The IRS released guidance on the version of the Employee Retention Credit (ERC) contained in the Taxpayer Certainty and Disaster Relief Act (TCDRA) of 2020 that is in effect for the first two quarters of 2021 in Notice 2021-23.[1]

As with Notice 2021-20, which was issued to cover the revised 2020 Employee Retention Credit, this Notice only updates the original Notice for issues related to the January-June 2021 version of the credit, and later guidance will be released governing new IRC §3134 that was added by the American Rescue Plan Act of 2021 and will apply from July-December 2021.

Expansion to Certain Governmental Entities

While the original ERC was not available to governmental entities, the TCDRA version created a limited exception:

…[A]mended section 2301(f)(2)(A) provides an exception for any organization described in section 501(c)(1) of the Code and exempt from tax under section 501(a) of the Code, and amended section 2301(f)(2)(B) provides an exception for any governmental entity if the entity is a college or university or the principal purpose or function of the entity is providing medical or hospital care. The flush language of amended section 2301(f)(2) provides that in the case of any governmental entity that is a college or university, or the principal purpose or function of which is providing medical or hospital care, the entity shall be treated as satisfying the trade or business requirement in section 2301(c)(2)(A)(i). Accordingly, these entities may be eligible employers for the first and second calendar quarters of 2021, assuming they satisfy the other requirements to be eligible employers.[2]

The Notice provides definitions of a college and university and an entity with the principal purpose or function of providing health care:

The Treasury Department and the IRS have determined that, for purposes of amended section 2301(f)(2)(B) of the CARES Act, a college or university means an educational organization as defined in section 170(b)(1)(A)(ii) of the Code and Treas. Reg. § 1.170A-9(c)(1) that is a college or university, and an entity that has the principal purpose or function of providing medical or hospital care means an entity that has the principal purpose or function of providing medical or hospital care within the meaning of section 170(b)(1)(A)(iii) of the Code and Treas. Reg. § 1.170A-9(d)(1).[3]

Prior Quarter Election for Decline in Gross Receipts Test

Under the TCDRA version of the ERC, a new election was added to allow an employer to choose to use either the current quarter or the immediately prior one to test for a decline in gross receipts. The Notice provides specific guidance for the first and second quarters of 2021 on this issue:

Accordingly, for the first calendar quarter of 2021, an employer may elect to use its gross receipts for the fourth calendar quarter of 2020 compared to those for the fourth calendar quarter of 2019 to determine if the decline in gross receipts test is met. If an employer was not in existence as of the beginning of the fourth calendar quarter of 2019, then the alternative quarter election will not be available for the first calendar quarter of 2021.

For the second calendar quarter of 2021, an employer may elect to use its gross receipts for the first calendar quarter of 2021 compared to those for the first calendar quarter of 2019 to determine if the decline in gross receipts test is met. If an employer was not in existence as of the beginning of the first calendar quarter of 2019, then that employer may elect to measure the decline in gross receipts for the second calendar quarter of 2021 using its gross receipts for the first calendar quarter of 2021 compared to those for the first calendar quarter of 2020.[4]

The Notice appears to provide that the employer will not necessarily be telling the IRS which quarter it tested on the Form 941, but rather must keep records that include showing which quarter was used to justify the ability to claim the credit:

Eligible employers must maintain documentation to support the determination of the decline in gross receipts, including which calendar quarter an eligible employer elects to use in measuring the decline. An election to use an alternative quarter to calculate gross receipts is made by claiming the employee retention credit for the quarter using the alternative quarter to calculate gross receipts.[5]

Maximum Amount of Employee Retention Credit per Employee

The Notice points out the larger amount of credit that employers can qualify for per employee under the early 2021 version of the ERC. For 2020 an employer’s maximum credit was $5,000 per employee for the year, being 50% of no more than $10,000 of qualified wages (including health care costs) paid during 2020 per employee. The maximums for the first and second quarter of 2021 are outlined in the Notice:

For the first and second calendar quarters of 2021, section 2301(a) of the CARES Act, as amended by section 207(b) of the Relief Act, provides that the employee retention credit equals 70 percent of qualified wages (including allocable qualified health plan expenses) that an eligible employer pays in a calendar quarter. Section 2301(b)(1) of the CARES Act, as amended by section 207(c) of the Relief Act, limits the amount of qualified wages (including allocable qualified health plan expenses) with respect to any employee that may be taken into account under section 2301(a) of the CARES Act to $10,000 for any calendar quarter; thus the maximum credit for qualified wages (including allocable qualified health plan expenses) paid to an employee is $7,000 for each of the first and second calendar quarters in 2021 (for a total of $14,000).[6]

Increase in the Size of Small Employers

Under the 2020 ERC, employers whose average number of full-time employees during 2020 was 100 or fewer could claim the credit paid during eligible periods for all employees of the employer paid during that period. For employers where the average was greater than 100 employees, the credit was only allowed to be claimed for employees who did not provide services.

Under the 2021 ERC more employers will now meet the small employer test, allowing those employers to claim the credit for employees regardless of whether or not they are performing services during that period:

Section 2301(c)(3)(A)(i) of the CARES Act, as amended by section 207(e)(1) of the Relief Act, provides that large eligible employers are eligible employers for which the average number of full-time employees during 2019 was greater than 500 (2021 large eligible employers). Section 2301(c)(3)(A)(ii) of the CARES Act, as amended by section 207(e)(1) of the Relief Act, provides that small eligible employers are eligible employers for which the average number of full-time employees during 2019 was not greater than 500 (2021 small eligible employers).[7]

Advance Payment Rules

The IRS provides a series of details about the advance payment rules for the first and second quarter of 2021. The Notice begins by noting that in the 2020 version of the ERC, all employers could receive an advance payment and there were no limits on that advance:

Section III.J. of Notice 2021-20 provides various rules related to claiming the employee retention credit, including the circumstances under which an eligible employer may request an advance payment of the employee retention credit. For calendar quarters in 2020 there was no restriction on the types of eligible employers that could claim an advance, nor was there a maximum advance amount other than the amount of the employee retention credit eligible to be claimed, subject to the requirement that an eligible employer reduce deposits in anticipation of the credit before requesting an advance.[8]

However, the Notice provides that in the 2021 version of the ERC, advance payments are only available to certain employers and are limited in amount:

Section 2301(j) of the CARES Act, as amended by section 207(g) of the Relief Act, prohibits the advance payment of the employee retention credit except to 2021 small eligible employers. Section 2301(j)(2) of the CARES Act, as amended, provides that 2021 small eligible employers may elect to receive an advance payment of the employee retention credit in an amount not to exceed 70 percent of the average quarterly wages paid in calendar year 2019 (the 70 percent advance rule). The requirement to reduce deposits in anticipation of the credit before requesting an advance continues to apply to 2021 small eligible employers.[9]

The Notice contains information on computing the average quarterly wages limit:

Section 2301 of the CARES Act does not define the term “average quarterly wages.” The Treasury Department and the IRS have determined that for purposes of the 70 percent advance rule the term “average quarterly wages” generally means the average of wages (as defined in section 3121(a) of the Code), or compensation (as defined in section 3231(e) of the Code), both determined without regard to the social security wage base, paid in each calendar quarter in 2019. The aggregation rules described in section III.B. of Notice 2021-20 apply to the determination of an eligible employer’s average quarterly wages. Accordingly, the average quarterly wages for the 70 percent advance rule are calculated based on the quarterly wages paid by all members of the aggregated group.[10]

The Notice begins by describing the calculation for employers who file the quarterly Form 941:

For 2021 small eligible employers who file Form 941, Employer’s Quarterly Federal Tax Return, average quarterly wages for the 70 percent advance rule are calculated by averaging the amount required to be reported on Line 5c, “Taxable Medicare wages & tips,” on all Forms 941 required to be filed by a small eligible employer for wages paid in 2019.[11]

For employers that file an annual federal employment tax return, the Notice provides:

For 2021 small eligible employers that file an annual federal employment tax return, “average quarterly wages” for the 70 percent advance rule are calculated by dividing the amount required to be reported on the following forms and lines, as applicable, by four:

Line 4, “Total wages subject to Medicare tax,” on the 2019 Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees;
Line 4c, “Taxable Medicare wages and tips,” on the 2019 Form 944, Employer’s Annual Federal Tax Return;
The sum of the amounts in the “Compensation” columns of Line 2, “Tier 1 Employer Medicare Tax – Compensation (other than tips and sick pay),” and Line 9, “Tier 1 Employer Medicare Tax – Sick Pay,” on the 2019 Form CT-1, Employer’s Annual Railroad Retirement Tax Return.

Special rules are described for computing this average wage amount for seasonal employers:

Section 2301(j)(2) of the CARES Act provides special rules for determining average quarterly wages for 2021 small eligible employers that are seasonal employers and 2021 small eligible employers not in existence in 2019. Under section 2301(j)(2)(B), 2021 small eligible employers that employ seasonal workers (as defined in section 45R(d)(5)(B) of the Code) may elect to determine the average quarterly wages based on the wages for the calendar quarter in 2019 which corresponds to the calendar quarter to which the election relates rather than the average quarterly wages paid in calendar year 2019. A 2021 small eligible employer that employs seasonal workers elects to use the special rule by requesting an advance based on the amount of wages for the calendar quarter in 2019 corresponding to the calendar quarter to which the election relates. Under section 2301(j)(2)(C), 2021 small eligible employers not in existence in 2019 may look to the average quarterly wages paid in 2020 for purposes of applying the 70 percent advance rule. A 2021 small eligible employer that was not in existence in 2019 elects to use the special rule by requesting an advance based on the average quarterly wages paid in 2020.[12]

Advance payments are not available for employers who come into existence in 2021:

The special rules provided by section 2301(j)(2) of the CARES Act do not provide a method for determining average quarterly wages for a 2021 small eligible employer that comes into existence in 2021. Accordingly, 2021 small eligible employers that come into existence in 2021 are ineligible to receive advance payment of the employee retention credit; however, these 2021 small eligible employers, like all eligible employers, may reduce their deposits of employment taxes in anticipation of claiming the employee retention credit on Form 941 (or other applicable federal employment tax return) in accordance with Notice 2020-22.[13]

Finally, the Notice concludes with guidance for employers in existence for only part of 2019 or 2020:

If an eligible employer was in existence for some, but not all, calendar quarters of 2019 or 2020, average quarterly wages should be determined by dividing the sum of the wages paid in 2019 or 2020, as applicable, by the number of calendar quarters in 2019 or 2020, as applicable, in which that eligible employer existed. For example, an eligible employer that existed in only the second, third, and fourth calendar quarters of 2019 would add the wages paid in each of those calendar quarters and divide the total by 3. If an eligible employer existed for only part of a calendar quarter, that eligible employer should estimate the wages paid in the entire calendar quarter based on the wages paid in the portion of the calendar quarter in which it existed using any reasonable method. For example, if an eligible employer existed for two out of three months in a calendar quarter, that eligible employer may multiply the wages paid in those two months by 1.5 before averaging the wages for that quarter with the wages for the other calendar quarters. If an eligible employer filing a Form 943, 944, or CT-1 existed for only part of 2019 or 2020, that eligible employer may use any reasonable method to annualize the wages paid (or compensation for Form CT-1 filers) prior to dividing the amount by four.[14]

[1] Notice 2021-23, April 2, 2021, https://www.irs.gov/pub/irs-drop/n-21-23.pdf (retrieved April 2, 2021)

[2] Notice 2021-23, Section III.B

[3] Notice 2021-23, Section III.B

[4] Notice 2021-23, Section III.C

[5] Notice 2021-23, Section III.C

[6] Notice 2021-23, Section III.D

[7] Notice 2021-23, Section III.E

[8] Notice 2021-23, Section III.F

[9] Notice 2021-23, Section III.F

[10] Notice 2021-23, Section III.F

[11] Notice 2021-23, Section III.F

[12] Notice 2021-23, Section III.F

[13] Notice 2021-23, Section III.F

[14] Notice 2021-23, Section III.F