IRS provides guidance for Employee Retention Credit

Passage of three major pieces of legislation over the last year required tax updates.
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The Internal Revenue Service has provided clarity to the guidelines of the Employee Retention Credit (ERC), which has proved to be a puzzling financial aid to employers and tax experts alike. 

In August, the IRS provided additional guidance for the ERC for the third and fourth quarters of this year, which covers cash tips, eligible qualified wages, gross receipts and ownership wages.

However, there is uncertainty about whether the ERC will extend to the fourth quarter, which begins on Oct. 1 because of the infrastructure bill that is before the U.S. Congress. If the bill is signed into law before Sept. 30, the ERC effectively ends, and employers can no longer claim credit for the fourth quarter of 2021.

Nonetheless, the IRS has provided employers with new guidance for how they can claim credit for their 2020 and 2021 payrolls after a series of laws were passed, continually updating requirements to the ERC. Those laws include the CARES Act 2020, Consolidated Appropriations Act 2021 and the American Rescue Plan Act 2021.

Under the new guidance, the IRS has included cash tips, which are mostly earned by employees in the restaurant industry, in its definition of qualified wages. Prior to the new guidance for qualified wages, Pete Isberg, vice president of government affairs for ADP in Grand Rapids, stated that qualified wages are Social Security wages (defined in IRC Section 3121(a) but without regard to the taxable wage limit).

“This definition is broad and includes most forms of compensation, including 401(k) contributions and other types of compensation that are excluded for federal income tax purposes,” he said. “It also includes any employer health plan expenses that are associated with such wages.”

In the 2020 CARES Act, employers could claim 50% of qualified wages paid, up to $10,000 per employee per quarter. However, when the Consolidated Appropriations Act was signed into law, employers could claim a 70% credit for qualified wages paid, up to $10,000 per quarter, if they continued to be eligible because of either a decline in gross receipts or were subjected to a government shutdown in 2020. The American Rescue Plan Act also extended those claim opportunities to the third and fourth quarters of this year.

Amy Forrester. Courtesy of Plante Moran

According to an article written by Amy Forester, partner and CPA for Plante Moran’s Kalamazoo’s office, and Donny Lucaj, principal and CPA for Plante Moran, the IRS created a safe harbor rule that employers can exclude amounts received from COVID-19 relief programs such as Payroll Protection Program (PPP) loan forgiveness, shuttered venue operator grants and restaurant revitalization grants in their calculated gross receipts. They said, “The guidance implies that grants or loan forgiveness from any other program will continue to count as gross receipts for the ERC.”

In addition to the ERC eligibility based on gross receipts and governmental shutdown effects on businesses, Forester said when the American Rescue Plan was signed into law there were two more eligibility categories added for the third and fourth quarters of 2021. They are significantly distressed business and recovery startup business.

Another clarification was in reference to what is considered a small business and a large business. The Consolidated Appropriations Acts deemed a small business as one that has up to 500 employees. Prior to that legislation, a small business was considered one with 100 employees or less.

Derik Rynearson. Courtesy Beene Garter

Derik Rynearson, a tax partner for Beene Gartner, said the guidance provides clarification on who is considered a full-time employee.

“The initial language in the statute referred to the Affordable Care Act rules, which were implemented in the Obama era, and that guidance was very complex in terms of how you count the number of full-time employees you have,” he said. “It required you to look at your full-time equivalent, which is essentially if you had a group of part-time employees who may work 20 hours per week (and) when you combine all of those people, 20 of those employees might equate to five full-time employees based on the hours they worked. What this new guidance for the ERC provided was that you don’t look at those full-time equivalents, you only look at the people who are considered full-time employees. So that was helpful in how you count employees. They are individuals who work at least 30 hours per week or 130 hours per month under the ERC.”

Duane Culver. Courtesy Culver Group

Duane Culver, a certified public accountant for Culver Group, said one of the biggest surprises was whether the owner’s wages qualified for the ERC.

“In the law, it said the wages to a related person does not qualify for ERC,” he said. “The big question was, ‘How do you define who is ‘related?’ That was not clear, but the guidance provided some clarity. The owner is not necessarily considered related if he/she does not have other relatives (working there), but a person who is related such as an ancestor or direct lineal descendant or a sibling. A spouse is not considered related.”

Related individuals would be considered a child, descendants, siblings, step-brothers/sisters, ancestors, aunts, uncles, nieces, nephews, step-parents and in-laws.

“You could have the owner of the company, and their spouse can be working there, they can be both getting salaries and neither one would be considered related,” he said. “But, if they have a child, that child would be a relative of the owner and he or she would be deemed to have the same ownership that his or her parents have of the company (due to the attribution rules.) Now you have a relative, and even though the owner is not paying wages to the child, the owner/parent wages does not qualify and neither does the child’s mother because she is related to the child.

“She is a spouse to the owner, but because she is the child’s parent, she is related, and her wages wouldn’t qualify even if the child doesn’t work in the company or isn’t even of age. It just changes the whole dynamic. For the owner to not be related, he would have to have no relatives. He must not have any living ancestors, no siblings and no descendants. If so, then the owner would not be considered related to the spouse. It is really odd.”

Even though there are some complexities to the ERC guidance, there is a lot more clarity regarding cash tips, eligible qualified wages, gross receipts and ownership wages. However, there is still some uncertainty for the fourth quarter of this year as to when the infrastructure bill is signed into law, before or after Sept. 30. 

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