Notice 2021-65[1] has been released by the IRS, providing guidance on the repeal of the employee retention credit (ERC), effective as of September 30, 2021, for all employers except those that are recovery startup businesses.  This retroactive change was part of the Infrastructure Investment and Jobs Act (IIJA)that was signed into law on November 15.  Prior to the enactment of the IIJA, employers who faced certain reductions in gross receipts or were subject to certain full or partial suspensions of their business due to COVID-19 governmental orders could qualify for the credit.

The Notice explains this law change as follows:

Section 80604 of the Infrastructure Act amended section 3134(n) of the Code to provide that the employee retention credit under section 3134 shall apply only to wages paid after June 30, 2021, and before October 1, 2021 (or, in the case of wages paid by an eligible employer which is a recovery startup business, January 1, 2022). Additionally, effective for calendar quarters beginning after September 30, 2021, section 80604 of the Infrastructure Act amended the definition of recovery startup business under section 3134(c)(5) of the Code to remove the requirement that a recovery startup business not otherwise be an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.[2]

The Notice modifies previously issued guidance to take into account the termination of the employee retention credit for other than recovery startup businesses for the fourth quarter of 2021, as well as providing certain penalty relief for employers who had reduced payroll tax deposits, received advance payments of the ERC or both prior to the retroactive repeal of the credit for the fourth quarter of 2021.

There is a significant oddity in this guidance—while an employer has until the due date of its employment tax return for the fourth quarter of 2021 to pay back any advances the employer received, any amounts that offset payroll tax deposits must be repaid by the date a payroll tax deposit would be due for wages paid on December 31, 2021—and if that amount is $100,000 or more, the One-Day Deposit Rule will be triggered for that payment.

Updating Prior IRS Guidance to Take Into Account Repeal of Most of the ERC for the Fourth Quarter

Section III.A. of the Notice provides the following guidance related to rules related to a decline in gross receipts or full or partial suspension of the employer’s business:

Due to the amendments made by section 80604 of the Infrastructure Act, rules for determining whether an employer is an eligible employer due to a full or partial suspension of operations (section III.D. of Notice 2021-20) or a decline in gross receipts (section III.C. of Notice 2021-23) no longer apply for the fourth calendar quarter of 2021. Any rules based upon the determination that an employer is an eligible employer due to a full or partial suspension of operations or a decline in gross receipts, such as rules relating to “severely financially distressed employers” discussed in section III.E. of Notice 2021-49, also no longer apply for the fourth calendar quarter of 2021. Further, references in Notice 2021-49 to eligible employers claiming the employee retention credit for qualified wages paid in the fourth calendar quarter of 2021 no longer apply unless the employer is a recovery startup business.[3]

The Notice removes the requirement that a recovery startup business not otherwise have a qualifying reduction in gross receipts or a full or partial suspension of business in the fourth quarter:

The rules related to recovery startup businesses in section III.D. of Notice 2021- 49 include the requirement that a recovery startup business not otherwise be an eligible employer due to a full or partial suspension of operations or a decline in gross receipts. Section 80604 of the Infrastructure Act removes this requirement for the fourth calendar quarter of 2021. Accordingly, this requirement no longer applies to recovery startup businesses in the fourth calendar quarter of 2021.[4]

However, aside from the above changes, prior guidance will continue to apply to the fourth quarter employee retention credit:

All other rules set forth in Notice 2021-20 and Notice 2021-23 addressing CARES Act provisions that are the same as those provided under section 3134 of the Code continue to apply for the fourth calendar quarter of 2021 to recovery startup businesses. Similarly, all other rules set forth in Notice 2021-49 continue to apply for the fourth calendar quarter of 2021 to recovery startup businesses.[5]

Repayment of Advances for the Fourth Quarter

Employers that expected to qualify for the employee retention credit may have used Form 7200 to apply for and have received advance payments on the fourth quarter employee retention credit, a credit they no longer qualify for unless the employer is a recovery startup business.

The Notice points out that these employers will need to repay these advances:

Employers may have requested advance payments of the employee retention credit for wages paid in the fourth calendar quarter of 2021 prior to the enactment of the Infrastructure Act. An advance payment of any portion of the employee retention credit to a taxpayer in excess of the amount to which the taxpayer is entitled is an erroneous refund that the employer must repay. Accordingly, if an employer requested and received an advance payment of the employee retention credit for wages paid in the fourth calendar quarter of 2021, and the employer is not a recovery startup business, the employer is not eligible for an employee retention credit and must repay the amount of the advance.[6]

The IRS is going to allow these employers to repay the advances with the payroll tax return that includes the fourth quarter of 2021 (normally the fourth quarter Form 941):

Employers who need to repay these excess advance payments of the employee retention credit must do so by the due date for the applicable employment tax return that includes the fourth calendar quarter of 2021. Employers should refer to the instructions to the applicable employment tax form for additional information.[7]

If an employer fails to make this payment timely, the IRS warns the employer may face penalties:

Failure to repay the advance payment by the due date of the applicable employment tax return may result in the imposition of failure to pay penalties under section 6651.[8]

Failure to Deposit Penalties for Employers Retroactively Ineligible for the Employee Retention Credit

Before applying for an advance payment of the employee retention credit, employers were to first reduce their payroll tax deposits.  Obviously, employers that reduced their deposits by a credit they will no longer qualify to take are behind on their payroll tax payments and, without special relief, would be subject to penalties for late payment of such deposits.

The IRS had previously announced in Notice 2021-24, issued prior to the repeal of the fourth quarter ERC for most employers, that the agency would waive failure to deposit penalties for those that offset their deposits by the ERC. The IRS now indicates they will no longer waive such penalties for deposits after December 20, 2021 (except for recovery startup businesses):

Due to the termination of the employee retention credit for wages paid in the fourth calendar quarter of 2021 for employers that are not recovery startup businesses, the IRS will no longer waive failure to deposit penalties for employers that reduce deposits in anticipation of the employee retention credit after December 20, 2021, unless the employer is a recovery startup business.[9]

For deposits due on or before that date, the employer will not face penalties if the following requirements are met (note the date the deposit must be made by):

For deposits due on or before December 20, 2021, with respect to wages paid on or after October 1, 2021, but before January 1, 2022, an employer that is not a recovery startup business will not be subject to a penalty under section 6656 for failing to deposit Employment Taxes for the fourth calendar quarter of 2021 if—

1.      The employer reduced its deposits in anticipation of the employee retention credit, consistent with the rules provided in section 3.b. of Notice 2021-24; and

2.      The employer deposits the amounts initially retained in anticipation of the employee retention credit on or before the relevant due date for wages paid on December 31, 2021 (regardless of whether the employer actually pays wages on that date). Deposit due dates will vary based on the deposit schedule of the employer; and

3.      The employer reports the tax liability resulting from the termination of the employer’s employee retention credit on the applicable employment tax return or schedule that includes the period from October 1, 2021 through December 31, 2021. Employers should refer to the instructions to the applicable employment tax return or schedule for additional information on how to report the tax liability.[10]

In a footnote, the IRS notes that if an employer has retained an amount of $100,000 or more, the Next-Day Deposit Rule will apply to that December 31 deemed wage payment date deposit:

If the amounts initially retained in anticipation of the employee retention credit total $100,000 or more with or without any additional liability on that date, then the employer is subject to the $100,000 One-Day rule of § 31.6302-1(c)(3) (also referred to as the “Next-Day Deposit Rule”).[11]

If a taxpayer does not qualify for relief under this Notice, the IRS notes that the taxpayer can attempt to obtain reasonable cause relief:

If an employer does not qualify for relief under this Notice, it may reply to a notice about a penalty with an explanation and the IRS will consider reasonable cause relief pursuant to section 6656(a).[12]

[1] Notice 2021-65, December 6, 2021, https://www.irs.gov/pub/irs-drop/n-21-65.pdf (retrieved December 6, 2021)

[2] Notice 2021-65, December 6, 2021, Section II BACKGROUND

[3] Notice 2021-65, December 6, 2021, Section III GUIDANCE, A. Termination of Employee Retention Credit for Employers other than Recovery Startup Businesses

[4] Notice 2021-65, December 6, 2021, Section III GUIDANCE, A. Termination of Employee Retention Credit for Employers other than Recovery Startup Businesses

[5] Notice 2021-65, December 6, 2021, Section III GUIDANCE, A. Termination of Employee Retention Credit for Employers other than Recovery Startup Businesses

[6] Notice 2021-65, December 6, 2021, Section III GUIDANCE, B. Repayment of Advance Payments for Employers other than Recovery Startup Businesses

[7] Notice 2021-65, December 6, 2021, Section III GUIDANCE, B. Repayment of Advance Payments for Employers other than Recovery Startup Businesses

[8] Notice 2021-65, December 6, 2021, Section III GUIDANCE, B. Repayment of Advance Payments for Employers other than Recovery Startup Businesses

[9] Notice 2021-65, December 6, 2021, Section III GUIDANCE, C. Failure to Deposit Penalties for Employers other than Recovery Startup Businesses

[10] Notice 2021-65, December 6, 2021, Section III GUIDANCE, C. Failure to Deposit Penalties for Employers other than Recovery Startup Businesses

[11] Notice 2021-65, December 6, 2021, Section III GUIDANCE, C. Failure to Deposit Penalties for Employers other than Recovery Startup Businesses, Footnote 8

[12] Notice 2021-65, December 6, 2021, Section III GUIDANCE, C. Failure to Deposit Penalties for Employers other than Recovery Startup Businesses