Since the Employee Retention Credit (ERC) was introduced in March 2020, it has helped many companies keep their teams employed. However, there are several common questions employers have been asking in relation to the credit.
In response, the IRS recently issued guidance via Notice 2021-49 and Rev. Proc. 2021-33. Specifically, Notice 2021-49 offers guidance on the ERC for Q3 and Q4 2021, while also clarifying and amplifying previous notices that addressed the credit for the first half of this year. Rev. Proc. 2021-33 provides a safe harbor to allow taxpayers trying to determine if they are eligible for the ERC to exclude certain items from the gross receipts test.
Below are the key questions and answers addressed in the new guidance.
1. Are Wages of a Corporation’s Majority Owner Eligible for the ERC?
The answer to this question is, in most situations, no. The rules disqualifying wages of certain related parties rely on the definitions used for the Work Opportunity Tax Credit found in Sections 51 and 52 of the Internal Revenue Code.
Essentially, wages are not eligible for the ERC if the taxpayer bears any relationship to an individual who owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Key relationships to the taxpayer include:
- Child or descendant of a child;
- Brother, sister, stepbrother or stepsister;
- Father or mother, or an ancestor of either;
- Stepfather or stepmother;
- Niece or nephew;
- Aunt or uncle;
- Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law; Or
- Individuals other than a spouse who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household.
While the list of potentially excluded persons is extensive, the rules do not specifically exclude the majority owner’s wages from qualifying for the ERC. Therefore, upon a quick read of the tax code, an employer may believe the wages of a majority owner qualify. However, additional language at the end of the section, in most cases, will result in the majority owner’s wages being disqualified.
Under the constructive ownership rules of Section 267(c), if the majority owner of a corporation has a brother/sister (whether whole or half-blood), ancestor or lineal descendant, the majority owner’s wages will not qualify. This is due to the fact that the majority owner’s stock will be attributed to the family member, therefore making the majority owner a related individual. If the majority owner does not have a brother/sister, ancestor or lineal descendant to attribute their stock, then they would not be a related individual and their wages would qualify for the ERC. A similar analysis would apply to the spouse of the majority owner. In most cases, the wages of a majority owner’s spouse would also likely be disqualified, unless the majority owner does not have a brother/sister, ancestor or lineal descendant to attribute their shares.
2. If You File an Amended 2020 Form 941 to Claim the ERC after Filing Your 2020 Income Tax Return, Do You Need to Amend the Income Tax Return Itself?
The short answer? Yes. Taxpayers must reduce their wage expense deduction for income tax purposes by the amount of the ERC. Notice 2021-49 provides that a taxpayer should file an amended federal income tax return or administrative adjustment request (AAR) for the tax year in which the qualified wages were paid or incurred.
While this conclusion may not be surprising, there had been requests/comments by the tax community to provide some relief in this situation. Although not addressed in the guidance, certain taxpayers may be able to file a superseded return, a subsequent return filed within the filing period (including extensions), as opposed to an amended return or AAR.
A superseded return will not be available to all, but, if it is, it may be a good option to consider, especially in the case of a partnership that would otherwise have to file an AAR.
3. Are PPP Loan Forgiveness Proceeds Included in Gross Receipts for Purposes of Testing Whether the Employer Meets the Substantial Decline in Gross Receipts Test?
Rev. Proc. 2021-33 provides a safe harbor to exclude certain items from the definition of gross receipts, but the exclusion only applies for purposes of the ERC. Therefore, amounts excluded by Rev. Proc. 2021-33 may still be considered gross receipts for other purposes of the internal revenue code.
The amounts excludable from gross receipts for ERC purposes include the amount of:
- The forgiveness of a PPP loan;
- Any Shuttered Venue Operators Grants; and
- Any Restaurant Revitalization Grants.
To exclude these amounts, the employer has to consistently apply the safe harbor. Consistency means excluding such amounts for each calendar quarter the gross receipts test is used to determine ERC eligibility, and that the safe harbor be used by all employers treated as a single employer. This exclusion should come as welcomed relief for taxpayers who would have not been able to meet the substantial decline in gross receipts otherwise. However, taxpayers should consider how the inclusion of these items in gross receipts for other purposes, including the small taxpayer exceptions added by the Tax Cuts and Jobs Act, could affect their overall tax situation.
What is the Future of the ERC in Light of the Infrastructure Bill?
Other important developments that may affect the ERC are underway in Congress. The ERC was originally set to expire at the end of 2020 but was subsequently extended on two separate occasions — until June 30, 2021, and then again until December 31, 2021. However, the $1 trillion Infrastructure Bill recently passed by the Senate would eliminate the ERC after September 30, 2021. Although the bill must still make its way through the rest of the legislative process and could of course change, taxpayers who anticipated or would have otherwise been eligible in Q4 2021 may find out this fall that the credit is no longer available to them. We will continue to follow this development closely as well as other legislation and provide further updates as they’re available.
Contact Robert Venables at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.