On March 1, 2021, the IRS issued Notice 2021-20 “Guidance for Employers Claiming Employee Retention Credit Against Payroll Tax for 2020”. This guidance does not address changes made to the employee retention credits (“ERC”) for qualified wages paid after December 31, 2020. The IRS will address 2021 credits in future guidance.
The Taxpayer Certainty and Disaster Relief Act of 2020 (“Relief Act”) made retroactive changes to employee retention credits available for qualified wages paid after March 12, 2020 and before January 1, 2021. These changes primarily related to who was qualified to claim the credit. The credit amount for this period is calculated as 50% of qualified wages paid (which also includes payments for group health insurance), limited to $10,000 in wages per employee, and all wages paid qualify for the credit for employers that averaged 100 or fewer full-time employees (“FTEs”) in 2019. Employers with more than 100 FTEs may also claim the credit, but only for wages paid to employees who were not providing services due to government ordered shutdowns. Furthermore, employers are required to comply with the IRS aggregation rules for related entities and will need to maintain adequate records to substantiate eligibility and support the amount of qualified wages. See our previous article for a more detailed discussion of the eligibility requirements, aggregations rules, and definition of eligible wages.
Interaction with PPP Loans
The most significant change made by the Relief Act was to allow PPP borrowers to be eligible to claim the employee retention credits. However, qualified wages which the borrower included on their PPP Loan Forgiveness Application as payroll costs are not eligible to also be used for claiming the ERC. PPP borrowers who claim the ERC will have been deemed to have made an election under Section 2301(g)(1) of the CARES Act, which allows an eligible employer to elect to not take into account certain qualified wages for purposes of the ERC.
If the borrower included more payroll costs on the forgiveness application than was necessary to support the amount of the PPP loan that was forgiven, the excluded payroll costs will be limited to the minimum amount of payroll costs, together with any other eligible expenses, necessary to achieve the forgiveness amount. This will allow any borrowers who included all eligible payroll costs incurred during the covered period to use the excess payroll costs as qualifying costs for the purpose of the ERC.
For example, a qualifying employer with a $200,000 PPP loan reported $250,000 in payroll costs on its forgiveness application. Since only $200,000 of those costs were necessary to obtain full forgiveness of the PPP loan, the excess $50,000 in payroll costs may be used as qualifying expenses for the ERC. Same example, but this time the borrower also included $70,000 of non-payroll costs on the PPP forgiveness application. In this scenario, $130,000 of payroll costs will be deemed as the minimum amount necessary to support loan forgiveness ($200,000 – $70,000 = $130,000). When calculating the minimum necessary payroll costs in this example, employers should be careful to not include less than the 60% payroll costs required by the PPP loan forgiveness rules.
Claiming the Employee Retention Credits
To claim the employee retention credits for newly eligible PPP borrowers, employers must generally file an amended quarterly tax return (941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund) for the relevant quarters during which the eligible wages were paid. Using a prior example, a PPP borrower who, after having obtained loan forgiveness, determined that it incurred $50,000 in payroll costs exceeding the minimum amount needed to achieve full forgiveness may then file an amended 941-X for the applicable quarters to claim the ERC. Employers should not use a subsequent 941 to claim an ERC for qualified wages paid during a previous quarter.
The one exception is for PPP borrowers who did not receive loan forgiveness by reason of a decision under section 7A(g) of the Small Business Act. These employers have the option to use the special fourth quarter rule which allows them to claim any eligible employee retention credits on the fourth quarter 2020 941 for qualified payroll costs paid during the second and third quarters of 2020. Eligible employers are not required to file using this option and may instead file the 941-X for each quarter instead.
Impact on Deductibility of Expenses
Claiming employee retention credits will result in a reduction of allowable expenses for federal income tax purposes. The deduction for qualified wages, including health plan expenses, will be reduced by the amount of employee retention credits received. The employer does not reduce its deduction for the employer’s share of social security and Medicare taxes by any portion of the credit. No portion of the ERC is included in the employer’s gross income.
Additional Guidance Topics
The Notice also includes detailed examples to assist employers with various potential questions. The topics addressed include: eligibility requirements; calculating FTEs; determining what qualifies as a “full or partial suspension” of operations; affiliation rules; what to include in “gross receipts” for both tax-exempt and for-profit entities; and what qualifies as eligible wages for the credit. While not all inclusive, the Notice will answer most commonly asked questions.
Claiming ERC Credits for 2021
As noted earlier, the Notice does not provide guidance on how to claim the expanded employee retention credits for 2021. The 2021 credits increase the maximum amount of the credit to $7,000 per employee, per quarter while also expanding the eligibility requirements. It is expected that the quarterly Form 941 will continue to be the primary means to file for the ERC with options for advance payments however these questions will be addressed in a future IRS Notice.