The IRS recently issued additional guidance on the Employee Retention Credit (“ERC”) primarily focused on the 3rd and 4th quarters of 2021 that were added with the American Rescue Plan back in March 2021. The guidance touched on some unknowns that we’ve had questions about since the program was created and then opened to employers that received a Paycheck Protection Program loan. Below are some of the key items from the guidance.
- Owner wages have been an unknown up until this point. In past guidance, the IRS has specifically said the wages of relatives of over 50% owners (direct and indirect) are not eligible for the credit, however, there hasn’t been specific guidance on the owners and their spouses. Well, now there is. Essentially, if an owner has a living relative (the IRS definition of a relative), that relative indirectly owns the same amount they do, which in turn makes the owner a relative of an indirect owner. This would also exclude spouses, as in-laws are considered relatives for this purpose also. Simple right? While it’s a convoluted way to get there, it makes sense that if all the relatives of an owner have their wages excluded that an owner would also. This just clarifies that’s the case and explains why. Keep in mind you still need to get over 50%, so if you have two 50% owners that are completely unrelated to each other, then they may not be excluded (depending on other factors – indirect ownership being the biggest thing to consider). Or, if the owner has no living relatives, then there is no relative to have indirect ownership.
- The employee counts in 2019 that determine if a company can use all eligible wages or just wages to employees that were not providing services (100 for 2020 and 500 for 2021) were clarified in a favorable manner. The notice clarifies that the company only needs to count full-time employees (defined under IRS rules as an employee that works 30 hours a week or 130 hours in a month), and that full-time equivalents are not considered for this. So, if you have 5 people working 20 hours a week, you’d essentially have approximately 3.3 full-time equivalents (100 hours / 30 hours). For ERC though, they count as 0. So, if your company has a lot of part-time employees or you were very close to being under the limits, it may be worth looking at your employee counts again with this new guidance to see if you’re under those limits
- If you claim the credit, the amount of wages and health plan expenses you can deduct on your income tax return is reduced. The timing of when that needs to occur was a question previously. Is it when the wages were paid or is it when you receive the credit? The IRS has clarified that it is when the wages or health plan expenses were paid or incurred. So, if you are amending a 2020 Form 941 and claiming the credit, then the credit will reduce your deductions on your 2020 income tax return. If it has already been filed, you will need to amend it. This could create situations where a company will owe additional income tax before they even receive the employee retention credit, so planning and discussing timing with your tax professional will be important.
- With a separate announcement on August 10th, the IRS has provided a safe harbor election so that Paycheck Protection Program forgiveness will be allowed to be excluded from gross receipts for the purposes of determining eligibility for the ERC. Normally it would be considered a gross receipt, and you can elect to treat it as such if you choose, but in most cases it would be advantageous to exclude it.
- Tips can be included as qualified wages if tips received by an employee are $20 or more in a month.
- For the 3rd and 4th quarter, the credit will be applied against Medicare instead of Social Security. The overall credit isn’t going to change, but how the 941 is filled out will change. So make sure you use the updated form 941 for the 3rd and 4th quarter of 2021.
- There is further clarification of a recovery startup business and how the credit applies to them. We won’t go into a lot of detail here as this won’t apply to most companies, but if you’re not sure if it applies to you, the first factor is your business must be started after February 15th, 2020. Most stimulus has not been available to new businesses, but the addition of the recovery start up business allowed ERC to be utilized by newer businesses. If this applies to you, click the link to the notice and the recovery start up section starts on page 6.
The first three items are the most significant information to come from this new notice and may mean that your business qualifies for more or less credit than you originally thought, and clarifies if you need to file an amended income tax return. If you already filed an amended 941, you could always amend it again if you’re under the employee counts once you exclude part-time employees. We are still waiting on some key guidance, such as if the IRS will further clarify partial shutdowns, which in most cases are a major grey area. Another emerging issue is that the 4th quarter credit may not be available any longer if the recent infrastructure bill passes the Senate and House as drafted, because that bill ends the ERC period on September 30th, 2021. We will keep an eye on this.
If there’s anything above you’d like to discuss further, please contact us. You can also visit our ERC resource page for additional information about partial shutdowns and other aspects of the ERC that we’ve covered with past articles.