The Internal Revenue Service (IRS) issued additional guidance for employers claiming the employee retention credit, including guidance for employers who pay qualified wages after June 30, 2021, and before Jan. 1, 2022, and further guidance on miscellaneous issues that apply to the employee retention credit in both 2020 and 2021.

Third and Fourth Quarter Guidance

Notice 2021-49 addresses changes made by the American Rescue Plan Act of 2021 (ARP) to the employee retention credit applicable to the third and fourth quarters of 2021, which include:

  1. Making the credit available to eligible employers that pay qualified wages after June 30, 2021, and before Jan. 1, 2022
  2. Expanding the definition of eligible employer to include “recovery startup businesses”
  3. Modifying the definition of qualified wages for “severely financially distressed employers”
  4. Providing that the employee retention credit does not apply to qualified wages taken into account as payroll costs in connection with a shuttered venue grant under Section 324 of the Economic Aid to Hard-Hit Small Businesses, Non-Profits, and Venues Act, or a restaurant revitalization grant under section 5003 of the ARP.

Recovery Startup Businesses

Under Code Sec. 3134(b)(1)(B), a recovery startup business is an employer (i) that began carrying on any trade or business after Feb. 15, 2020; (ii) for which the average annual gross receipts of the employer for the three-tax-year period ending with the tax year that precedes the calendar quarter for which the credit is determined does not exceed $1 million; and (iii) that is not otherwise an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.

For an eligible employer that is a recovery startup business, the amount of the credit allowed under Code Sec. 3134(a) (after application of the limit under Code Sec. 3134(b)(1)(A)) for each of the third and fourth calendar quarters of 2021 cannot exceed $50,000. The determination of when a recovery startup business “began carrying on a trade or business” is made in the same manner as for purposes of Code Sec. 162. It is appropriate for the term “qualified wages” to include wages paid by a recovery startup business. In the third and fourth calendar 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. Whether an employer is a recovery startup business is determined separately for each calendar quarter.

The determination of when a recovery startup business “began carrying on a trade or business” is made in the same manner as for purposes of Code Sec. 162. It is appropriate for the term “qualified wages” to include wages paid by a recovery startup business. In the third and fourth calendar 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. Whether an employer is a recovery startup business is determined separately for each calendar quarter.

Qualified Wages

The rules in Notice 2021-20 for determining the average number of full-time employees continue to apply in the third and fourth calendar quarters of 2021. However, Code Sec. 3134(c)(3)(C) provides a different rule for qualified wages paid by “severely financially distressed employers.” For the third and fourth calendar quarters of 2021, an eligible employer with gross receipts that are less than 10% of the gross receipts for the same calendar quarter in calendar year 2019 (or 2020, if the employer was not in existence in 2019) is a severely financially distressed employer.

Further, the rules for determining whether an employer is an eligible employer based on a decline in gross receipts also apply, in the third and fourth calendar quarters of 2021, for determining whether an eligible employer is a severely financially distressed employer based on the 10% threshold. For the third and fourth calendar quarters of 2021, a severely financially distressed employer that is a large eligible employer may treat all wages paid to its employees during the quarter in which the employer is considered severely financially distressed as qualified wages.

Miscellaneous Guidance

Notice 2021-49 also provides guidance on several miscellaneous issues with respect to the employee retention credit for both 2020 and 2021, including:

  • The definition of full-time employee and whether that definition includes full-time equivalents. For purposes of determining whether an eligible employer is a large eligible employer or a small eligible employer, eligible employers are not required to include full-time equivalents when determining the average number of full-time employees. However, for purposes of identifying qualified wages, an employee’s status as a full-time employee is irrelevant and wages paid to an employee who is not full-time may be treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied.
  • The treatment of tips as qualified wages and the interaction with the section 45B credit. Any cash tips treated as wages within the definition of section 3121(a) of the Code or compensation within the definition of section 3231(e)(3) of the Code are treated as qualified wages, if all other requirements to treat the amounts as qualified wages are satisfied. Additionally, the guidance confirms that eligible employers are not prevented from receiving both the employee retention credit and the section 45B credit for the same wages.
  • Timing of the qualified wages deduction disallowance and whether taxpayers that already filed an income tax return must amend that return after claiming the credit on an adjusted employment tax return. When a taxpayer claims the employee retention credit because of the retroactive amendment of section 2301 of the CARES Act by section 206(c) of the Relief Act (relating to eligibility of PPP borrowers to claim the employee retention credit) or otherwise files an adjusted employment tax return to claim the employee retention credit, the taxpayer should file an amended federal income tax return or administrative adjustment request (AAR), if applicable, for the taxable year in which the qualified wages were paid or incurred to correct any overstated deduction taken with respect to those same wages on the original federal tax return.
  • Whether wages paid to majority owners and their spouses may be treated as qualified wages. The Treasury Department and the IRS have concluded that the section 267(c) ownership attribution rules apply for purposes of determining both an individual’s ownership of stock of a corporation and an individual’s capital and profits interests in a partnership or other entity, therefore, the wages paid to employees with an immediate family relationship to a majority owner of a corporation or of a partnership or other entity are not qualified wages.

Claiming the Credit

Notice 2021-20 and Notice 2021-23 set forth the rules for claiming the employee retention credit in 2020 and the first and second calendar quarters in 2021, respectively. These rules, including the rules pertaining to claiming an advance and relevant limitations, continue to apply for the third and fourth quarters in 2021.

Reporting

Eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their employment tax returns (Form 941) for the applicable period. If a reduction in the employer’s employment tax deposits is not sufficient to cover the credit, certain employers may receive an advance payment from the IRS by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19.

Doeren Mayhew continues to follow the guidance related to the employee retention credit as it becomes available. To obtain assistance with the employee retention credit or to evaluate whether you qualify, contact our tax advisors today.