IRS Provides Updated FAQs and Examples on Employee Retention Credit

(Parker Tax Publishing March 2021)

The IRS issued guidance on the employee retention credit provided under Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as amended by Section 206 of the Taxpayer Certainty and Disaster Relief Act of 2020 (Disaster Tax Relief Act), enacted as part of the Consolidated Appropriations Act, 2021. The notice provides employers with information on determining their eligibility to receive the employee retention credit, provides multiple examples, expands upon the guidance set forth in the Frequently Asked Questions (FAQs) posted on the IRS website, and also answers additional questions relating to changes made by the Disaster Tax Relief Act not addressed in the FAQs. Notice 2021-20.

Background

Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows a credit (employee retention credit) against applicable employment taxes for eligible employers, including tax-exempt organizations, that pay qualified wages, including certain health plan expenses, to employees after March 12, 2020, and before January 1, 2021. Section 206 of the Tax Certainty and Disaster Relief Act of 2020 (Disaster Tax Relief Act), enacted as part of the Consolidated Appropriations Act, 2021, provides that, for qualified wages paid after March 12, 2020, and before January 1, 2021, an employer that received a loan under the Paycheck Protection Program (PPP) is eligible to claim an employee retention credit. Section 207 of the Disaster Tax Relief Act extended the employee retention credit to qualified wages paid after December 31, 2020, and before July 1, 2021, and modified the calculation of the credit amount for qualified wages paid during that time. The following discussion generally applies to 2020 and does not apply to the post-2020 extension of the employee retention credit under Section 207 of the Disaster Tax Relief Act.

Employers eligible for the employee retention credit are employers that carry on a trade or business during calendar year 2020 and tax-exempt organizations that have a full or partial suspension of operations during any calendar quarter in 2020 due to an order from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, religious, or other purposes) due to COVID-19, or experience a significant decline in gross receipts during the calendar quarter.

The employee retention credit is a fully refundable tax credit for employers equal to 50 percent of qualified wages. Because the maximum amount of qualified wages taken into account with respect to each employee is $10,000, the maximum employee retention credit for an eligible employer for qualified wages paid to any employee is $5,000. The credit is allowed against the taxes imposed on employers by Code Sec. 3111(a), first reduced by any credits allowed under Code Sec. 3111(e) and (f) and Sections 7001 and 7003 of the Families First Act, and the taxes imposed under Code Sec. 3221(a) that are attributable to the rate in effect under Code Sec. 3111(a), first reduced by any credits allowed under Sections 7001 and 7003 of the Families First Act, on all wages and compensation paid to all employees. The same wages or compensation cannot be counted for both the Families First Act leave credits and the CARES Act employee retention credit.

Section 2301(g)(1) of the CARES Act allows an eligible employer to elect not to apply the employee retention credit to qualified wages paid by the eligible employer. Section 2301(g)(2) of the CARES Act provides that the IRS, in consultation with the Administrator of the Small Business Administration (SBA), will issue guidance providing that payroll costs paid during the covered period for a PPP loan will not fail to be treated as qualified wages, if an employer makes an election under Section 2301(g)(1) of the CARES Act, to the extent that the PPP loan of the eligible employer is not forgiven because of a decision under Section 7A(g) of the Small Business Act.

Observation: Section 7A(g) of the Small Business Act sets forth the timing rule for lenders that receive an application for loan forgiveness from eligible recipients that received a PPP loan. Specifically, Section 7A(g) requires lenders to provide a decision regarding forgiveness no later than 60 days after the date on which the lender receives an application of loan forgiveness from an eligible recipient.

Related to Section 2301(g)(2) of the CARES Act, Section 206(e)(2) of the Disaster Tax Relief Act provides a special rule for employers that filed an employment tax return before December 27, 2020. Such employers may elect to treat any "applicable amount" as an amount paid in the fourth calendar quarter of 2020. The "applicable amount," is defined in part, as the amount of wages that are permitted to be treated as qualified wages under guidance issued pursuant to Section 2301(g)(2) of the CARES Act (relating to the decision not to forgive a loan under Section 7A(g) of the Small Business Act), that were paid in the first, second, or third calendar quarter of 2020, and that were not taken into account by the taxpayer in calculating the employee retention credit for such calendar quarter.

Following the enactment of the CARES Act, the IRS posted Frequently Asked Questions (FAQs) on IRS.gov to aid taxpayers in calculating and claiming the employee retention credit. The FAQs have not been updated to reflect the changes made by the Disaster Tax Relief Act.

Notice 2021-20

Last week, the IRS issued Notice 2021-20 to provide additional guidance on the employee retention credit. The notice incorporates the information provided in the FAQs posted on the IRS website and addresses additional issues, including the amendments made by Section 206 of the Disaster Tax Relief Act. The guidance provided in Notice 2021-20 relates to, among other topics: (1) the definition of eligible employers; (2) what is a full or partial suspension of trade or business operations; (3) what is a significant decline in gross receipts; (4) how much is the maximum amount of an eligible employer's employee retention credit; (5) what are qualified wages; (6) how an employer can claim the employee retention credit; and (7) how an eligible employer substantiates a claim for the employee retention credit. Notice 2021-20 does not address changes made by Section 207 of the Disaster Tax Relief Act. According to the IRS, changes for 2021 will be addressed in separate guidance.

Notice 2021-20 also provides guidance on the interaction of the employee retention credit with PPP loans and specifically, when and how employers that received a PPP loan can claim the employee retention credit for 2020. The IRS confirmed in Notice 2021-20 that an employer that received a PPP loan may claim the credit for any qualified wages paid to employees if the employer is an eligible employer that meets the requirements for the credit. However, qualified wages for which the employer claims the employee retention credit are excluded from payroll costs paid during the covered period (payroll costs) for purposes of loan forgiveness under the PPP.

Section 2301(g)(1) of the CARES Act, as amended by the Disaster Tax Relief Act, permits an eligible employer to elect not to take into account certain qualified wages for purposes of the employee retention credit. According to the IRS, an eligible employer generally makes the Section 2301(g)(1) election by not claiming the employee retention credit for those qualified wages on its federal employment tax return. However, an eligible employer that received a PPP loan is deemed to have made the election under Section 2301(g)(1) for those qualified wages listed as payroll costs reported on a PPP loan forgiveness application. Specifically, the amount for which the eligible employer is deemed to have made the election is the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP loan forgiveness application, sufficient to support the amount of the PPP loan that is forgiven.

The IRS stated that the employee retention credit does not apply to the qualified wages for which the Section 2301(g)(1) election or deemed election is made. According to the IRS, an eligible employer is not deemed to have made an election for any qualified wages paid by the eligible employer that are not included in the payroll costs reported on the PPP loan forgiveness application. Notwithstanding a deemed election, if an eligible employer reports any qualified wages as payroll costs on a PPP loan forgiveness application to obtain forgiveness of the PPP loan amount, but the loan amount is not forgiven by reason of a decision under Section 7A(g) of the Small Business Act, the IRS clarified that those qualified wages may subsequently be taken into account for purposes of the employee retention credit. In addition, if an eligible employer obtains forgiveness of only a portion of the PPP loan amount, then the employer is deemed to have made an election for the minimum amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application necessary to obtain the forgiveness of that amount of the PPP loan.

Example: Employer A received a PPP loan of $100,000. Employer A is an eligible employer and paid $100,000 in qualified wages that would qualify for the employee retention credit during the second and third quarters of 2020. In order to receive forgiveness of the PPP loan in its entirety, Employer A was required, under the SBA rules, to report a total of $100,000 of payroll costs and other eligible expenses (and a minimum of $60,000 of payroll costs). Employer A submitted a PPP loan forgiveness application and reported the $100,000 of qualified wages as payroll costs in support of forgiveness of the entire PPP loan. Employer A received a decision under Section 7A(g) of the Small Business Act in the first quarter of 2021 for forgiveness of the entire PPP loan amount of $100,000. Employer A is deemed to have made an election not to take into account $100,000 of the qualified wages for purposes of the employee retention credit, which was the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP loan forgiveness application, sufficient to support the amount of the PPP loan that is forgiven. It may not treat that amount as qualified wages for purposes of the employee retention credit.

Example: Employer B received a PPP loan of $200,000. Employer B is an eligible employer and paid $250,000 of qualified wages that would qualify for the employee retention credit during the second and third quarters of 2020. In order to receive forgiveness of the PPP loan in its entirety, Employer B was required, under the SBA rules, to report a total of $200,000 of payroll costs and other eligible expenses (and a minimum of $120,000 of payroll costs). Employer B submitted a PPP loan forgiveness application and reported the $250,000 of qualified wages as payroll costs in support of forgiveness of the entire PPP loan. Employer B received a decision under Section 7A(g) of the Small Business Act in the first quarter of 2021 for forgiveness of the entire PPP loan amount of $200,000. Employer B is deemed to have made an election not to take into account $200,000 of the qualified wages for purposes of the employee retention credit, which was the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP loan forgiveness application, sufficient to support the amount of the PPP loan that is forgiven. It may not treat that amount as qualified wages for purposes of the employee retention credit. Employer B is not treated as making a deemed election with respect to $50,000 of the qualified wages ($250,000 reported on the PPP loan forgiveness application, minus $200,000 reported on the PPP loan forgiveness application up to the amount of the loan that is forgiven), and it may treat that amount as qualified wages for purposes of the employee retention credit.

Example: Employer C received a PPP loan of $200,000. Employer C is an eligible employer and paid $200,000 of qualified wages that would qualify for the employee retention credit during the second and third quarters of 2020. Employer C also paid other eligible expenses of $70,000. In order to receive forgiveness of the PPP loan in its entirety, Employer C was required, under the SBA rules, to report a total of $200,000 of payroll costs and other eligible expenses (and a minimum of $120,000 of payroll costs). Employer C submitted a PPP loan forgiveness application and reported the $200,000 of qualified wages as payroll costs in support of forgiveness of the entire PPP loan, but did not report the other eligible expenses of $70,000. Employer C received a decision under Section 7A(g) of the Small Business Act in the first quarter of 2021 for forgiveness of the entire PPP loan amount of $200,000. Employer C is deemed to have made an election not to take into account $200,000 of qualified wages for purposes of the employee retention credit, which was the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with any other eligible expenses reported on the PPP loan forgiveness application, sufficient to support the amount of the PPP loan that is forgiven. Although Employer C could have reported $70,000 of eligible expenses (other than payroll costs) and $130,000 of payroll costs, Employer C reported $200,000 of qualified wages as payroll costs on the PPP loan forgiveness application. As a result, no portion of those qualified wages reported as payroll costs may be treated as qualified wages for purposes of the employee retention credit. Employer C cannot reduce the deemed election by the amount of the other eligible expenses that it could have reported on its PPP loan forgiveness application.

Example: Assume the same facts as the above example, except Employer C submitted a PPP loan forgiveness application and reported the $200,000 of qualified wages as payroll costs, as well as the $70,000 of other eligible expenses, in support of forgiveness of the PPP loan. Employer C received a decision under Section 7A(g) of the Small Business Act in the first quarter of 2021 for forgiveness of the entire PPP loan amount of $200,000. In this case, Employer C is deemed to have made an election not to take into account $130,000 of qualified wages for purposes of the employee retention credit, which was the amount of qualified wages included in the payroll costs reported on the PPP loan forgiveness application up to (but not exceeding) the minimum amount of payroll costs, together with the $70,000 of other eligible expenses reported on the PPP loan forgiveness application, sufficient to support the amount of the PPP loan that was forgiven. As a result, $70,000 of the qualified wages reported as payroll costs may be treated as qualified wages for purposes of the employee retention credit.

For a discussion of the employee retention credit, 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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