IRS Updates on Employee Retention Tax Credit Claims. What a Business Should Know

Is the IRS Still Accepting ERTC Claims?

As of Aug. 8, the IRS’s ERTC moratorium on processing claims filed after Sept. 14, 2023, has been lifted. The agency will begin processing claims filed between Sept. 14, 2023, and Jan. 31, 2024 – the latter of these dates was proposed in a bill as the new end date to file employee retention tax credit (ERTC), also known as the employee retention credit (ERC), claims. The U.S. House of Representatives passed the bill, but the Senate failed to consider it. The result: The original end date to file amended returns for tax year 2021 to claim the ERTC remains April 15, 2025.

The IRS continues to be diligent and deliberate in its handling of ERC claims, focusing on processing low-risk submissions while ferreting out fraudulent claims. In its recent announcement, the IRS said it was moving forward on tens of thousands of valid claims, but the agency also sent out 28,000 disallowance letters for claims that did not meet the eligibility requirements. Individuals receiving this type of letter have the right to initiate a formalized appeal process.

The IRS has provided no timetable on when claims filed after Jan. 31, 2024, will be processed.

Although the IRS said it is accelerating the processing of valid claims to the ERTC program and earmarking September to begin issuing refunds, with the mere volume of submissions taxpayers should not expect an expedited pace for payments. Paychex, which can help businesses prepare and submit amended tax returns to claim the ERTC, is not responsible for issuing refunds.

What Is the IRS ERC Voluntary Disclosure Program?

During the moratorium, the IRS offered a Voluntary Disclosure Program (VDP) for employers who thought they received ERC funds erroneously.¹ After more than 2,600 applicants disclosed getting nearly $1.1 billion in funds they were not qualified to receive, the IRS reopened the program until Nov. 22, 2024. Businesses that believe they were ineligible to receive the tax credit for the 2021 tax year can take steps to remediate the issue.

A process is in place to apply for the program, including repaying 85% of the funds received and cooperating with requests for information from the IRS to name a few. During the initial VDP, these requests included providing information on the individuals or third parties that prepared the ERTC submission.

If eligible for the second VDP, your business gets to keep 15% of the funds received while potentially avoiding future audits, penalties, and interest.

ERTC Withdrawal Program

Businesses that have pending claims still can withdraw a submission if the employer subsequently determines they might not be eligible for the tax credit. The Withdrawal Program is for those who have not received payment or have received but not deposited the payment.² During the moratorium, the IRS said that it had 1.4 million pending claims to process.

IRS Notifications About ERTC

The IRS also announced its intent to mail as many as 30,000 letters to individuals and businesses in an effort to reverse or recapture potentially more than $1 billion in improper employee retention tax credit claims. These letters are different than disallowance letters.

Original article

The employee retention tax credit is a refundable credit available to eligible businesses that paid qualified wages after March 12, 2020, through the end of the program to keep their staffs employed during the height of the COVID-19 pandemic.

This tax credit was introduced by the Coronavirus Aid, Relief, and Economic Security Act (CARES) in March 2020 and subsequently amended three times by the following laws; the Consolidated Appropriations Act 2021, the American Rescue Plan Act (ARPA), and the Infrastructure Investment and Jobs Act.

This article highlights eligibility, qualified wages, how the credits work and more. It also delineates by law and date because what a business can claim is determined by the provisions of the law that was in place when a business originally paid the wages to retain their employees. Additional factors such as whether you took a Paycheck Protection Program (PPP) loan impact the credit that can be claimed.

ERC Deadlines: Can You still Apply for the Tax Credit?

Yes, businesses can still apply for the ERTC. Although the ERTC program has officially ended and businesses can no longer pay wages that would qualify to claim the ERC credit, this does not impact the ability of a business to claim the credit retroactively.

In fact, businesses can do a lookback to determine if they meet the eligibility requirements. At the present time, businesses have until April 15, 2025, to file amended returns for the quarters in 2021 in which they were eligible to claim the ERC.

For most businesses, the credit could be claimed on wages paid until Sept. 30, 2021, with certain businesses having until Dec. 31, 2021, to have paid qualified wages. Again, businesses can no longer pay wages to apply for the credit. The ERC is not a loan. It is a tax credit based on payroll taxes employers previously remitted, so employers do not have to pay back the funds they receive.

What is the Employee Retention Credit?

The employee retention credit (ERC) is a refundable credit that businesses can claim on qualified wages, including certain health insurance costs, paid to employees. The following laws — passed between March 2020 and November 2021 — changed requirements, either through expansion or contraction, and other details such as eligibility about the employee retention tax credit.

The following summarizes some of the changes of each law and its impact on the employee retention credit.

CARES Act of 2020 and ERC

Eligible employers included those operating a trade, business, or tax-exempt organization. For employers who qualify, the credit was taken against the employer’s portion of Social Security tax and can be claimed against 50 percent of qualified wages paid, up to $10,000 per employee annually for wages paid between March 13 and Dec. 31, 2020.

Consolidated Appropriations Act of 2021 and ERC

Employers who qualify, including PPP recipients and now colleges/universities whose main purpose is to provide medical care as well as 501(c)(1) organizations, can claim a credit against 70% of qualified wages paid. Additionally, the amount of wages that qualifies for the credit is now $10,000 per employee per quarter.

American Rescue Plan Act of 2021 and ERC

The credit remains at 70% of qualified wages up to a $10,000 limit per quarter so a maximum of $7,000 per employee per quarter. So, an employer could claim $7,000 per quarter per employee through the first three quarters of 2021 after the passage of the Infrastructure Investment and Jobs Act changed the end date of the program for most businesses. However, Recovery Startup Businesses were eligible through the end of 2021. They could be eligible to take a credit of up to $50,000 for the third and fourth quarters of 2021.

How Does the Employee Retention Credit Work?

The ERC is a refundable tax credit based on payroll taxes your business paid. New laws passed during the pandemic made some changes, but these changes did not change the amount of the credit itself.

The American Rescue Plan Act stipulated that the nonrefundable pieces of the employee retention tax credit would be claimed against Medicare taxes instead of against Social Security taxes as they were in 2020. However, this change will only apply to wages paid after June 30, 2021 and will not change the total credit amount.

If the credit exceeds the employer’s total liability of the portion of Social Security or Medicare, depending on whether before June 30, 2021 or after in any calendar quarter, the excess is refunded to the employer.

At the end of the quarter, the amounts of these credits will be reconciled on the employer’s Form 941.

How to Apply for the ERTC Retroactively

The IRS Notice 2021-20  provides guidance for employers claiming the Employee Retention Tax Credit. However, the notice only provides guidance for the credit as it applies to qualified wages paid between March 12, 2020 and Sept. 30, 2021. Additionally, the bulk of the notice reiterates the ERTC FAQs that previously were published on the IRS website.

Included in the notice is guidance on how employers who received a PPP loan can retroactively claim the employee retention tax credit. In order to claim the credit for past quarters, employers must file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the applicable quarter(s) in which the qualified wages were paid. The IRS includes three examples (Q&A No. 57) to highlight the process.

The IRS notice 2021-20 includes seven examples (Q&A No. 49) with scenarios of how an employer with a PPP loan determines which wages, if any, are eligible for the tax credit. The amount of wages eligible largely depends on how the qualified wages were reflected on the PPP loan forgiveness application.

The IRS makes it clear that expenses eligible for PPP forgiveness that were not included in the loan forgiveness application cannot be factored in after the fact. Consequently, it’s important to ensure all eligible expenses, including non-payroll costs such as utilities, rent and operations expenses, to name a few, are included on PPP loan forgiveness applications in order to maximize the qualified wages available for ERTC.

Employee Retention Credit Eligibility: Who Can Claim?

When it was determined that many of the hardest-hit businesses by the pandemic didn’t meet the eligibility requirements to claim the ERTC, subsequent laws were passed to expand the program to allow more small businesses to take advantage of the tax credit.

ERC Qualifications for Employers

Most employers, including colleges, universities, hospitals and 501(c) organizations following the enactment of the American Rescue Plan Act, could qualify for the credit. Previously, the Consolidated Appropriations Act expanded qualifications to include businesses who took a loan under the Paycheck Protection Program (PPP), including borrowers from the initial round of PPP who originally were ineligible to claim the tax credit.

Qualification is determined by one of two factors for eligible employers — and one of these factors must apply in the calendar quarter the employer wishes to utilize the credit:

1. A trade or business that was fully or partially suspended or had to reduce business hours due to a government order.

The credit applies only for the portion of the quarter the business is suspended, not the entire quarter. Some businesses, based on IRS guidance, generally do not meet this factor test and would not qualify.

• Those considered essential, unless they have supply of critical material/goods disrupted in manner that affects their ability to continue to operate.

• Businesses shuttered but able to continue their operations largely intact through telework.

However, any of these businesses still may qualify for the credit with the second factor test.

2. An employer that has a significant decline in gross receipts.

The IRS released Revenue Procedure 2021-33 in Aug. 2021 that provides a safe harbor under which an employer may exclude the amount of the forgiveness of a PPP loan and the amount of a Shuttered Venue Operators Grant or a Restaurant Revitalization Fund grant from the definition of gross receipts solely for the purpose of determining eligibility to claim the ERTC. Employers must apply the safe harbor consistently across all entities.

The following summarizes some of the changes of each law and its impact on the employee retention credit.

• CARES Act – 2020

  • Generally, if gross receipts in a calendar quarter are below 50% of gross receipts when compared to the same calendar quarter in 2019, an employer would qualify. They are no longer eligible if in the calendar quarter immediately following the quarter their gross receipts exceed 80% compared to the same calendar quarter in 2019.

• Consolidated Appropriations Act, 2021

  • Beginning in 2021, businesses must be impacted by forced closures or quarantines or have seen more than 20% drop in gross receipts in the quarter compared to the same quarter in 2019.
  • If you are a new business, the IRS allows the use of gross receipts for the quarter in which you started business as a reference for any quarter which they do not have 2019 figures because you were not yet in business.

• American Rescue Plan Act – 2021

  • In addition to eligibility requirements under the Consolidated Appropriations Act, 2021, business also have the option of determining eligibility based on gross receipts in the immediately preceding calendar quarter (compared with the corresponding quarter in 2019).

3. Recovery Startup Business

• American Rescue Plan Act – 2021

  • 3^rd and 4^th quarter 2021 only — a third category has been added. Those entities that qualify may be entitled to up to $50,000 per quarter.

To qualify as a Recovery Startup Business, one must:

• Have begun carrying on trade or business after Feb. 15, 2020
• Have annual gross receipts that do not exceed $1 million
• Not be eligible for the ERTC under the other two categories, partial/full suspension of operations or decline in gross receipts

The IRS notice 2021-49 clarified that Recovery Startups may use all qualified employee wages for purposes of the credit, regardless of the number of employees. It should also be noted that determining if this category applies is assessed for each quarter. So, if one of the other two categories — gross receipt decline or full/partial suspension — applies to 3^rd quarter but not 4^th, they would not be a recovery startup in 3^rd quarter, yet they may still qualify as a recovery startup in 4^th quarter.

The IRS notice is important in understanding how to apply changes to Form 941 necessary to claim the credit. Form 941-X will be used to retroactively file for the applicable quarter(s) in which the qualified wages were paid.

• Infrastructure Investment and Jobs Act – 2021

  • This law removes a condition of eligibility. Recovery startups are no longer subject to the business closure or gross receipts reduction to qualify. Essentially all RSBs are eligible in 4^th quarter.

The Paychex ERTC Service can help businesses determine if they qualify to claim the credit.

What wages qualify when calculating the ERC?

Wages/compensation, in general, that are subject to FICA taxes, as well as qualified health expenses qualify when calculating the employee retention tax credit. These must have been paid after March 12, 2020 and qualify for the credit if paid through Sept. 30, 2021 (Recovery Startup Businesses had until Dec. 31, 2021).

Remember, the credit can only be taken on wages that are not forgiven or expected to be forgiven under PPP.

When determining the qualified health expenses, the IRS has multiple ways of calculating depending on circumstances. Generally, they include the employer and employee pretax portion and not any after-tax amounts.

When determining the qualified wages that can be included, an employer must first determine the number of full-time employees.

For the purposes of the employee retention credit, a full-time employee is defined as one that in any calendar month in 2019 worked at least 30 hours per week or 130 hours in a month (this is the monthly equivalent of 30 hours per week) and the definition based on the employer shared responsibility provision in the ACA.

Note: The employee calculation of full-time equivalent (FTE) used for the PPP forgiveness report is not calculated the same way as a full-time employee for the employee retention credit. If you are an accounting professional, do not provide your clients with the PPP Forgiveness FTE information. Also, remember that if a client has taken and will be forgiven for a PPP loan, they may now be eligible for the employee retention credit on certain wages.

The following laws impacted eligibility requirements for the employee retention tax credit.

CARES Act – 2020

Businesses with more than 100 full-time employees can only use the qualified wages of employees not providing services because of suspension or decline in business. Furthermore, any wages paid for vacation, sick or other days off based on the employer’s current policy cannot be included in qualified wages for the larger employers. Basically, employers can only use this credit on employees who are not working.

Employers with 100 or fewer full-time employees can use all employee wages — those working, as well as any time paid not being at work with the exception of paid leave provided under the Families First Coronavirus Response Act. Leave under FFCRA included paid sick leave and family leave, which when taken under the provisions of the act offered businesses an opportunity to claim a tax credit.

Consolidated Appropriations Act – 2021

This law increased the employee limit to 500 for determining which wages are applicable for the credit.

American Rescue Plan Act – 2021

This law allowed certain hardest-hit businesses — severely financially distressed employers — to claim the credit against all employees’ qualified wages instead of just those who are not providing services. These hardest hit businesses are defined as employers whose gross receipts in the quarter are less than 10% of what they were in a comparable quarter in 2019 or 2020. This only applies to the third quarter of 2021 for businesses that aren't Recovery Startup Businesses.

The IRS does have guardrails in place to prevent wage increases that would count toward the credit once the employer is eligible for the employee retention tax credit.

Are Tipped Wages Included in Qualified Wages?

IRS notice 2021-49 clarified that tips would be included in qualified wages if these wages were subject to FICA. In general, this mean if tips are over $20 in a calendar month for an employee, then all tips (including the first $20) would be included in qualified wages for the purpose of the retention credit. Tips that amount to less than $20 in a month are not subject FICA wages and would not qualify for the retention credit.

Are Owner/Spouse Wages Included in Qualified Wages?

It was well understood from a previous statute and previous IRS guidance that related individuals to a majority owner were not included in qualified wages (see IRS FAQ #59 for specifics). However, the owner and spouse wages were unclear. Related individuals are:

• Child or a 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

Notice 2021-49 clarified that attribution rules must be applied to assess whether the owner or spouse’s wages can be included for the ERTC. Essentially, if they are considered a majority owner, then their wages are not qualified wages for ERTC.

Keep in mind, these rules the IRS clarified apply to all quarters for ERTC. Consequently, if wages were previously miss-categorized as qualified wages for ERTC, then amendments to the 941 would be necessary to correct any inadvertent errors.

What is the Interaction with Other Credits and Funding Sources?

• There is no double-dipping for credits. Employers who take the employee retention credit cannot take credit on those same qualified wages for paid family medical leave.
• If an employee is included for the Work Opportunity Tax Credit, they may not be included for the employee retention credit.

Remember, the credit can only be taken on wages that are not forgiven or expected to be forgiven under PPP.

• American Rescue Plan Act — 2021

Shuttered Venue Operators Grant (SVOG) or Restaurant Revitalization Fund (RRF) recipients may not treat any payroll costs that they take into account in connection with either program to justify use of the grant as qualified wages for the employer retention tax credit in the third quarter 2021 (Recovery Startups still have the fourth quarter).

Keep in mind, an eligible employer receiving these grants must retain records justifying where the funds were used. The funds must be used for eligible uses no later than March 11, 2023 for RRF while the SVOG dates vary (June 30, 2022 is the latest).

How Soon Can Eligible Businesses See an ERC Refund?

Paychex can assist clients with checking eligibility and handle the processing of the amended tax returns. However, it is the IRS that reviews the submissions and ultimately refunds the credit. Generally speaking, it has taken about six months to get the refund. If it is a larger refund, it might require additional review by IRS auditors that adds more time before businesses see the ERC funds.

What Businesses Should Know about ERTC Retroactive Termination Guidance?

Notice 2021-65 lists conditions that must be met to avoid a failure to deposit penalty. An employer (not a Recovery Startup Business) who reduced employment tax deposits in anticipation of receiving ERTC in the fourth quarter of 2021 before becoming ineligible due to the program’s early termination must have met deadlines included in the notice.

Employers (not Recovery Startup Business) who requested and received an advanced payment of the ERTC for wages paid in the fourth quarter of 2021 will be required to repay the advances by the due date for the applicable employment tax return that includes the fourth quarter of 2021. The advances resulted from filing Form 7200, Advance Payment of Employer Credits Due to COVID-19. For more information, employers should refer to instructions for the applicable tax form.

Failure to pay penalties could result if repayments are not made according to these specific parameters.

For PEO/CPEO customers who had employment tax deposits reduced, as well as received advance payments by filing Form 7200, they will need to repay these under their PEO/CPEO accounts.

How does a PEO client employer reconcile?

Employers utilizing a Professional Employer Organization (PEO) or Certified Professional Employer Organization (CPEO) do not have an individual 941 filed on their behalf, so it’s important for them to understand how they would reconcile this information and receive the credit. The IRS posted guidance to clarify how it would work.

If an eligible employer uses a PEO or CPEO, the retention credit is reported on the PEO/CPEO aggregate Form 941 and Schedule R.

Looking forward

Businesses still have time to claim the ERC, although that could change with the proposed legislation. Paychex can help them understand what’s required to check on their eligibility. There is much to consider, including what laws impact eligibility and the potential credit that might be due to your business. If employers have questions or need more information, they should work with their accountant and payroll specialist.

This article was previously updated Sept. 14, 2023.

¹ IRS Voluntary Disclosure Program for ERTC, details and instructions, 2024

² IRS Withdrawal Program for ERTC, details and instructions, 2024