Employee Retention Credit Changes: What Business Owners Need to Know

Employee Retention Credit – Early Termination Penalty Relief

By: Stan Rose, CPA, MST, Baker Newman Noyes

A few weeks ago, federal legislation set in motion an unexpected and early end to the Employee Retention Credit (“ERC”). Surprisingly, it did so retroactively, and in a manner that seemed likely to create the risk of penalties for unsuspecting employers who, prior to the legislation, had legitimately claimed this credit. Congress often enlists the IRS to clear up ambiguities in its legislation, and with the issuance of a recent notice they did, offering some potential relief – but only for employers who act in a timely manner.

Background

The ERC allowed employers to reduce their payroll taxes and claim refunds if the reductions exceeded the payroll taxes otherwise owed. It was made available to employers who met specific criteria – primarily decreased revenue resulting from the pandemic. It was implemented by the filing of customary payroll tax returns. The credit was created with the CARES Act in 2020, but underwent several changes, including extension until December 31 of this year.  However, the Infrastructure Investment and Jobs Act eliminated this credit for most retroactively by disallowing the credit for wages paid after September 30, 2021. (A small category of filers known as “recovery startup businesses” can continue to qualify through year-end).

This reversal concerned many employers because a feature of the ERC allowed employers to claim the credit in advance by reducing deposits in anticipation of qualifying for the credit. When Congress retroactively pulled the plug on the ERC, it meant that many employers found themselves in the position of having legitimately utilized a credit that no longer existed! Penalties can result from underpaying payroll taxes, and even worse, this type of underpayment is one that can be imposed not only on the employer itself, but also personally on employees within the company who are responsible for implementing payroll (CFOs, controllers, and payroll administrators, for example).  This month, though, relief was provided by the IRS in the form of Notice 2021-65.

What Is Notice 2021-65?

Notice 2021-65 provides guidance that allows employers to sidestep the harsh penalties that otherwise could be imposed for underpaying payroll taxes. The notice addresses (1) how to end the use of the credit, (2) how to “undo” any portion of the credit already obtained that is now invalid due to the retroactive law change, and (3) how to report the “undoing.”

Ending the credit:  The notice states that beginning with payroll taxes due on or before December 21, 2021, deposits no longer cannot be reduced (to claim the credit) for wages paid in the fourth quarter of the year (October 1 through December 31).

Undoing credits already taken:  Some employers have already claimed the credit for that period, and if so, that amount must be repaid. Normal deposit frequency varies between companies, but regardless of the method used, the repayment date (to “undo” the credit) must occur no later than the deposit date that applies to wages paid on December 31, 2021. This date applies whether or not any wages are actually paid at that time.

Reporting the change:  As those familiar with payroll filings know, filing payroll tax returns is often required with less frequency than the underlying deposits that the returns report. The reversal of the credit must be reported on the employment tax return filed by the employer that covers the period October 1 through December 31, 2021.

Conclusion

Notice 2021-65 represents the guidance that many nervous employers hoped would follow the legislation that recently announced the abrupt (and inexplicably retroactive) end to the Employer Retention Credit.  Without its guidance, penalties could apply to anyone who had obtained advance benefit of the credit for wages paid in the fourth quarter of this year, even if they had done nothing wrong. The path to preventing the penalties is straightforward, but requires specific steps to be taken very soon, and employers are encouraged to become familiar with the rules and act quickly.

Stan Rose is a director in the tax department of the accounting firm Baker Newman Noyes with headquarters in Portland, Maine and offices in Manchester, Portsmouth, Boston and Woburn, Mass.