Employee Retention Credit – Important Updates

On August 4th, the IRS released Notice 2021-49 regarding the Employee Retention Credit (ERC).  This notice includes some very important updates to how the IRS is interpreting the rules of the ERC and includes some complete changes from guidance they released previously.

Here are some of the critical points (please note this is not comprehensive).

Does the company qualify?

First, the company must qualify for the ERC – either because of government shut down or significant decrease in income.  The rules for qualifying for the credit are different for 2020 vs. 2021, so be careful in determining if you are eligible or not.

Previously the IRS indicated that the only way to measure income for this credit was based on cash receipts from customers.  More recent guidance instructs to measure based on either cash basis income or accrual basis income, whichever is used on the federal income tax return.  If you are an accrual basis reporter for your tax return, I recommend you check your income and qualification again, as it may be different than initially indicated based on cash.

Also, pay attention to the infrastructure legislation that is in process, but not yet passed.  It currently includes an update to the ERC to discontinue it as of 9/30/21 instead of 12/31/21 for most employers.  We’ll have to wait and see if this goes through or not.

What wages qualify?

Second, only certain wages qualify for the credit.  Again, the rules are different for 2020, 2021, and for businesses that started after 2/15/20.

Previously the IRS indicated that business owners receiving wages could qualify for the ERC.  The updated notice changes this position.  Wages paid to majority owner (those owning over 50% of the company) cannot be included in the ERC.  The same is true for their family members (with a few very specific exceptions for spouses if the business owner has no living relatives).

For owners who own 50% or less of the company, the IRS uses very complex “related parties” rules to determine if their wages or wages of their family members are included.  If this is you, I strongly recommend working with a qualified payroll accountant to verify which wages do or do not qualify.

You cannot use the same wages for the PPP loan forgiveness and the ERC – maximizing these relief options can take some careful analysis and planning.

How do I fix it if I did it wrong?

If you claimed the credit under prior guidance and you no longer qualify based on these updated rules, you will need to file a form 941-X (amended 941) to remove/reduce the credit and show additional tax due.  Head’s up – the IRS will likely assess late payment penalties!  You can request that the penalties be removed for “reasonable cause” – that reasonable cause being that you filed prior to Notice 2021-49 in which the rules changed.

Where’s my ERC refund?

If you are just now seeing that you are eligible, you can file a form 941-X to claim the credit and obtain a refund from the IRS.  Or maybe you have already filed the 941-X and you’re wondering when the check will show up.  It will take a very long time for them to process it, so don’t hold your breath!  The IRS currently has 1.8 million payroll tax returns filed on paper backlogged and waiting to be processed.  We have no information about how long it will take them to get through them all.