The IRS issued Notice 2021-49 (the “Notice”) on August 4, 2021 to provide additional guidance on the Employee Retention Tax Credit (“ERTC”) applicable to the third and fourth quarters of 2021.
Summary of ERTC and Prior Guidance
As discussed in our advisory on March 17, 2021, the CARES Act provided a tax credit designed to aid employers that experienced a significant decline in revenues or were otherwise forced to shut down during the COVID-19 pandemic, but nonetheless retained their employees during that time. The Notice provides additional clarifications to employers regarding the ERTC in the third and fourth calendar quarters of 2021.
Measuring a Significant Decline in Gross Receipts
Eligible employers for the ERTC include employers that (1) had operations fully or partially suspended due to orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19 or (2) experienced a significant decline in gross receipts.
In determining whether an employer had a significant decline in gross receipts in 2021, the employer may elect to compare the prior quarter’s gross receipts (rather than the current quarter’s) for purposes of determining if the company’s gross receipts were less than 80% of those in the same quarter in 2019. The Notice clarifies that this election is made on a quarterly basis. As such, an employer is not required to consistently use the alternative quarter election. An employer that acquired a business in 2020 or 2021 may include the 2019 gross receipts of the acquired business in determining whether a significant decline in gross receipts occurred.
Determining the Size of an Employer
For the third and fourth quarters of 2021, the same rules regarding small and large employers apply for determining qualified wages as applied for the first and second quarter of 2021. In summary, a small eligible employer may treat all wages paid with respect to an employee during the quarter as qualified wages, whereas a large employer may only treat wages as qualified wages if such wages were paid to an employee not providing services.
For 2021, a large employer is an employer that had an average of 500 or more full-time employees in 2019. If an employer was not in existence in 2019, the employer should determine their average number of full-time employees in 2020 rather than in 2019. A full-time employee is an employee who averaged 30 hours of service per week or 130 hours of service per month. Employers are not required to include full-time equivalents when determining their average number of full-time employees for purposes of determining with the employer is large or small.
Maximum Amount of Credit
With the exception of a separate credit limit for recovery startup businesses, as discussed below, the maximum ERTC per employee for the third and fourth calendar quarters of 2021 is $7,000 (70% of up to $10,000 in qualified wages).
Wages paid to a majority owner’s spouse, child, sibling, step-sibling, parent, step-parent, niece, nephew, aunt, uncle, son-in-law, daughter-in-law, or individual who shares a home with the majority owner are not qualified wages and therefore not eligible for the ERTC. Wages paid to a majority owner who has a brother, sister, ancestor, or lineal descendant are not qualified wages. Wages paid to a majority owner with no brother or sister, ancestor, or lineal descendant are qualified wages.
Notice 2021-49 explains that tips received by an employee in a calendar month that equal $20 or more are included in calculating qualified wages.
With respect to a “severely financially distressed employer,” which is an employer whose gross receipts in a calendar quarter are less than 10 percent of their gross receipts as compared to the same calendar quarter in 2019, all wages paid by the employer, regardless of whether it is a large or small employer, are deemed to be qualified wages.
Recovery Startup Businesses
Under the American Rescue Plan Act of 2021, “recovery startup businesses” became eligible for the ERTC. A “recovery startup business” is an employer that (1) began carrying on a trade or business post-February 15, 2020, (2) has average annual gross receipts of less than $1 million, and (3) is not otherwise an eligible employer due to a full or partial suspension of operations or a significant decline in gross receipts.
Notice 2021-49 explains that the “small” and “large” employer rules for purposes of determining qualified wages are applicable to recovery startup businesses. Meaning that for the third and fourth quarters of 2021, a recovery startup business that is a small eligible employer may treat all wages paid with respect to an employee during the quarter as qualified wages, whereas a large employer may only treat wages as qualified wages if paid to an employee not providing services.
The maximum ERTC a recovery startup business may take in each quarter is $50,000.
The determination of whether a business is a recovery startup business is made separately for each calendar quarter. This means that an employer may be a recovery startup business in the third quarter of 2021 and be limited to an ERTC of $50,000 but then in the fourth quarter may qualify as an eligible employer due to a full or partial suspension of operations or a decline in gross receipts and will therefore not be subject to the $50,000 maximum credit.
Applicable Employment Tax
Eligible employers are entitled to claim the ERTC against the employer’s share of Medicare tax (1.45% of wages) for the third and fourth quarters of 2021. Once the Medicare tax is reduced to zero, any excess credit under the ERTC will be refunded to the employer.
Claiming the Credit
If an employer receives an excess advance payment of the credit, the amount of tax due for the quarter is increased by the amount of the excess payment.
An employer’s deduction for qualified wages is reduced by the amount of the ERTC received by the employer. If an employer claims the ERTC for a prior year, the employer should file an amended federal income tax return or administrative adjustment request for the taxable year in which the wages were paid or incurred to correct any overstated deduction.
ERTC Intersection with Other Programs
The credit cannot be claimed with respect to wages taken into account as payroll costs in connection with (1) a first or second draw PPP loan, (2) a shuttered venue operators grant, or (3) a restaurant revitalization grant.
The ERTC continues to be a potentially significant benefit to employers affected by COVID-19. The IRS continues to monitor potential legislation related to the ERTC.