IRS Clarifies Rules for 2021 Employee Retention Tax Credit

(Parker Tax Publishing April 2021)

The IRS issued guidance for taxpayers claiming an employee retention tax credit (ERTC) for 2021, as well as advance payments of the ERTC. Among other things, the guidance provides that (1) the previously provided 2020 requirement to reduce employment tax deposits in anticipation of the credit before requesting an advance continues to apply to 2021 small eligible employers; (2) eligible employers may continue to access the ERTC for the first and second calendar quarters of 2021 before filing their employment tax returns by reducing employment tax deposits in anticipation of the ERTC; and (3) 2021 small eligible employers that come into existence in 2021 are ineligible to receive advance payment of the ERTC, but may reduce their employment tax deposits in anticipation of claiming such credit. Notice 2021-23.

Background

Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted an employee retention tax credit (ERTC) which allows eligible employers to take a credit against certain employment taxes. Originally, the credit related to employment taxes paid on a percentage of qualified wages paid after March 12, 2020, and before December 31, 2020. That termination date was later extended to July 1, 2021, by Section 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Tax Relief Act), which was enacted as part of the Consolidated Appropriations Act, 2021 (Pub. L. 116-260). Section 207 also made several other changes to the ERTC. The American Rescue Plan Act of 2021 (Pub. L. 117-2) subsequently enacted Code Sec. 3134, which extended the ERTC to wages paid after June 30, 2021, and before January 1, 2022.

In addition to Section 207, Section 206 of the Disaster Tax Relief Act also made changes to the ERTC. Those changes relate to the calculation of the ERTC in conjunction with the gross receipts of tax-exempt organizations, the treatment of health plan expenses, the coordination between the Paycheck Protection Program (PPP) (enacted as part of the CARES Act) and the ERTC, and the effect on the ERTC of the leaseback of employees.

In March, the IRS issued Notice 2021-20, to address changes made to the ERTC by Section 206 of the Disaster Tax Relief Act. On April 2, the IRS issued Notice 2021-23, which expands on the guidance provided in Notice 2021-20 by addressing the changes made to the ERTC by Section 207 of the Disaster Tax Relief Act. Those changes are effective beginning January 1, 2021.

Employers Eligible for the ERTC

Under Section 2301(c)(2)(A)(i) of the CARES Act, as amended by Section 207(a)(2) of the Disaster Tax Relief Act, in order to be an employer eligible for the ERTC (i.e., an eligible employer), the employer must have been carrying on a trade or business during the calendar quarter for which the ERTC is determined. The CARES Act provides that in the case of any governmental entity that is a college or university, or the principal purpose or function of which is providing medical or hospital care, such entity is treated as satisfying the trade or business requirement in Section 2301(c)(2)(A)(i). Thus, the IRS states in Notice 2021-23, these entities may be eligible employers for the first and second calendar quarters of 2021, assuming they satisfy the other requirements to be eligible employers.

Decline in Gross Receipts

Section 2301(c)(2)(A)(ii)(II) of the CARES Act, as amended by Section 207(d)(1)(A) of the Disaster Tax Relief Act, provides that an employer is an eligible employer with respect to any calendar quarter for which its gross receipts for the calendar quarter are less than 80 percent of its gross receipts for the same calendar quarter in 2019. Accordingly, for purposes of the ERTC for the first and second calendar quarters of 2021, the determination of whether an employer is an eligible employer based on a decline in gross receipts is made separately for each calendar quarter and is based on an 80 percent threshold.

In addition, the CARES Act, as further amended by Section 207(d)(1)(B) of the Disaster Tax Relief Act, states that with respect to any employer for any calendar quarter, if the employer was not in existence as of the beginning of the same calendar quarter in calendar year 2019, the CARES Act is applied by substituting "2020" for "2019." Accordingly, under Notice 2021-23, if an employer was not in existence as of the beginning of the first calendar quarter of 2019, that employer generally determines whether the decline in gross receipts test is met in the first calendar quarter of 2021 by comparing its gross receipts in the first calendar quarter of 2021 to its gross receipts in the first calendar quarter of 2020. Similarly, if an employer was not in existence as of the beginning of the second calendar quarter of 2019, that employer generally determines whether the decline in gross receipts test is met in the second calendar quarter of 2021 by comparing its gross receipts in the second calendar quarter of 2021 to its gross receipts in the second calendar quarter of 2020.

However, the CARES Act, as amended by Section 207(d)(2) of the Disaster Tax Relief Act, permits an employer to elect to use an alternative quarter to calculate gross receipts. Under this election, an employer may generally determine if the decline in gross receipts test is met for a calendar quarter in 2021 by comparing its gross receipts for the immediately preceding calendar quarter with those for the corresponding calendar quarter in 2019 (substituting 2020 for 2019 if the employer did not exist as of the beginning of that quarter in 2019). Notice 2021-23 provides that, for the first calendar quarter of 2021, an employer may elect to use its gross receipts for the fourth calendar quarter of 2020 compared to those for the fourth calendar quarter of 2019 to determine if the decline in gross receipts test is met. If an employer was not in existence as of the beginning of the fourth calendar quarter of 2019, then the alternative quarter election will not be available for the first calendar quarter of 2021.

For the second calendar quarter of 2021, an employer may elect to use its gross receipts for the first calendar quarter of 2021 compared to those for the first calendar quarter of 2019 to determine if the decline in gross receipts test is met. If an employer was not in existence as of the beginning of the first calendar quarter of 2019, then that employer may elect to measure the decline in gross receipts for the second calendar quarter of 2021 using its gross receipts for the first calendar quarter of 2021 compared to those for the first calendar quarter of 2020.

Compliance Tip: Eligible employers must maintain documentation to support the determination of the decline in gross receipts, including which calendar quarter an eligible employer elects to use in measuring the decline. An election to use an alternative quarter to calculate gross receipts is made by claiming the employee retention credit for the quarter using the alternative quarter to calculate gross receipts.

Claiming the ERTC

Notice 2021-20 provides various rules for claiming the ERTC, including the circumstances under which an eligible employer may request an advance payment of the ERTC. For calendar quarters in 2020, there was no restriction on the types of eligible employers that could claim an advance, nor was there a maximum advance amount other than the amount of the employee retention credit eligible to be claimed, subject to the requirement that an eligible employer reduce deposits in anticipation of the credit before requesting an advance.

The Disaster Tax Relief Act did not amend Section 2301(k) of the CARES Act, which provides for a waiver of penalties for a failure to deposit employment taxes if the failure was due to the reasonable anticipation of the employee retention credit. In Notice 2021-23, the IRS provides that eligible employers may continue to access the employee retention credit for the first and second calendar quarters of 2021 before filing their employment tax returns by reducing employment tax deposits in anticipation of the employee retention credit, in accordance with the requirements of Notice 2020-22.

The CARES Act was amended by Section 207(g) of the Disaster Tax Relief Act to add Section 2301(j), which provides for advance payments of the ERTC. It prohibits the advance payment of the ERTC except to 2021 small eligible employers (i.e., eligible employers for which the average number of full-time employees during 2019 was not greater than 500). Such employers may elect to receive an advance payment of the ERTC in an amount not to exceed 70 percent of the average quarterly wages paid in calendar year 2019 (the 70 percent advance rule). In Notice 2021-23, the IRS provides that the previously provided 2020 requirement to reduce deposits in anticipation of the credit before requesting an advance continues to apply to 2021 small eligible employers.

While the CARES Act does not define the term "average quarterly wages," Notice 2021-23 provides that, for purposes of the 70 percent advance rule, the term "average quarterly wages" generally means the average of wages or compensation, both determined without regard to the social security wage base, paid in each calendar quarter in 2019. The aggregation rules described in Notice 2021-20 apply in determining an eligible employer's average quarterly wages. Accordingly, the average quarterly wages for the 70 percent advance rule are calculated based on the quarterly wages paid by all members of the aggregated group.

For 2021 small eligible employers who file Form 941, Employer's Quarterly Federal Tax Return, Notice 2021-23 provides that average quarterly wages for the 70 percent advance rule are calculated by averaging the amount required to be reported on Line 5c, "Taxable Medicare wages & tips," on all Forms 941 required to be filed by a small eligible employer for wages paid in 2019. For 2021 small eligible employers that file an annual federal employment tax return, "average quarterly wages" for the 70 percent advance rule are calculated by dividing the amount required to be reported on the following forms and lines, as applicable, by four: (1) Line 4, "Total wages subject to Medicare tax," on the 2019 Form 943, Employer's Annual Federal Tax Return for Agricultural Employees; (2) Line 4c, "Taxable Medicare wages and tips," on the 2019 Form 944, Employer's Annual Federal Tax Return; and (3) the sum of the amounts in the "Compensation" columns of Line 2, "Tier 1 Employer Medicare Tax - Compensation (other than tips and sick pay)," and Line 9, "Tier 1 Employer Medicare Tax - Sick Pay," on the 2019 Form CT-1, Employer's Annual Railroad Retirement Tax Return.

Section 2301(j)(2) of the CARES Act provides special rules for determining average quarterly wages for 2021 small eligible employers that are seasonal employers and 2021 small eligible employers not in existence in 2019. Under Section 2301(j)(2)(B), 2021 small eligible employers that employ seasonal workers may elect to determine the average quarterly wages based on the wages for the calendar quarter in 2019 which corresponds to the calendar quarter to which the election relates rather than the average quarterly wages paid in calendar year 2019. A 2021 small eligible employer that employs seasonal workers elects to use the special rule by requesting an advance based on the amount of wages for the calendar quarter in 2019 corresponding to the calendar quarter to which the election relates. Under Section 2301(j)(2)(C), 2021 small eligible employers not in existence in 2019 may look to the average quarterly wages paid in 2020 for purposes of applying the 70 percent advance rule. A 2021 small eligible employer that was not in existence in 2019 elects to use the special rule by requesting an advance based on the average quarterly wages paid in 2020.

Because no method is provided for determining average quarterly wages for a 2021 small eligible employer that comes into existence in 2021, such employers are ineligible to receive advance payment of the employee retention credit. However, Notice 2021-23 provides that these employers, like all eligible employers, may reduce their deposits of employment taxes in anticipation of claiming the employee retention credit on Form 941 (or other applicable federal employment tax return) in accordance with Notice 2020-22.

If an eligible employer was in existence for some, but not all, calendar quarters of 2019 or 2020, average quarterly wages are determined by dividing the sum of the wages paid in 2019 or 2020, as applicable, by the number of calendar quarters in 2019 or 2020, as applicable, in which that eligible employer existed.

If an eligible employer existed for only part of a calendar quarter, Notice 2021-23 provides that eligible employer should estimate the wages paid in the entire calendar quarter based on the wages paid in the portion of the calendar quarter in which it existed using any reasonable method. For example, if an eligible employer existed for two out of three months in a calendar quarter, that eligible employer may multiply the wages paid in those two months by 1.5 before averaging the wages for that quarter with the wages for the other calendar quarters. If an eligible employer filing a Form 943, 944, or CT-1 existed for only part of 2019 or 2020, that eligible employer may use any reasonable method to annualize the wages paid (or compensation for Form CT-1 filers) prior to dividing the amount by four.

For a discussion of the ERTC, see Parker Tax ¶106,460.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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