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IRS Issues Notices With Updated, Formal Guidance on Employee Retention Credits

June 17, 2021, 8:00 AM

The Treasury Department issued three notices in March and April 2021 regarding employee retention credits, Notice 2021-20, Notice 2021-23, and Notice 2021-24.

In March 2021, the Treasury Department issued Notice 2021-20 and Notice 2021-23, providing formal guidance relating to Employee Retention Credits (ERCs), replacing pre-existing FAQs first issued in May 2020 and updated periodically, with the last update having been made January 2021. Notice 2021-20 provides some new guidance, and makes official some of the guidance provided under the FAQs, clarifying the FAQs in a way generally consistent with the previously published FAQs.

Notice 2021-20 provides new guidance implementing changes made by the Consolidated Appropriations Act (CAA) to allow employers that previously received a Paycheck Protection Program (PPP) loan to be retroactively eligible for 2020 ERCs. Notice 2021-20 also provides new guidance regarding substantiation requirements. Notice 2021-23 provides some guidance on documentation of a decline in gross receipts.

Notice 2021-23 provides new guidance regarding other changes made by the CAA, including the expansion of eligible employers to include certain not-for-profit organizations and colleges or universities whose principal purpose is providing medical or hospital care. For these expanded categories of eligible employers, Notice 2021-23 provides new guidance on the definition of qualified wages.

While Notice 2021-20 states that it only applies to qualified wages paid in 2020, Notice 2021-23 extends Notice 2021-20’s application to ERCs paid in the first two quarters of 2021, pursuant to the CAA. Neither Notice 2021-20 nor Notice 2021-23 applies to ERCs paid in the second two quarters of 2021, pursuant to the American Rescue Plan Act (ARPA). Notice 2021-23 explains that additional guidance will be published regarding the ARPA ERCs. (The additional guidance referenced in Notice 2021-23 regarding penalty relief is covered by Notice 2021-24.)

In April 2021, IRS issued Notice 2021-24, which extends to the 2021 ERCs the penalty relief previously provided for in Notice 2020-22 for failure to deposit employment taxes if the failure was due to the reasonable anticipation of receipt of ERCs.

Prior Ropes & Gray LLP coverage of ERCs includes alerts on the CARES Act’s tax-related provisions, initial ERC guidance, CAA’s tax-related provisions, and ARPA’s tax-related provisions.

Notice vs. FAQs

IRS notices provide greater legal authority than do IRS FAQs. IRS notices are published in the Internal Revenue Bulletin and constitute “authority” for penalty defense purposes. See Treasury Regulation 1.6662-4(d). On the other hand, the IRS takes the position that FAQs are non-binding and cannot be relied on as authority for defending penalties under Treas. Reg. 1.6662-4(d). When the IRS issues FAQs, it does so to provide taxpayers “clarity and certainty,” pursuant to a March 2019 Treasury policy statement. However, FAQs do not carry legal weight, and a taxpayer cannot rely upon them if a tax position is called into question. For example, the IRS FAQs related to ERCs specifically state that they “may not be relied upon as legal authority.” Even though many of the FAQ answers are not substantively changed in Notice 2021-20, by issuing a formal notice, the IRS has provided taxpayers with greater certainty regarding the decision to claim ERCs.

Notice 2021-20 provides new guidance regarding PPP loans and substantiation requirements, and clarifies previously issued FAQs in a way generally consistent with the prior FAQs by:

  • [New] Allowing businesses receiving an SBA Loan under the PPP to also claim ERCs retroactively for 2020;
  • [New] Establishing substantiation requirements; and
  • Providing additional guidance related to partial closures of businesses, including: Factors showing an employer’s operations have been fully or partially suspended, and factors showing a government order causing a partial suspension of operations.

Notice 2021-20: PPP, ERC, and the CARES and Consolidated Appropriations Acts

The 2020 ERCs are a fully refundable tax credit equal to 50% of “qualified wages” paid to employees by “eligible employers.” For the 2020 ERCs, qualified wages are capped at $10,000 per employee, and, subject to exceptions, eligible employers are employers that either fully or partially suspended operations due to orders from an appropriate governmental authority related to Covid-19 or experienced a significant decline in gross receipts of 50% or more during a specified period.

Initially, the CARES Act prevented any business receiving an SBA Loan under the PPP from claiming ERCs. While other legislation allowed businesses receiving SBA Loans under the PPP to obtain other relief, such businesses remained ineligible to claim ERCs until the CAA was passed in December 2020. The CAA allows employers that previously received a PPP loan to be retroactively eligible for 2020 ERCs. Notice 2021-20 implements the CAA’s change, with Section I (Answer 49) dedicated to explaining the interaction between ERCs and the PPP. Answers 56, 57, and 58 also contain information on interaction with the PPP.

Pursuant to Notice 2021-20, an employer that received a PPP loan may now claim ERCs for any qualified wages paid to employees by an eligible employer that otherwise meets the requirements for the credit. However, qualified wages cannot be used for ERCs and as payroll costs for PPP loan forgiveness. Section 2301(g)(1) of the CARES Act, as amended by the CAA, permits an eligible employer to elect not to take into account certain qualified wages for purposes of the employee retention credit.

The employer is deemed to make the election for any qualified wages included in the amount of payroll costs on the PPP Loan Forgiveness Application. The employee retention credit does not apply to the qualified wages for which the election or deemed election is made. (Answer 49, Answer 56.) If the PPP loan is not forgiven, any qualified wages included as payroll costs in the PPP Loan Forgiveness Application can subsequently be used as qualified wages for ERC. If only part of the PPP loan is forgiven, then the employer is deemed to make the election for the minimum amount of wages that are necessary to result in the forgiven amount. (Answer 58.)

An eligible employer that received a PPP loan and did not claim the employee retention credit may file a Form 941-X for the relevant calendar quarters in which the employer paid qualified wages, but only for qualified wages for which no deemed election was made. (Answer 57.)

Substantiation Requirements

Notice 2021-20 provides new guidance to eligible employers about the records they should retain to substantiate eligibility for ERCs, located within Section N (Answer 70, 71.) Notice 2021-20 provides that the employer will have adequately substantiated eligibility for ERCs if the employer retains records that include the information listed below. (Answer 70.) Notice 2021-20 specifies that the documentation should be retained for at least four years from the later of the date the tax becomes due or is paid. (Answer 71.) Notice 2021-23 states that eligible employers must maintain documentation to support an employer’s eligibility based on a decline in gross receipts, without providing any concrete examples of documentation.

Notice 2021-20, Answer 70, provides this list of documentation to substantiate eligibility for ERCs:

  • Documentation to show how the employer determined it was an eligible employer that paid qualified wages, including:
    • any governmental order to suspend the employer’s business operations;
    • any records the employer relied upon to determine whether more than a nominal portion of its operations were suspended due to a governmental order or whether a governmental order had more than a nominal effect on its business operations;
    • any records the employer used to determine it had experienced a significant decline in gross receipts;
    • any records of which employees received qualified wages and in what amounts; and
    • in the case of a large eligible employer, work records and documentation showing that wages were paid for time an employee was not providing services.
  • Documentation to show how the employer determined the amount of allocable qualified health plan expenses.
  • Documentation related to the determination of whether the employer is a member of an aggregated group treated as a single employer for purposes of the employee retention credit and, if so, how the aggregation affects the determination and allocation of the credit.
  • Copies of any completed Forms 7200 that the employer submitted to the IRS.
  • Copies of the completed federal employment tax returns that the employer submitted to the IRS (or, for employers that use third-party payers to meet their employment tax obligations, records of information provided to the third-party payer regarding the employer’s entitlement to the credit claimed on the federal employment tax return).

Notice 2021-20: Partial Suspension of Operations

An “eligible employer” is an employer that either fully or partially suspended operations because of a governmental order or experienced significant declines in gross revenues, as defined. Notice 2021-20 makes official most of the guidance previously provided by the FAQs regarding when operations are considered partially suspended. Notice 2021-20 provides further clarity to the previously issued FAQs by including a safe harbor for when a partial suspension constitutes more than a nominal portion of business operations (Answer 11), providing a non-exhaustive list of factors to consider when evaluating whether a business is able to continue its operations in a comparable manner (Answer 16), and providing a safe harbor and guidance regarding when a modification of operations constitutes a partial suspension (Answer 18.)

Notice 2021-20 formalizes previously issued guidance that had explained that essential businesses may be considered partially suspended if “more than a nominal portion of its business operations are suspended by a government order.” (Answer 11; FAQ 30.) Notice 2021-20 provides a new safe harbor for what is to be considered “more than [] nominal:” if the gross receipts from that portion of the business operations is not less than 10% of the total gross receipts (both determined using the gross receipts of the same calendar quarter in 2019), or if the hours of service performed by employees in that portion of the business is not less than 10% of the total number of hours of service performed by all employees in the employer’s business (both determined using the number of hours of service performed by employees in the same calendar quarter in 2019). (Answer 11.)

Notice 2021-20 formalizes previously issued guidance that had explained that a business whose workplace was closed by government orders was not considered suspended if it could “continue operations comparable to its operations prior to the closure[.]” (Answer 15; FAQ 33.) Notice 2021-20 provides new guidance by providing a non-exhaustive list of factors that can be considered in determining if an employer’s modifications to operations allow the business to operate in a comparable manner: the employer’s telework capabilities; the portability of employees’ work; the need for presence in employee’s physical work space; and delays caused by transitioning to telework operations. The guidance makes it clear that “additional factors may be considered as well if relevant[.]” (Answer 16.)

Notice 2021-20 formalizes prior guidance explaining that business operations can be partially suspended if a workplace is closed for certain purposes but may remain open for other purposes, and the modification of business operations “has more than a nominal effect . . . under the facts and circumstances.” (Answer 17, FAQ 34.) Notice 2021-20 provides new guidance by providing a non-exhaustive description of factors that “may be used for determining if a modification . . . has more than a nominal effect.” (Answer 17 (referencing Answer 18).)

  • Notice 2021-20 provides new guidance by creating a safe harbor for what is considered “more than a nominal effect” on business operations. An order that results in a reduction in an employer’s ability to provide goods or services in the normal course of the employer’s business by 10% or more is deemed to have more than a nominal effect on business operations. (Answer 18.)
  • Notice 2021-20 provides new guidance by explaining that the only modifications to be considered when evaluating whether there is a more than nominal impact on business operations are those required by a governmental order as a condition of reopening a physical space. A non-exhaustive list of modifications include limiting occupancy to provide for social distancing, requiring appointments for service instead of walk-in service, changing the format of service, and requiring employees and customers to wear face coverings. Modifications altering customer behavior (mask requirements, one-way aisles for social distancing) or that require employees to wear masks and gloves will not result in a more than nominal effect on business operations. (It is worth noting that mask-wearing is included both in the list of modifications that may and may not be considered!) (Answer 18.)

Conclusion

Prior IRS guidance regarding ERCs came via FAQs, which are non-binding and subject to change. In March and April 2021, the IRS provided employers with more authoritative guidance through Notice 2021-20, Notice 2021-23, and Notice 2021-24. Under this new guidance, the IRS confirms that employers who previously took PPP loans can now also claim ERCs, providing them greater access to benefits under Covid-related legislation. The IRS provides employers with guidance regarding documentation requirements for substantiating eligibility for ERCs, which employers should follow closely.

The IRS also provides employers with additional insight in determining whether they qualify for ERCs, including when an employer would be considered partially suspended. On the whole, the additional insight is largely consistent with prior guidance issued by the IRS. Employers should continue to monitor the IRS’s interpretive guidance for upcoming guidance on ERCs paid pursuant to the American Rescue Plan Act (ARPA).

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Isabelle Farrar is an attorney in Ropes & Gray LLP’s Boston office. Alec Oveis and Joshua Thomas are associates in the New York office.
The authors thank Ropes & Gray LLP law clerk Phillip Popkin for his assistance in preparing this article.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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