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A new IRS safe harbor (Revenue Procedure 2021-33) will allow taxpayers to exclude certain items from gross receipts under IRC Sections 448(c) and 6033, solely for determining eligibility for the employee retention credit (ERC). The excludable items are: (1) the forgiven portion of a Paycheck Protection Program (PPP) loan; (2) a shuttered venue operators grant; and (3) a restaurant revitalization grant.

The safe harbor applies for determining an employer's eligibility to claim the ERC for wages paid after March 12, 2020, and before January 1, 2022, the full period for which the ERC is available.

Background

The American Rescue Plan Act of 2021 (ARPA) added Section 3134 to the Internal Revenue Code (IRC), codifying and extending the ERC as created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and later enhanced and extended by the Consolidated Appropriations Act, 2021 (CAA).

Originally, the CARES Act allowed eligible employers, including tax-exempt organizations, to claim ERCs against applicable employment taxes attributable to qualified wages paid after March 12, 2020 and before January 1, 2021. The CAA later extended the availability of the ERC for qualified wages paid after December 31, 2020 and before July 1, 2021, and the ARPA extended the period again to apply for wages paid before January 1, 2022.

Notices 2021-20 (Tax Alert 2021-0513) and 2021-23 (Tax Alert 2021-0724), issued in Spring 2021, provide guidance on who was eligible for the ERC and how to claim the credit. Notice 2021-49 (Tax Alert 2021-1489), issued in early August, explains how the earlier notices apply to ERCs as modified and extended to the end of 2021 by the ARPA.

Eligible employers. The ERC is available solely to eligible employers (IRC Section 3134(c)(2)) for applicable calendar quarters in 2020 and 2021. To qualify, the employer must experience either (a) a full or partial suspension due to certain COVID-19-related government orders, or (b) a specified percentage decline in gross receipts for the calendar quarter when compared to the same quarter in 2019 (known as the "gross receipts test"). Different methods for determining the requisite percentage decline apply for different calendar quarters; the specific rules are found in section III.E. of Notice 2021-20, section III.C. of Notice 2021-23 and section III.D of Notice 2021-49.

PPP loans' interaction with the ERC. For purposes of Revenue Procedure 2021-33, PPP loans fall into three categories, which the guidance refers to collectively as "PPP Loans." (1) "PPP First Draw Loans" were established under the CARES Act and amended by the Paycheck Protection Program Flexibility Act of 2020 and the Economic Aid Act to allow Small Business Act loans to be made to eligible recipients. (2) "Section 1109 Loans" are loans that certain lenders could make because section 1109 of the CARES Act allowed them to do so. (3) "PPP Second Draw Loans" are additional loans authorized to be made to certain "eligible entities." Under the CARES Act, an eligible recipient of a PPP First Draw Loan or a Section 1109 Loan is eligible to have all or part of the loan's principal forgiven if certain conditions are met. The Economic Aid Act extended the same forgiveness eligibility for PPP Second Draw Loans.

Although an employer that has received a PPP Loan may claim the ERC for the calendar quarter, the employer may not count qualified wages for both the ERC and as a payroll cost for the covered period.

Certain grants' interaction with the ERC. The Economic Aid Act authorized the Small Business Administration to make "shuttered venue operator grants" to eligible venues that had been significantly affected by the COVID-19 pandemic, including performing arts and museum operators and promoters to cover payroll costs and other expenses. The ARPA provided similar "restaurant revitalization grants" to qualifying restaurants and food vendors. Revenue Procedure 2021-33 refers to these two grant categories collectively as "ERC-Coordinated Grants." Section 3134(h)(1)(B)(C) allows an employer that has received an ERC-Coordinated Grant to claim the ERC available to it for the calendar quarter as long as qualified wages are not counted for both the ERC and payroll costs in connection with the grant.

Exclusion from gross income. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted as part of the CAA, provided that loan forgiveness related to PPP Loans is not included in the gross income of an eligible recipient or eligible entity. Similarly, no part of an ERC-Related Grant may be included in the gross income of an eligible recipient, and this exclusion from gross income may not result in the denial of a deduction, reduction of a tax attribute, or denial of a basis increase.

Gross receipts. For purposes of determining whether an entity (except a tax-exempt entity) may claim the ERC, gross receipts are defined under IRC Section 448(c) and Treas. Reg. Section 1.448-1T(f)(2)(iv). Generally, gross receipts for purposes of IRC Section 448(c) include total sales, net of returns and allowances, and all amounts received for services. In addition, gross receipts include any income from investments, and from incidental or outside sources, regardless of whether that income is included in the taxpayer's gross income under IRC Section 61. For example, gross receipts include tax-exempt interest within the meaning of IRC Section 103 even though that interest is not included in the taxpayer's gross income under IRC Section 61. In addition, gross receipts are reduced by the taxpayer's adjusted basis in the property sold for sales of capital assets as defined in IRC Section 1221, or sales of property described in IRC Section 1221(2), relating to property used in a trade or business.

For tax-exempt organizations, gross receipts for these purposes are defined under IRC Section 6033. Generally, these are the gross amounts the organization receives during its annual accounting period from all sources, without any reduction for costs or expenses. For an exempt organization, gross receipts include: (1) all contributions, gifts or grants, with no reduction for expenses; (2) all dues or assessments received, with no reduction for expenses; (3) gross sales or receipts from business activities, whether related or unrelated to the entity's exempt purpose; (4) gross amounts from the sale of assets, with no reduction for cost or other basis and expenses; and (5) gross amounts from investment income. To determine gross receipts, a tax-exempt entity should use the same accounting method it generally uses for its books and records.

ERC gross receipts safe harbor

Although neither the PPP Loan forgiveness amount nor the grant amount is included in gross income, the revenue procedure points out, they would be included in gross receipts under IRC Section 448(c) and Treas. Reg. Section 1.448-1T(f)(2)(iv), or IRC Section 6033 and Treas. Reg. Section 1.6033-2(g)(4). Therefore, unless an employer takes advantage of the safe harbor, "the employer must include the amount of the forgiveness of a PPP Loan and the amount of any ERC-Coordinated Grants in gross receipts for determining eligibility" to claim the ERC for applicable calendar quarters in 2020 and 2021, the IRS states.

Revenue Procedure 2021-33 explains the safe harbor as permitting an employer to exclude from gross receipts, solely for purposes of determining eligibility to claim the ERC: (1) the forgiven amount of PPP Loans and (2) ERC-Coordinated Grants.

Applying the safe harbor. The guidance emphasizes that an employer choosing to utilize the safe harbor for a calendar quarter must consistently apply the safe harbor in determining eligibility to claim the ERC. To consistently apply the safe harbor, an employer must: (1) exclude the PPP Loan forgiveness amount or ERC-Coordinated Grant amount from gross receipts for each calendar quarter relevant for determining ERC eligibility, and (2) apply the safe harbor to all employers treated as a single employer under the ERC aggregation rules.

Electing to use the safe harbor. An employer elects to use the safe harbor simply by excluding the forgiven PPP Loan amount or ERC-Coordinated Grant amount from gross receipts when determining eligibility to claim the ERC on its employment tax return applicable to the calendar quarter at issue.

Revoking the safe harbor election. To revoke use of the safe harbor, an employer must include the amount of PPP Loan forgiveness or ERC-Coordinated Grant in gross receipts when determining eligibility to claim the ERC for a calendar quarter on its adjusted employment tax return for that calendar quarter or on its annual return that includes the calendar quarter. The employer must also adjust all employment tax returns that are affected by its revoking the safe harbor election.

Implications

Generally, taxpayers may be eligible to claim the ERC if there is a specified percentage decline in gross receipts for the calendar quarter when compared to the same quarter in 2019. Absent a safe harbor, taxpayers' gross receipts would include a forgiven PPP Loan or an ERC-Coordinated Grant, even though the amount is not included in gross income. Such an inclusion in gross receipts may affect taxpayers' ability to demonstrate a decline in gross receipts to qualify for the ERC. Under the safe harbor in Revenue Procedure 2021-33, however, taxpayers may exclude such amounts from gross receipts.

Accordingly, taxpayers should analyze whether excluding a forgiven PPP Loan or ERC-Coordinated Grants from gross receipts would help them satisfy the specified percentage decline in gross receipts for the calendar quarter and qualify for the ERC. For taxpayers that opt to utilize the safe harbor to qualify for the ERC under the gross receipts test, processes should be established to prevent the inadvertent inclusion of those amounts in future calculations so that the election is not revoked. Finally, taxpayers that have not satisfied the gross receipts test in prior quarters as a result of including those amounts in gross receipts may want to reevaluate whether excluding those amounts may help them qualify for the ERC under the gross receipts test.

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