Claiming the Employee Retention Credit for Past Quarters Using Form 941-X
The Employee Retention Credit (ERC) is a tax credit available to employers who have seen a reduction in gross revenue due to the coronavirus pandemic. As described below, the credit, which was originally enacted in 2020, was extended, with improved terms, for 2021. Employers who mistakenly failed to take advantage of the ERC in the first two quarters of 2021 can still take advantage of the ERC by filing a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, described below. For 2021, an employer who did not meet the 20% reduction test for the second quarter of 2021 is still eligible for the ERC for the second quarter if it met the 20% reduction test for the first quarter of 2021.
On Form 941-X for the first and second quarters of 2021, the nonrefundable portion of the ERC equals the employer’s share of the Social Security tax, or 6.4 percent of wages. The term “nonrefundable” is a misnomer if the taxpayer did not claim the ERC, and instead paid the employer’s share of the Social Security tax via federal tax deposits. If the employer’s share of the Social Security tax was paid, then the nonrefundable portion of the ERC is refundable. The instructions for line 18 of the Form 941-X provide for this by stating, “Copy the amount in column 3 to column 4. However, to properly show the amount as a credit or balance due item, enter a positive number in column 3 as a negative number in column 4 or a negative number in column 3 as a positive number in column 4.” If one does not change column 4 to a negative number, pursuant to the computations in the Form the taxpayer will not claim the full ERC available.
General Description of the ERC
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) originally established the ERC to encourage companies to keep employees on their payroll during the pandemic. Under the CARES Act, the ERC provided a refundable 50 percent payroll tax credit for up to $10,000 in qualified wages per quarter per employee. Under the CARES Act, the maximum ERC for 2020 was $5,000 per employee.
The following significant improvements were made to the ERC under the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), which was enacted in December 2020, and under the American Rescue Plan Act of 2021 (ARPA), which was signed into law on March 11, 2021:
- Under the Relief Act, the ERC was extended for wages paid for the first two quarters of 2021, and was significantly increased to a maximum tax credit of $7,000 per quarter per employee (70 percent of $10,000 in qualified wages).
- Under ARPA, the ERC was further extended through December 31, 2021, allowing eligible employers to claim the refundable ERC in the third and fourth quarters of 2021. Thus, the maximum ERC for 2021 is $28,000 per employee.
- The Relief Act also addressed whether Paycheck Protection Program (PPP) loan recipients could qualify for the ERC. In early March, the IRS issued guidance in Notice 2021-20 clarifying how PPP loan recipients can claim the ERC. For 2020, recipients of PPP loans could not claim the ERC. For 2021, the recipients of PPP Loans are eligible for the ERC.
The ERC offsets the eligible employer’s portion of payroll taxes. The ERC is fully refundable because the eligible employer may get a refund if the amount of the ERC is more than the applicable employment taxes owed by the eligible employer. The applicable employment taxes for 2020, as well as for the first and second quarters of 2021, were the employer’s share of Social Security taxes, which is 6.2 percent of wages. For the third and fourth quarters of 2021, applicable employment taxes are the employer’s share of Medicare taxes, which is 1.45 percent of wages.
The IRS released Notice 2021-20 to address the Relief Act revisions to the ERC. The IRS also released Notice 2021-23, which amplifies the guidance in Notice 2021-20, but does not address the ERC for the third and fourth quarters of 2021. The IRS plans to issue additional guidance for those two quarters.
For the first two quarters of 2021, the Relief Act provides that employers are eligible for the ERC if they operate a trade or business and experience: (i) a full or partial suspension of the operation of their business because of governmental orders, or (ii) at least a 20 percent decline in gross receipts in a calendar quarter in 2021, as compared to the same calendar quarter in 2019. For the third and fourth quarters of 2021, the eligibility requirements under ARPA are the same as under the Relief Act.
As described in IRS Notice 2021-23, the Relief Act permits an employer to elect to use an alternative quarter to determine eligibility. Under this election, an employer is eligible for a calendar quarter in 2021 if the gross receipts for the immediately preceding calendar quarter have declined by at least a 20 percent as compared to the same calendar quarter in 2019. For example, an employer who did not meet the 20% reduction test for the second quarter of 2021 is still eligible for the ERC for the second quarter if it met the 20% reduction test for the first quarter of 2021.
Under the CARES Act, if an eligible employer averaged more than 100 full-time employees during 2019, qualified wages paid in 2020 were those wages paid by the eligible employer to an employee who is not providing services. If an eligible employer averaged 100 or fewer full-time employees in 2019, qualified wages were the wages paid to any employee, including those performing services.
The Relief Act increased the operative employee threshold from 100 full-time employees to 500 full-time employees. ARPA further modified the ERC for the third and fourth quarters of 2021 by adding certain severely financially distressed large employers to those that may include wages paid to all employees.
ERC and PPP Eligibility
Under the CARES Act, the recipient of a PPP loan was prohibited from claiming the ERC. The Relief Act retroactively repealed that prohibition, subject to certain limitations. In Notice 2021-20 the IRS clarified that payroll costs that were paid for with forgiven PPP loans are not “qualifying wages” for purposes of the ERC. An eligible employer is deemed to elect to exclude qualified wages reported on the employer’s PPP Loan Forgiveness Application for purposes of claiming the ERC. The deemed election applies to the minimum amount of wages necessary to achieve PPP loan forgiveness. Notice 2021-20, Question 49, provides numerous examples applying the IRS’s guidance to a variety of situations.
Claiming the ERC
An eligible employer claims the ERC on the employer’s federal employment tax return(s) on IRS Form 941. In anticipation of receiving the ERC, eligible employers can: (i) reduce their deposits of federal employment taxes that would otherwise be required up to the amount of the anticipated credit, and (ii) request an advance of the amount of the anticipated credit to the extent it exceeds the reduced federal employment tax deposits by filing IRS Form 7200. In 2021, only small employers (i.e., employers with an average of 500 or fewer full-time employees in 2019) may request advance payment of the credit in an amount not to exceed 70 percent of the average quarterly wages paid in calendar year 2019. Notice 2021-23 confirmed that the requirement to reduce deposits in anticipation of the credit before requesting an advance continues to apply to 2021 eligible small employers.
If an employer finds that they were an eligible employer for a past quarter in which they did not claim the ERC, they can retroactively claim the credit by filing an Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund on IRS Form 941-X. As described at the beginning of this post, taxpayers should pay close attention to the instructions to Form 941-X, line 18, particularly as they relate to changing a positive number in column 3 to a negative number in column 4. The failure to change a positive number in column 3 to a negative number in column 4 will result in an unnecessary reduction to the ERC claimed on the Form 941-X.
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