In Notice 2021-65, the IRS explained the actions that employers who received advanced payments or reduced employment tax deposits in anticipation of 2021 fourth-quarter employee retention credits (ERCs) must take to avoid failure-to-pay penalties under IRC Section 6651. The ERC was retroactively repealed by the Infrastructure Investment and Jobs Act (IIJA, HR 3684) on November 15, 2021, for the fourth quarter of 2021.

This guidance does not apply to recovery startup businesses (RSBs) because they may still claim 2021 fourth-quarter ERCs.

The IRS said it would consider reasonable relief for employers that do not qualify under Notice 2021-65 and respond to penalty notices with an explanation.

Background

The American Rescue Plan Act of 2021 (ARPA) added Section 3134 to the Internal Revenue Code (IRC), codifying and extending the ERC that was 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 to claim refundable ERCs against applicable employment taxes for 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 (See Tax Alerts 2021-0513, 2021-0724 and 2021-1489).

For 2021, an employer was eligible for the ERC for any quarter in which it experienced a full or partial suspension of operations due to certain governmental orders or its gross receipts were less than 80% of its gross receipts for the same quarter in 2019 (alternatively, employers could elect to compare gross receipts for the prior quarter to the corresponding quarter in 2019). The ERC for each quarter of 2021 for which the ERC was available was 70% of qualified wages.

An employer that paid qualified wages during a quarter could reduce its otherwise due federal employment tax deposits (including withheld income taxes and taxes under the Federal Insurance Contributions Act and the Railroad Retirement Tax Act) in anticipation of claiming the ERC by the amount of the anticipated credit. In accordance with Section 2301(k) of the CARES Act, Notice 2020-22 waived IRC Section 6656 failure-to-deposit-penalties for employers that reduced their employment tax deposits by the dollar amount of their anticipated ERC, provided they had not claimed an advance payment of the credit on Form 7200, Advance Payment of Employer Credits Due to COVID-19. Following the extension of the ERC by the CAA and the ARPA, Notice 2021-24 extended this penalty relief through the end of 2021.

The IIJA repealed the ERC for the fourth quarter of 2021, unless the employer is an RSB. This repeal retroactively cut in half the extension of ERCs under the ARPA so wages paid after September 30, 2021, are not eligible for the credit (see Tax Alert 2021-2075).

Notice 2021-65 supplies anticipated guidance

Employers that requested and received an advanced payment of the ERC for wages paid in the fourth quarter of 2021 must repay the advanced amount by the due date of the applicable employment tax return to avoid failure-to-pay penalties.

Employers that reduced their employment tax deposits for fourth-quarter wages on or before December 20, 2021, in anticipation of claiming the ERC will avoid failure-to-pay penalties if they meet all three of the following criteria:

• They reduced their deposits in compliance with Notice 2021-24 (see Tax Alert 2021-0821).
• They deposited the amounts retained in anticipation of the ERC on or before the due date for wages paid on December 31, 2021 (regardless of whether the employer actually pays wages on that date); if the initially retained amounts are $100,000 or more, then Treas. Reg. Section 31.6302-1(c)(3) applies, which requires an employer that has accumulated a total employment tax liability of $100,000 or more during a deposit period to satisfy the obligation by the next business day, without regard to the employer's normal deposit schedule (the Next-Day Deposit Rule)
• They report the tax liability from terminating the ERC on the applicable employment tax return or schedule that includes the 2021 fourth quarter.

Implications

Employers that received advanced payments or reduced their employment tax deposits for ERCs for the fourth quarter of 2021 should consider taking the steps necessary to avail themselves of the penalty relief in Notice 2021-65. This relief is more generous than some practitioners were expecting, but it does require employers to act quickly if they want to take advantage of it.

If the Next-Day Deposit Rule applies, the due date for depositing the tax appears to be January 3, 2022 (because January 1, 2022, is a Saturday and January 2, 2022, is a Sunday). Given the potential for unexpected administrative issues, however, and the fact that Notice 2021-65 does not specifically address the weekend/holiday rule under IRC Section 7503, employers may benefit from making the deposit sooner than required.

For most employers, the employment tax return for the fourth quarter of 2021 will be Form 941, Employer's QUARTERLY Federal Tax Return. Although this form is not required to be filed until January 31, 2022, most employers rely on third-party payroll administrators that may impose commercial deadlines weeks in advance of that date.

If an employer is unable to meet the three criteria for automatic penalty relief under Notice 2021-65, it may be wise to document the reasons in preparation for the possibility that the employer will need to provide an explanation in response to a penalty notice in the future.

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