April 7, 2021
IRS issues guidance on employee retention credit for 2021
In Notice 2021-23, the IRS released guidance on the employee retention credit (ERC) for the first two quarters of 2021. The new guidance amplifies Notice 2021-20 (see Tax Alert 2021-0513) by incorporating the changes made by Section 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Relief Act), which apply on a prospective basis for qualified wages paid in the first two quarters of 2021.
The ERC was enacted on March 27, 2020, as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) for wages paid from March 13, 2020 through December 31, 2020, by employers that (1) were fully or partially suspended due to COVID-19-related governmental orders or (2) experienced a more than 50% decline in gross receipts for the calendar quarter as compared to the same calendar quarter in 2019 (see Tax Alert 2020-0761). The ERC is a refundable employment tax credit for eligible employers paying qualified wages (including qualified health plan expenses). On April 29, 2020, the IRS posted over 90 ERC FAQs on its website. Certain FAQs were later modified, and new FAQs were added over time.
On December 27, 2020, the Consolidated Appropriations Act, 2021 was enacted, which included the Disaster Relief Act. Sections 206 and 207 of the Disaster Relief Act extended and broadened the expiring ERC. Certain changes were retroactive to enactment of the CARES Act, but most apply only to wages paid from January 1, 2021 through June 30, 2021 (see Tax Alert 2021-0019).
Notice 2021-20, released on March 1, 2021, provided guidance on qualified wages paid in 2020. It incorporated most of the FAQs from the IRS website and addressed the retroactive ERC amendments made by Section 206 of the Disaster Relief Act. Notice 2021-23 incorporates the changes made by Section 207 of the Disaster Relief Act and applies to qualified wages paid in the first two quarters of 2021. The IRS said it will issue further guidance on applying Section 9651 of the American Rescue Plan Act of 2021 (ARPA), which extends the ERC to qualified wages paid in the last two quarters of 2021.
The CARES Act excluded governmental employers from eligibility for the ERC. For the first two quarters of 2021, however, Section 207 of the Disaster Relief Act includes an exception for tax-exempt public colleges, universities and hospitals that are described in IRC Section 501(c)(1). Notice 2021-23 clarifies that this exception applies to governmental entities classified as (1) an educational organization as defined in IRC Section 170(b)(1)(A)(ii) and Treas. Reg. Section 1.170A-9(c)(1) that is a college or university or (2) an entity that has the principal purpose or function of providing medical or hospital care within the meaning of IRC Section 170(b)(1)(A)(iii) and Treas. Reg. Section 1.170A-9(d)(1). In addition, Notice 2021-23 acknowledges ARPA's statutory modification to the definition of wages to disregard certain exclusions from "employment" under IRC Section 3121. These modifications allow remuneration paid by governmental employers to constitute qualified wages for the ERC, notwithstanding that the remuneration may not constitute wages for purposes of IRC Section 3121.
Notice 2021-23 also clarifies the gross receipts test that employers may use to qualify for the ERC. For the first two quarters of 2021, employers are eligible for the ERC for one or both quarters (determined separately) that their gross receipts are less than 80% of their gross receipts for the same calendar quarter in 2019. Alternatively, for each of the first two quarters of 2021, employers may elect to compare gross receipts for the prior quarter to the corresponding calendar quarter in 2019. For example, an employer could elect to be a Q2 2021 eligible employer if its Q1 2021 gross receipts are less than 80% of its Q1 2019 gross receipts. An employer makes this election to qualify using the prior quarter by claiming the credit on this basis. Employers that did not exist in the same quarter in 2019 must use the corresponding quarter in 2020 as the benchmark quarter. Notice 2021-23 indicates that an employer must keep documentation of its decline in receipts.
For the first two quarters of 2021, the maximum per-employee qualified wages that may be taken into account increase to $10,000 per quarter. Under the ERC as originally enacted, the credit was 50% of qualified wages (including qualified health plan expenses), up to $10,000 in wages for all quarters in 2020. As amended by Section 207 of the Disaster Relief Act, the ERC is 70% of qualified wages (including qualified health plan expenses) that an eligible employer pays in a calendar quarter (for a maximum total credit of $14,000 for the first two quarters of 2021). That is, the maximum per-employee credit for all of 2020 was $5,000 whereas the maximum per-employee credit for the first half of 2021 is $14,000.
An employer's size is a factor in determining qualified wages. Section 207 of the Disaster Relief Act expanded the definition of small employer for the first two quarters of 2021 to include those with 500 or fewer full-time employees in 2019 (up from 100 or fewer for 2020). For small employers, qualified wages are wages (including qualified health plan expenses) paid to any employee during the period operations were suspended or the period of the decline in gross receipts, regardless of whether its employees are providing services. For large employers, qualified wages are wages (including qualified health plan expenses) paid to an employee who is "not providing services" due to the operational suspension or the decline in gross receipts.
In keeping with the Disaster Relief Act, Notice 2021-23 allows employers to claim any applicable amount of qualified wages up to the statutory cap, rather than limiting qualified wages to the employee's immediately preceding rate, as the CARES Act had originally required.
Notice 2021-23 clarifies that, as in 2020, employers may access the ERC for the first two quarters of 2021 before they file their employment tax returns by reducing their employment tax deposits (see Tax Alert 2020-0816 for requirements in 2020). Notice 2021-23 also provides rules allowing small eligible employers to receive advance payments of their ERC under certain circumstances.
While limited in scope, Notice 2021-23 provides some helpful clarifications for the employers that will be eligible for the expanded ERC in the first two quarters of 2021. Employers do not have to make any formal elections to calculate their gross receipts declines under the alternative method available to them, and they can continue accessing the credit by reducing their employment tax deposits or seeking refunds on an original or amended employment tax return. The limitations on receiving advance payments (Form 7200) are not likely to affect many employers, as that seems to have been the least common way employers have chosen to access the ERC.
Governmental entities that were excluded from claiming the ERC under the CARES Act (i.e., educational institutions or entities whose principal purpose is medical or hospital care) should review the clarifications provided by Notice 2021-23 to determine if they qualify for the ERC under Section 207 of the Disaster Relief Act. For example, a governmental healthcare provider could now qualify for this expanded benefit if it is not exempt under IRC Sections 501(c)(3) and 170(b)(1)(A)(iii) and maintains a principal purpose of providing medical care. The determination should be documented and payroll systems enabled to capture any expenses eligible for the credit.