The Infrastructure Investment and Jobs Act passed in November ended the employee retention credit (ERTC) early, changing the eligible wages to only those paid before Oct. 1, 2021 rather than Jan. 1, 2022 as previously expanded in the American Rescue Plan Act. This change does not apply to recovery startup businesses. 

Many businesses were filing for this credit on quarterly Form 941, or retroactively on Form 941-X, and thus, are not be able to file for the fourth quarter. Some businesses, though, may have been holding payroll tax deposits in anticipation of fourth quarter credits as prior guidance allowed. The IRS has now released Notice 2021-65 (the Notice) to provide guidance for those employers to make adjustments for the taxes now owed for the fourth quarter that were not previously anticipated.

Specifically, the Notice provides:

• Employers who already received an advance payment of the fourth quarter credit, and who are no longer eligible for the fourth quarter, must repay the amount by the due date for the fourth quarter employment tax return or be subject to failure to pay penalties.
• Employers who were following prior guidance to reduce fourth quarter deposits in anticipation of a credit, and who are no longer eligible for a credit in the fourth quarter, will not be subject to failure to deposit penalties for deposits due on or before Dec. 20, 2021 if the employer deposits such amounts by the due date for wages paid on Dec. 31, 2021, according to the employer’s deposit schedule and reports the liability on the fourth quarter employment tax return per the instructions. It is important to note if this liability would result in more than $100,000 due on Dec. 31, 2021, then the next day rule will apply.

Employers who do not qualify for penalty relief under the Notice may provide a reasonable cause explanation upon receipt of an IRS notice of a failure to deposit penalty.

This Notice has been anticipated since legislation to remove the credit drifted into the fourth quarter itself. Some companies had speculated a longer grace period through the first quarter of 2022 may apply, but this is not the case. Employers should carefully review the guidance and coordinate with payroll providers, where applicable, to address the deadlines for penalty relief.

In very welcomed news, the IRS released guidance allowing employers to exclude Paycheck Protection Program (PPP) loan forgiveness, Restaurant Revitalization Fund (RRF) grants, and Shuttered Venue Operator Grants (SVOG) from the Employee Retention Tax Credit (ERTC) gross receipts calculation. 

Background

Eligibility for the ERTC may be dependent on the relative reduction in gross receipts between periods (for more background on the ERTC, read our article here). For example, an employer that can demonstrate at least a 50% decline in gross receipts for a quarter in 2020 may be eligible. For 2021, the employer that can demonstrate at least a 20% decline in gross receipts may be eligible. To determine gross receipts, the ERTC requires employers to look to section 448(c) and Reg. section 1.448-1T(f)(2)(v) or section 6033 and Reg. section 1.6033-2(g)(4) depending on the classification of an entity. 

In this recent revenue procedure, the IRS concluded that congressional intent was to allow employers to participate in the ERTC in conjunction with the aforementioned loan forgiveness or grant programs in the CARES Act and that including these items in gross receipts may preclude eligibility for some employers that would otherwise be eligible. As a result, the IRS issued a safe harbor election in Rev. Proc. 2021-33 to exclude PPP loan forgiveness and the relief grant amounts in the calculation of gross receipts for ERTC eligibility calculations. 

RSM INSIGHT:

These sections of the Internal Revenue Code and regulations would normally require the inclusion of tax-exempt income such as PPP loan forgiveness, restaurant revitalization grants, and shuttered venue operator grants. This exemption is only for the ERTC and does not change reporting for any other tax reporting purpose, including Form 990 reporting.

Election of safe harbor for ERTC gross receipts calculation

Employers that wish to elect the safe harbor method should consistently exclude amounts related to PPP loan forgiveness, RRF grants, and SVOGs from ERTC gross receipt calculations for all relevant periods. Additionally, all employers treated as a single employer under the ERTC aggregation rules for the employer must apply the safe harbor. 

Employers are able to revoke this election, should they so choose, by adjusting all affected employment tax returns.

Final thoughts

This safe harbor is only applicable to the ERTC gross receipts computation and only exempts PPP, RRF, and SVOG. Employers should determine if they received any other funding sources or other non-traditional items that should be included in ERTC gross receipts. For example, for tax-exempt entities, the ERTC credit amount itself was not eliminated from the gross receipt calculation.

The ERTC refund amount is not income to the employer but does cause a reduction in the tax deduction for the year in which the qualified ERTC wages are paid. Given the upcoming tax return deadlines for 2020, employers and their advisors need to determine ERTC credits for 2020 fairly soon to apply them to the tax return. Otherwise, the employer may have to amend the 2020 tax return to reduce the compensation tax deductions by the ERTC refund amount.

The guidance issued in Rev. Proc. 2021-33 is a continuation of recent guidance in regard to ERTC, including guidance released last week in Notice 2021-49 as discussed in our recent tax alert. Employers should contact their tax advisor for more information on ERTC and the safe harbor election.

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.