under the Relief Act, for 2021, only a ‘small employer’ can use Form 7200 to claim the ERTC.  
  • However, even a ‘small employer’ can only claim 70% of the ‘average quarterly wages’ paid in 2019. However, both a ‘large employer’ and a ‘small employer’ can reduce payroll tax deposits as a mechanism for obtaining the credit earlier than under the Form 941.  
  • The Notice provides guidance on how a small employer should determine the average quarterly wages, including guidance for seasonal employers. In general, the employer averages the wages from the four quarters in 2019 reported on Form 941 Line 5c (Medicare wages and tips). An employer not in existence in 2019 can generally use the average quarterly wages for 2020. Other detailed guidance is provided for other fact patterns.
  • As a note, because the first quarter of 2021 is now complete and most payroll companies have closed, or will soon close, the Form 941 processing period, most companies will have to use the Form 941 X to claim the credit for the first quarter of 2021.

On March 1, 2021, the IRS issued much anticipated guidance related to the Employee Retention Credit (ERC) in Notice 2021-20. 

Under the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), Congress retroactively made changes to the ERC, as we previously discussed. The most significant change is that companies that received a Paycheck Protection Program (PPP) loan are now eligible to claim the ERC retroactively in 2020. The IRS issued this Notice to address the areas in need of clarity with respect to this interaction, as well as to formalize many of the previously issued IRS FAQs (which have not yet been updated on the FAQ site but now contain a legend alerting taxpayers of the Notice). 

Items of note in the Notice

Notably, the Notice only covers the 2020 implications for the Employee Retention Credit (ERC), it does not address changes made for 2021 from the Relief Act, although many of the items covered will apply to both periods as much of the rules work the same for both years. Businesses should expect further guidance to address other 2021 issues stemming from the Relief Act expansion and extension of the credit.

In addition, the Notice primarily uses language that mirrors that published in earlier FAQs while giving taxpayers more authoritative guidance to rely on when taking positions with respect to the credit. Much of the Notice is written in question and answer format similar to the FAQs, structured with very similar categories, and using many of the same examples. A few areas addressed in the Notice provide more insight than the previous FAQs such as:

• What is a nominal portion of the business that will be considered a partial suspension?  An essential employer may qualify for the ERC if it has a partial suspension of operations that is more than a nominal portion of its business and due to a government order. Nominal was not previously defined. The Notice provides that a portion of the business that makes up 10% of a business’s gross receipts or 10% of the total number of hours of service performed by the employer’s employees is deemed to be more than nominal. Essentially this provides a safe harbor for treating a portion of a business as more than nominal, and if not using that safe harbor, a facts and circumstances general rule still applies to determine what is nominal.
• What is considered comparable operations?  Under the previous FAQs and the Notice, employers that are able to continue comparable operations even though they were subject to government orders, are not considered to be fully or partially suspended by government orders. The Notice added factors to consider in determining whether operations are considered to be comparable to operations prior to closure including telework capabilities, the amount of portable work, the role of the physical work space, and the transition time to be able to telework (with transitions longer than two weeks being considered significant).
• What modifications are considered to have more than a nominal impact? While the examples of modifications from the FAQs are repeated in the Notice, the Notice also adds factors to consider whether modifications have more than a nominal effect. Those factors include limited occupancy, appointment-only services that previously offered walk-ins, restrictions on certain services such as buffets or requiring face coverings. Although these modifications are listed as examples, facts and circumstances still apply to determine whether they have more than a nominal impact. Similar to above, a 10% impact on the ability to provide services is deemed to be more than nominal as a safe harbor.
• What documentation should businesses keep with respect to the ERC?  The Notice provides that employers should maintain adequate records for at least four years to support credits claimed including documentation showing eligibility (e.g. orders that suspended operations, records supporting more than nominal impacts or proof of gross receipts levels), records of qualified wages by employee (including support for time not working for large employers), allocable qualified health plan expenses, determination of aggregated group status and copies of any applicable forms claiming the credit.

Many of the other items addressed in the Notice do not contain additional detail beyond the FAQs despite there being a lot of ambiguity left in the FAQs. For example, the Notice does not further clarify the definition of full-time employee or the impacts of mergers, acquisitions or divisions that change the aggregated group during applicable periods. Likewise, the Notice does not give further relief for the section 280C(a) income tax deduction implication. 

Nonetheless, having certain items stated in an IRS Notice, which can be relied upon, provides additional clarity where there has been some confusion, for example, stating that a larger employer cannot count paid time off as qualified wages. In addition, the Notice clarifies that employers do need to file Form 941-X for earlier quarters in which the qualified wages were paid to claim the credit for those quarters. 

PPP forgiveness interaction

Obviously, the most significant guidance many taxpayers were awaiting relates to the interaction for those entities that took PPP loans that were, or will be, forgiven and that cannot use the same wages for both purposes. The Notice provides many examples with respect to various scenarios an employer may have with respect to its PPP forgiveness amounts and payroll expenses reported on the PPP forgiveness application.

The Notice provides that an employer that received a PPP loan is deemed to have elected not to take the ERC for the amount of payroll costs reported on the PPP forgiveness application up to (but not exceeding) the minimum amount of payroll costs sufficient to support the amount of PPP loan forgiveness. Any qualified wages that are not included in the PPP payroll costs, or that exceed the amount of the PPP forgiveness amount, are still eligible for the ERC, as an election is not deemed to have been made for those qualified wages. 

For example, an employer that had a $200,000 PPP loan and that reported $250,000 of eligible payroll costs on its PPP forgiveness application is deemed to have made an election out of the ERC for the $200,000 (up to the amount of the forgiveness), but the remaining $50,000 that exceeds the PPP loan amount is not deemed to have been elected out of ERC and remains eligible for ERC.

Unfortunately, though, the Notice provides that if taxpayers already filed for PPP forgiveness and did not include other eligible expenses on its PPP forgiveness application, the deemed ERC election cannot be reduced by the amount of eligible expenses that could have been claimed but were not claimed on the PPP forgiveness application. 

For example, an employer that had a $200,000 PPP loan and showed $200,000 of payroll costs and no other eligible expenses on its forgiveness application is deemed to have elected out of the ERC with respect to the $200,000, even though it may have had $70,000 of other eligible expenses that could have been reported on the PPP forgiveness application.

For now, there is no mechanism for PPP borrowers that have already submitted forgiveness applications to amend the payroll and nonpayroll costs included on the forgiveness application. With the amount of PPP recipients now eligible to claim the ERC it remains to be seen whether the SBA will issue procedures on amending forgiveness claims.

To the extent a taxpayer has not yet applied for PPP forgiveness, a taxpayer might want to consider whether to include some other expenses, not just payroll expenses, to support the forgiveness, in order to claim more wages for ERC credits. 

Takeaway

The additional light shone on the Employee Retention Credit (ERC) by the changes in the Relief Act have caused many taxpayers to revisit the applicability of the ERC for 2020, both those who originally were ineligible due to PPP loans and those who were not but were unaware of the broader partial suspension rules for eligibility because businesses had so many items to focus on and adapt to during 2020. The Notice provides welcome guidance that can be relied upon, but also leaves many aspects of the credit up to facts and circumstances analyses, which still require careful thought and documentation. Businesses should work with qualified advisors to understand the guidance, take reasonable positions based upon that guidance and have adequate documentation of those positions. In many instances, following a careful process such as this will result in significant liquidity opportunities for employers experiencing business impacts from COVID-19.

On Sept. 30, 2020, the IRS issued final regulations that provide guidance for meal and entertainment deductions under section 274 of the Internal Revenue Code (Code). We previously summarized the proposed regulations and the related IRS Notice 2018-76 here. This alert summarizes the changes made by the final regulations.

Entertainment expenses 

The final regulations generally keep the existing definition of entertainment. Similarly, the final regulations confirm that the nine exceptions to entertainment expenses under section 274(e) remain the same. 

The final regulations generally apply the guidance in Notice 2018-76 and the proposed regulations to all food or beverages, including travel meals and employer-provided meals, as well as food and beverages provided at or during an entertainment activity. In particular, the final regulations keep, but clarify the distinction between entertainment expenditures and food or beverage expenses in the context of business meals provided at or during an entertainment activity. For example, the final regulation adds a requirement that the amount separately invoiced or separately charged for food or beverage on the bill for an entertainment event must reflect the venue’s usual selling cost if they were purchased separately from the entertainment, so as to avoid inflating the food and beverage expenses to take advantage of the potential deduction. The final regulations provide examples showing the difference in deduction treatment between situations in which the cost of food and beverages provided as part of an entertainment activity were stated separately or were not stated separately on the invoices for the event. 

Food and Beverage Expenses 

Generally, the final regulations apply the guidance in the proposed regulations to food and beverage expenses. This includes keeping the conditions a taxpayer must satisfy to qualify for a 50% deduction.

The final regulations also provide some helpful definitions. First, the deduction limitation rules generally apply to all food and beverage, whether characterized as meals, snacks or other type of food. Additionally, a food and beverage expense includes any delivery fees, tips, and sales tax. However, it does not include indirect expenses such as the cost of transportation to a meal. 

1. Business meal

The final regulations modified and added to examples provided in section 1.274-11 and 1.274-12 to clarify how certain expenses may satisfy the conditions to deduct a business meal. Additionally, for the purpose of better understanding the conditions, the final regulations include employees in the definition of “business associate.”

2. Travel meal 

In addition to applying the general rules for meal expenses from proposed regulations, the final regulations incorporate the substantiation requirements in section 274(d) to travel meals and confirm that most meals (food and beverage) while an employee is on travel are 50% deductible. However, the final regulations apply the limitations in section 274(m)(3) to expenses for food or beverages incurred while on travel for spouses, dependents or other individuals accompanying the taxpayer (or an officer or employee of the taxpayer) on business travel. Thus, if an employee and the employee’s spouse (or a self-employed individual and spouse) travel together for the employee’s business, the cost of a meal for the spouse is almost always nondeductible.  

3. Exceptions

The final regulations explain how the six exceptions in section 274(e) apply to food and beverage expense. Much of the application remained the same but the regulations add some helpful examples. 

Expenses treated a compensation under section 274(e)(2) or (e)(9)

Section 274(e) provides that if a meal is included in the employee’s (or self-employed individuals) taxable compensation, the cost of the meal can be deducted. The final regulations note that including an amount that is too low will limit the tax deduction. Where a taxpayer includes less than the proper value of the meal in compensation, the final regulations provide that the taxpayer must apply the dollar-for-dollar methodology. Under that dollar-for-dollar methodology, the taxpayer may deduct meal expenses to the extent that the expenses do not exceed the amount of the expenses that are treated as taxable compensation.  The regulations provide examples of the treatment of meals provided in employer-run cafeterias, including where companies use the “direct cost” method of charging employees for the meals.

Reimbursement under section 274(e)(3)

The final regulations address reimbursements arrangements between an employer and its customer where the customer is obligated to reimburse the employer for meals (usually travel meals) provided to the employees working on a customer contract.  As in current regulations, the 50% deduction limitations apply to employer unless, under a reimbursement arrangement, the employer accounts to its customer with substantiation that satisfies the requirements of section 274(d) (in which case the customer bears the 50% loss of deduction. The regulations provide examples further addressing these fact patterns and fact patterns involving independent contractors under similar arrangements.

Recreation under section 274(e)(4)

The final regulations confirm that the “social or recreational event” exception in section 274(e)(4) applies to food or beverage expenses for company holiday parties, annual picnics, or summer outings that are primarily for employees other than owners and highly compensated employees and thus do not discriminate in favor of the highly compensated or owners of the company.

Items available to the public under section 274(e)(7)

The final regulations generally retain the guidance provided in the proposed regulations, along with the examples of what constitutes offering items to the general public. As a general rule, if more than 50% of the food or beverage is likely to be consumed by the general public, the expenses are likely to be 100% deductible. The regulations and examples add some clarity to who is or is not a member of the general public. The general public does not include employees, owners or contractors. In addition, if there is a specifically invited guest list, the invited list is not treated as members of the general public.

Goods or services sold to customers under section 274(e)(8) 

The final regulations adopt the interpretations that a restaurant or catering business may continue to deduct 100% of its costs for food or beverage items, purchased in connection with preparing and providing meals to its paying customers, which are also consumed at the worksite by employees who work in the employer’s restaurant or catering business. The regulations retain the examples on the application of this rule, including meals for camp counselors eating with campers, real estate agents providing food during open houses and auto service centers providing food to customers waiting for their cars to be serviced.