On November 15, 2021, President Biden signed the Infrastructure Investment and Jobs Act (the “IIJA”), which retroactively eliminated and repealed the employee retention credit (“ERC”) as of September 30, 2021. The credit was previously set to expire on January 1, 2022. This law effectively eliminates an employer’s ability to claim the ERC for eligible wages paid after September 30, 2021. Recovery startup businesses (discussed below), however, may still claim the credit through the end of this year. In other words, any qualified wages paid by an eligible employer that is not a recovery startup business in the fourth quarter of 2021 are no longer eligible for the credit. On December 6, 2021, the IRS issued guidance related to the impact of this change on employers.
Congress originally enacted the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) on March 27, 2020, in response to the COVID-19 pandemic. It intended for the CARES Act to incentivize employers to retain employees during the pandemic. As part of the CARES Act, Congress established the ERC, a refundable dollar-for-dollar payroll tax credit for each calendar quarter that an employer’s business operations were either partially or fully suspended due to a governmental COVID-19 related order or that they suffered a significant decline in gross receipts. The ERC was also available to recovery startup businesses which were not otherwise eligible under the gross receipts or partial/full suspension test.
Initially, the ERC applied to qualified wages paid after March 12, 2020, and before January 1, 2021, and employers to claim a maximum credit of up to 50% of qualified wages paid (capped at $10,000 per employee, per year), for a maximum credit of $5,000 per employee, per year. On December 27, 2020, the Consolidated Appropriations Act extended the application of the credit to include qualified wages paid after December 31, 2020, and before July 1, 2021. The credit was increased to up to 70% of the qualified wages paid to each employee up to a limit of $10,000 of wages per employee, per calendar quarter, for a maximum credit of $7,000 per employee for each calendar quarter of 2021 paid before July 31, 2021. On March 11, 2021, the American Rescue Plan Act again extended the deadline to include qualified wages paid from July 1, 2021, through December 31, 2021. The American Rescue Plan Act also limited the ERC for recovery startup businesses to $50,000 for each of the third and fourth calendar quarters of 2021.
Prior to the IIJA, in anticipation of claiming the ERC, employers could retain a corresponding amount of the employment taxes that otherwise would have been deposited, up to the amount of the credit, without penalty, taking into account any reduction for deposits in anticipation of the paid sick and family leave credit provided in the Families First Coronavirus Response Act. Now, employers who retained payroll taxes in anticipation of the ERC for wages paid after September 30, 2021, will have to repay the underpaid employment taxes and may be subject to a 10% penalty and interest by the IRS. This could have major implications for employers who did not deposit employment taxes in anticipation of taking the ERC in the fourth quarter. Thankfully, on December 6, 2021, the IRS issued Notice 2021-65, providing guidance and penalty relief for those employers who comply with certain deadlines and requirements.
Notice 2021-65 provides that employers who reduced employment tax deposits in anticipation of the credit will not be subject to penalties for deposits retained before December 20, 2021, if the deposits were reduced pursuant to the rules of prior IRS guidance, the employer deposits the retained amounts on or before the due date for wages paid on December 31, 2021, and the employer reports the tax liability resulting from the termination of the employer’s ERC on its employment tax return for the period from October 1, 2021, through December 31, 2021. Further, employers who received advance payments in anticipation of the credit may avoid penalties if they repay the amounts by the due date of their applicable employment tax returns. However, it is important to note that the IRS will not waive penalties for employers who reduce deposits after December 21, 2021(unless the employer is a recovery startup business).
On the upside of the IIJA changes, a recovery startup business (i.e., one that began operating after February 15, 2020, and has average annual gross receipts of less than $1 million) that was previously ineligible may now be able to claim the ERC for the fourth quarter of 2021. The IIJA modified the requirements for a taxpayer to be considered an eligible recovery startup business by eliminating the rule that disqualifies a recovery startup business if it also meets the gross receipts or full/partial suspension tests discussed above. Thus, an employer that is a recovery startup business but was previously disqualified because it also satisfied the gross receipts or full/partial suspension tests in prior quarters, may now be an eligible recovery startup business in the fourth quarter and may be able to claim the ERC for the fourth quarter of 2021.
Although the retroactive truncation of the ERC doubtless disappointed many taxpayers, it seems unlikely that the legislation can be successfully challenged. Although there is no bright-line rule as to whether a constitutional challenge to the retroactive repeal of the credit would be successful, the U.S. Supreme Court has repeatedly upheld retroactive tax legislation against due process challenges. In United States v. Carlton, 512 U.S. 26 (1994), for example, the Court stated that “[p]rovided that the retroactive application of a statute is supported by a legitimate legislative purpose furthered by rational means, judgments about the wisdom of such legislation remain within the exclusive province of the legislative and executive branches,” and upheld an amendment to the Code with what it called “a modest period of retroactivity” that was slightly more than one year. Given that the retroactivity period here is only three months, it is likely that a challenge to that portion of the IIJA on due process grounds would be unsuccessful.
Accordingly, employers should be aware of the new deadlines and plan appropriately to avoid incurring penalties.
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