The IRS recently issued new guidance on the employee retention credit (ERC) that creates a safe harbor to exclude Paycheck Protection Program (PPP) loan forgiveness and other grants from the gross receipts test, and answers important questions on the definition of full-time equivalents and qualified wages. The guidance provides welcome clarity that should help many businesses file refund claims both retroactively and prospectively for 2020 and 2021.
The guidance was issued in two separate releases, a notice and a revenue procedure. Notice 2021-49 provides guidance on qualified wages after June 30, 2021, and before Jan. 1, 2022, and miscellaneous ERC issues that apply in both 2020 and 2021, including whether qualified wages include amounts paid to certain shareholders and their spouses. Rev. Proc. 2021-33 provides the safe harbor that permits an employer to elect to exclude PPP loan forgiveness and certain other grant amounts from the definition of gross receipts solely for the purpose of determining eligibility to claim the ERC.
The ERC was originally enacted by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and provides a refundable payroll tax credit that is generally available to certain employers impacted by COVID-19. The credit was extended and enhanced twice and is currently available in 2021 as a 70% credit against up to $10,000 in wages per employee per quarter. If claimed all four quarters, the credit can be as much as $28,000 per employee, though a bipartisan infrastructure bill that recently passed the Senate would end the credit early after the third quarter of 2021.
In order to claim the ERC, an employer must be an eligible employer that has paid qualified wages after March 12, 2020, and before Jan. 1, 2022. Eligible employers include businesses either fully or partially suspended due to a government order, or those that experience a significant decline in gross receipts in 2020 or 2021. For 2020, a business had a significant decline in gross receipts if it saw a greater than 50% reduction in gross receipts in a 2020 calendar quarter compared to the same quarter in 2019. For 2021, a business generally had a significant decline in gross receipts if its gross receipts in a 2021 quarter decreased by more than 20% compared to the same quarter in 2019.
Gross receipts safe harbor for PPP loan forgiveness
Many businesses that received a PPP loan in either 2020 or 2021 found that if they included the forgiven PPP loan amounts in their gross receipts, they would not experience a significant decline in gross receipts in the quarter the loan was forgiven. Rev. Proc. 2021-33 provides a safe harbor for employers to elect to exclude the forgiven PPP loan amounts from gross receipts solely for purposes of determining eligibility to claim the ERC.
Prior to the safe harbor, even though the amount of forgiveness of a PPP loan was not included in gross income, the forgiveness amount would be included in gross receipts under Section 448(c) and Treas. Reg. Sec. 1.448-1T(f)(2)(iv), or Section 6033 and Treas. Reg. Sec. 1.6033-2(g)(4). Thus, unless the safe harbor provided in Rev. Proc. 2021-33 is elected, an employer must include the amount of the forgiven PPP loan in gross receipts when determining eligibility to claim the ERC.
The safe harbor can also apply to certain other “ERC-Coordinated Grants,” which include the following:
- Grants made pursuant to Section 324 of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act awarded by the Small Business Administration to eligible live venues, performing arts organizations and museum operators and promoters (shuttered venue operator grants)
- Grants made pursuant to Section 5003 of the American Rescue Plan Act of 2021 to qualifying restaurants and food vendors (restaurant revitalization grants)
These ERC-Coordinated Grants can also be excluded from gross receipts for purposes of the ERC pursuant to the safe harbor.
Companies should re-evaluate whether the applicable reduction in the gross receipts threshold for a calendar quarter could be satisfied by excluding the value of PPP loan forgiveness and ERC-Coordinated Grants from gross receipts when determining eligibility to claim the ERC. The ERC gross receipts safe harbor does not permit the exclusion of the amount of a forgiven PPP loan or ERC-Coordinated Grant from the definition of gross receipts under Section 448(c) or Section 6033 for any other federal tax purpose.
Electing or revoking the safe harbor
An employer elects to use and applies the safe harbor through the consistent exclusion of the applicable amounts from gross receipts when determining eligibility to claim the ERC on its employment tax return. This must be applied consistently for each calendar quarter in which gross receipts for that calendar quarter are relevant for an ERC determination. Further, the safe harbor must be applied to all employers treated as a single employer under the ERC aggregation rules.
An employer may revoke a safe harbor election by including the applicable amounts in its gross receipts when determining ERC eligibility for a calendar quarter. Under the consistency rule, an employer that revokes the safe harbor must adjust all employment tax returns that are affected by the revocation of the election.
Notice 2021-49Notice 2021-49 addresses a question that many owners were struggling with: whether wages paid to an employee who owns more than 50% of the value of a C corporation or an S corporation (i.e., a majority owner) and the spouse may be treated as qualified wages for purposes of claiming the ERC.
applies the Section 267(c) constructive ownership rules to its analysis of whether wages paid to a majority owner (or spouse) may be considered qualified wages. The notice provides that if the majority owner and/or the spouse does not have a living “brother or sister (whole or half-blood),” ancestor or lineal descendant, then the wages paid to the owner and/or spouse may be considered qualified wages for the ERC.
If the majority owner does have a living “brother or sister (whole or half-blood),” ancestor or lineal descendant, then the majority owner and spouse would be considered related individuals to those constructive majority owners, and wages paid to the majority owner and/or spouse would not be considered qualified wages for purposes of the ERC. This applies even when the “brother or sister (whole or half-blood),” ancestor or lineal descendant are neither employed nor receiving wages from the corporation.
Notice 2021-49 does not address owners of a partnership or another noncorporate entity as these owners generally cannot be employees of that entity. As such, these individuals do not have wages within the meaning of Section 3121(a). An individual’s earned income from self-employment is not eligible for the ERC.
Notice 2021-49 also discusses other topics that may impact companies:
- Full-time equivalents: For purposes of determining whether an eligible employer is a small or large employer, full-time equivalents are not included in the count.
- Determining qualified wages: Notice 2021-49 provides additional clarifying examples of employers eligible to deem their wages paid as “qualified,” including for “severely financially distressed employers” that may be eligible based on a decline in gross receipts.
- ERC interaction with certain programs: Employers that claimed wages that would otherwise be qualified wages for ERC purposes as payroll costs for (i) the forgiveness of first or second-draw PPP Loans, or (ii) shuttered venue operators grants or restaurant revitalization grants may not claim these wages as qualified wages for ERC purposes. The employers taking advantage of these other programs must retain documentation showing they did not claim the ERC on those wages.
- Treatment of tips: Eligible employers are not prevented from receiving both the ERC and the Section 45B credit for employer Social Security and Medicare taxes paid on certain unreported employee tips. Further, cash tips may be qualified wages under certain circumstances.
- Disallowed federal income tax deduction: Notice 2021-49 clarifies that an employer’s compensation deduction is reduced by the amount of the ERC in the taxable period in which the applicable qualified wages are otherwise deductible. Employers that claimed the ERC after taking a deduction through the employer’s income tax return should file an amended federal income tax return or administrative adjustment request (to the extent the employer did not disallow the deduction for the wages on its original return).
- Gross receipts safe harbor: Notice 2021-49 clarifies that the gross receipts safe harbor provided under Section III.E of Notice 2021-20 applies to employers that acquired a business in 2021. The acquiring employer is permitted to include the gross receipts of the acquired business in its gross receipts for 2019 to determine whether the employer experienced a significant decline in gross receipts in 2021. Notice 2021-49 also clarifies that in order to calculate gross receipts of employers that came into existence in the middle of a calendar quarter—for example, the middle of the third calendar quarter of 2020—employers should use that quarter as the base period to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2021.
The gross receipts safe harbor for PPP loan forgiveness can have a significant impact on a company’s ability to claim the ERC, and thereby reduce employment taxes owed for applicable calendar quarters. Companies should re-evaluate how forgiven PPP loan amounts and ERC-Coordinated Grants were handled in determining whether they experienced a significant decrease in gross receipts in 2020 or 2021, as applicable. To the extent the amounts were excluded from gross receipts, a company should ensure they met the conditions under the safe harbor. To the extent the amounts were included in gross receipts, a company should determine whether they met the conditions for the safe harbor and, if so, whether excluding the amounts from gross receipts would change whether they experienced a significant decline in gross receipts for any applicable calendar quarter in 2020 or 2021.
Owners of corporations should also review the four examples provided in Notice 2021-49 to determine whether payments made to its owner-employees and their spouses are qualified wages for purposes of the ERC.
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