On Wednesday, August 4, 2021, the IRS published Notice 2021-49 with new guidance on the Employee Retention Tax Credit. This overdue guidance deals with the extension and changes to the ERC applicable for the third and fourth quarters of 2021 and answers some hotly debated questions applicable to the program as a whole.
Section III of the Notice discusses the new features of the program. Section III.D describes the new Recovery Startup Business eligibility rule. Employers who began carrying on a trade or business after February 15, 2020, and for which the average annual gross receipts for the 3-taxable-year period do not exceed $1,000,000 will be eligible to receive a retention credit even if they were not suspended due to government order and did not experience a decline in gross receipts. The credit allowable under this qualification is limited to $50,000 per quarter.
While we discussed in a previous post that the Senate is currently debating a bill which would end the ERC on September 30, even if passed, that bill would maintain this Recovery Startup Business credit through the fourth quarter.
The new Notice is not overly specific about some of the rules pertaining to the Recovery Startup Business. New businesses will have to consider:
- How to determine the actual start date of “carrying on a trade or business.” The Notice reflects a recent Court of Appeals decision that differentiates between startup activities and actually carrying out a trade or business, and notes that in general, “a taxpayer has not begun carrying on a trade or business ‘until such time as the business has begun to function as a going concern and performed those activities for which it was organized.’”
- How to determine the gross receipts for the 3-taxable-year period ending with the taxable year preceding the calendar quarter for which the credit is claimed. The statute and the Notice reference section 448(c)(3) of the Code which says that an entity which was not in existence for the entire 3-year period should determine gross receipts based on the months that it was in existence. Therefore, a business that started after February 15, 2020, and has a tax year ending before June 30, 2021, will be eligible if the gross receipts generated in that period were less than $1,000,000. Apparently, businesses that start in 2021 without ending their first tax year prior to the third quarter can generate any amount of gross receipts and be eligible for this credit.
- Since the same aggregation rules apply to the Recovery Startup Business as for the ERC as a whole, it appears that if the new entity is part of an aggregated group that has been engaged in a trade or business prior to February 15, 2020, the new entity will be ineligible for the credit.
Section IV of the Notice addresses certain questions which apply to the ERC for all quarters.
The first question is whether full-time equivalents need to be counted when determining employer size. The IRS answers unequivocally that “For purposes of determining whether an eligible employer is a large eligible employer or a small eligible employer, eligible employers are not required to include full-time equivalents when determining the average number of full-time employees.” They also note that this does not mean that wages paid to part-time employees cannot be considered qualified wages.
In the second question, the IRS determines that employers may receive the retention credit and the section 45B tip credit for the same wages, effectively receiving a double benefit.
The third question deals with the timing of the corresponding wage deduction disallowance. Unfortunately, the IRS has decided that the wage deduction must be reduced in the same year for which the qualified ERC wages were paid. Therefore, if a taxpayer amends their payroll tax return to claim the ERC for quarters in 2020 and has already filed their income tax return for 2020, they will also have to amend their income tax return to reflect the change in the wage deduction.
The fourth question deals with an issue that has been extensively debated: can a business owner claim a retention credit for the wages paid to themselves? The answer in the Notice takes six pages to answer and is a logical mess, but the short answer is, no.