The IRS has expanded upon previous guidance for the Employee Retention Credit (ERC) in Notice 2021-49. New guidance outlines the amounts eligible for owners of businesses, defines a recovery start up business, gives clarification on gross receipts determination, and expands the payroll taxes that the credits can offset.
Recovery start up business
This category of eligible employer is only applicable to the third and fourth quarter of 2021. These entities are defined by regulation as:
- Began carrying on any trade or business after February 15, 2020
- Has average annual gross receipts of under $1,000,000
- Is not otherwise eligible (under government shut downs or decline is gross receipts under previous guidance)
The above determination is made on a quarterly basis.
Entities that qualify for claiming the Employee Retention Credit under this provision are subject to a maximum credit of $50,000 of payroll tax credits related to the ERC for each of the third and fourth quarter. Non-profits are eligible for this provision.
Employers that meet the definition of Recovery Start Up Business are permitted to treat all wages paid to employees during eligible quarters as qualifying wages for the ERC.
Severely Financially Distressed Employer
This category of eligible employer is defined by regulations as having only 10% of the revenue in the quarter in question as compared to the same quarter in 2019. If an employer falls into this category and is a large employer, per previous definitions, all of the employer’s wages are eligible for the ERC. In contrast, a large employer would generally only have qualified for wages for employees being compensated but not providing services.
Shuttered Venue Operator Grants & Restaurant Revitalization Grant
The IRS has established that funds received for the Shuttered Venue Operator Grants and the Restaurant Revitalization Fund may not be used for wages also used for ERC. This is consistent with previous regulations that PPP borrowers could not claim the ERC for wages that were also used for PPP forgiveness.
The Notice clarifies that certain tips are qualified wages for the ERC and that wages eligible for the section 45B credit may also be used for the ERC.
Reporting of ERC on Income Tax Returns
Tax credits related to wages are required to be reported on federal income tax returns as a reduction of the deduction for wages. For example, if an employer received $5,000 of ERC, they would be required to reduce the wages reported on their 2020 income tax return by $5,000. The IRS has now clarified when to reduce the deduction, as many employers are filing amended Form 941s to claim the ERC after their tax returns have been filed. If an employer applies for the ERC in a previous year and their income tax return has already been filed, the employer must file an amended tax return to adjust the taxable income by the amount of ERC to be received.
Owner’s and Family Members’ Qualified Wages
Initially, the ERC guidance did not clearly indicate whether or not a more than 50% shareholder and shareholder spouse’s wages were qualified wages. Now the IRS has given us several examples and a great deal of clarity on this determination. Under original guidance we knew that wages paid to employees with the following relationships to a majority owner were not qualified wages:
- A child or descendant of a child
- Brother, sister, stepbrother or stepsister
- Father or mother or any ancestor of either
- Stepfather or stepmother
- Niece or nephew
- Aunt or uncle
- Son-in-law, daughter-in law, mother-in-law, father-in-law, brother-in-law, sister-in-law
- An individual (other than spouse) who has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household
Under Notice 2021-49 it is made clear that essentially if a more than 50% owner has any familial relationships it is highly unlikely their wages are considered qualified wages for the ERC. Please see the following examples shared by the IRS in the guidance:
- Example 1: Corporation A is owned 80 percent by Individual E and 20 percent by Individual F. Individual F is the child of Individual E. Corporation A is an eligible employer with respect to the first calendar quarter of 2021. Both Individual E and Individual F are employees of Corporation A. Pursuant to the attribution rules of section 267(c) of the Code, both Individual E and Individual F are treated as 100 percent owners of Corporation A. Individual E has the relationship to Individual F described in section 152(d)(2)(C) of the Code, and Individual F has the relationship to Individual E described in section 152(d)(2)(A). Accordingly, Corporation A may not treat as qualified wages any wages paid to either Individual E or Individual F because both Individual E and Individual F are each related individuals for purposes of the employee retention credit.
- Example 2: Corporation B is owned 100 percent by Individual G. Individual H is the child of Individual G. Corporation B is an eligible employer with respect to the first calendar quarter of 2021. Individual G is an employee of Corporation B, but Individual H is not. Pursuant to the attribution rules of section 267(c) of the Code, Individual H is attributed 100 percent ownership of Corporation B, and both Individual G and Individual H are treated as 100 percent owners. Individual G has the relationship to Individual H described in section 152(d)(2)(C) of the Code. Accordingly, Corporation B may not treat as qualified wages any wages paid to Individual G because Individual G is a related individual for purposes of the employee retention credit.
- Example 3: Corporation C is owned 100 percent by Individual J. Corporation C is an eligible employer with respect to the first calendar quarter of 2021. Individual J is married to Individual K, and they have no other family members as defined in section 267(c)(4) of the Code. Individual J and Individual K are both employees of Corporation C. Pursuant to the attribution rules of section 267(c), Individual K is attributed 100 percent ownership of Corporation A, and both Individual J and Individual K are treated as 100 percent owners. However, Individuals J and K do not have any of the relationships to each other described in section 152(d)(2)(A)-(H) of the Code. Accordingly, wages paid by Corporation C to Individual J and Individual K in the first calendar quarter of 2021 may be treated as qualified wages if the amounts satisfy the other requirements to be treated as qualified wages.
- Example 4: Corporation D is owned 34 percent by Individual L, 33 percent by Individual M, and 33 percent by Individual N. Individual L, Individual M, and Individual N are siblings. Corporation D is an eligible employer with respect to the first calendar quarter of 2021. Individual L, Individual M, and Individual N are employees of Corporation D. Pursuant to the attribution rules of section 267(c) of the Code, Individual L, Individual M, and Individual N are treated as 100 percent owners. Individual L, Individual M, and Individual N have the relationship to each other described in section 152(d)(2)(B) of the Code. Accordingly, Corporation D may not treat as qualified wages any wages paid to Individual L, Individual M, or Individual N.
Alternative Quarter Election
The Treasury and the IRS noted the determination of whether an employer is an eligible employer based on a decline in gross receipts is made separately each quarter. Therefore, an employer may be eligible for the second quarter of 2021 based on a 25% decline in gross receipts when compared to second quarter 2019 but then for the third quarter 2021 instead of comparing gross receipts to the third quarter of 2019 the employer may use the alternative quarter election and base eligibility off of the second quarter of 2021 compared to 2019.
How can we help?
The Employee Retention Credit continues to be a sought after COVID recovery tool for small business. If you believe your organization may qualify, contact your Mitchell Wiggins advisor for a consultation or complete this brief questionnaire and a member of our COVID response team will be in touch.