Almost a year after the employee retention credit was adopted as part of the Coronavirus, Aid, Relief, and Economic Security Act (“CARES Act”), and nearly a month after the final Form 941, Employer’s Quarterly Federal Tax Return, claiming the credit for 2020 was due, the IRS issued Notice 2021-20 (the “Notice”).  This is the final article in our three-part series looking at how the IRS’s guidance on the employee retention credit has changed over the past ten months.  This article focuses on how Notice 2021-20 builds on previous IRS guidance to narrow the scope of the credit and limit its availability.  Part I focuses on the statute and approach the IRS took in interpreting statute when the IRS issued frequently asked questions (“FAQs”) in April 2020. Part II focuses on the initial signs of trouble for employers that first appeared in the updated FAQs in June 2020.

The Notice is the proverbial effort to close the barn door after the horse is out of the barn–and in this case, clear across the pasture.  Although much of the guidance in the Notice reflects the (“FAQs”) that were posted to the IRS website beginning last April and that have been revised multiple times since, the Notice continues the trend that began last June of narrowing the availability and the amount of the employee retention credit—and in some instances, narrowing it in a way not contemplated by the permissive statutory language. (For our complete coverage of the employee retention credit and IRS guidance, click here.)

Now, as the pandemic looks to be entering its denouement, the IRS has rushed in to finish what it started in June when it began to walk back its initial guidance.  In doing so, it appears to have lost sight of the credit’s purpose of encouraging employers to retain workers that they did not need.  The fact that, perhaps, an employer might have been able to retain workers without the credit does not mean it necessarily would have done so in the absence of the credit—especially in light of the significant uncertainty regarding the depth and duration of any pandemic-driven economic contraction.  Employees at many employers likely recognized the potentially precarious position they were in as their workloads declined and their friends and family members who worked elsewhere were furloughed and laid off as the pandemic drove even large, respected companies toward potential financial calamity.  The IRS’s initial approach to interpreting the statutory language may well have preserved many such employees’ jobs, as Congress intended.

Having chosen in June 2020 to require that a “partial suspension” requires more than a “nominal effect” on business operations or that more than a “nominal portion” of the business be suspended, the IRS has stretched the word “nominal” beyond all recognition in the Notice.  Nominal generally means “existing in name only” or “very small.”  But Notice 2021-21—issued nearly nine months after the IRS introduced the concept of “nominal” to the partial suspension analysis—deems a portion of the business to be more than a nominal portion only if it constitutes at least 10% of the revenue of the business or 10% of the hours worked in the business.  Similarly, the Notice deems an order to have more than a nominal effect only if it results in a greater than 10% reduction in the ability of the business to provide goods and services to customers.  Pity the CEO who describes a 10% decline in revenue as “nominal.”  Similarly, it is doubtful that the IRS would feel particularly charitable toward a taxpayer who paid 90% of its tax obligation and described the unpaid balance as “nominal.”  While these rules appear to operate more as a safe harbor for a general facts and circumstances test than as a strict cut-off, significant questions remain regarding how much of a suspension the IRS will actually require.  For example, the Notice states that an employer that is unable to operate for up to two weeks while it transitions to mandatory telework as a result of a governmental order does not suffer a partial suspension.

In the Notice, the IRS also addresses what factors should be considered in determining whether an employer can continue its trade or business on a comparable basis via telework.  The factors include the employer’s telework capabilities, the portability of the employees’ work, and the need for presence in the employee’s physical workspace.  Like the deeming provisions for “nominal effect” and “nominal portion,” these factors seem designed to narrow the scope of the credit in a way that will exclude many employers who may have relied on the availability of the credit to maintain a workforce larger than they needed in light of the disruption to their office—which, after all, is Congress’ whole goal in enacting the retention credit.  For example, a consulting firm whose consultants may be able to continue to work remotely would likely have significantly less work for support staff such as administrative assistants and office services staff.  Yet, the IRS’s interpretation of the statute and the new “comparable basis” standard seems to suggest that an employer should furlough those workers and allow the furloughed employees to seek unemployment insurance benefits rather than utilizing the retention credit to cover a portion of such workers’ pay for the time the workers are idle.

It is important to remember that employers generally have the option to furlough and lay off employees when their business operations are impacted by governmental orders.  Congress sought, in both the CARES Act and the Consolidated Appropriations Act, 2021, to help employers avoid those steps and keep their workers employed.  It is not the job of the IRS to second-guess Congress by limiting the relief provided by statute, now that it has the benefit of hindsight.  Congress, in changing the definition of a “significant” decline in gross receipts from more than a 50% reduction to more than a 20% reduction, raising the threshold for “small” employer treatment from 100 to 500 full-time employees, increasing the credit from 50% to 70% of qualified wages, and increasing the limit on qualified wages from $10,000 in 2020 to $10,000 in each of the first two quarters of 2021, signaled its intention to help businesses of all sizes weather the pandemic and maintain their workforces.  If these actions were not enough evidence of Congressional intent, one need only look to the HEROES Act and several other proposals that were introduced in both the House and Senate last year to help employers keep employees on their payroll to recognize that Congress has repeatedly made efforts to make the retention credit more generous and not less generous as embodied in the Notice.  Unfortunately, the IRS has now attempted to retroactively exclude from eligibility a number of employers who took advantage of the incentive that Congress offered to keep their employees on the payroll—employees that, in many cases, the employers, at least temporarily, did not need.

The Notice is the most definitive guidance on the scope and operation of the employee retention credit to date.  It may well be the most authoritative guidance that the IRS will ever share with taxpayers on the topic.  The IRS was careful to note on each page of the website FAQs that they were not authoritative and could not be cited as authority.  In contrast, the Notice may be relied on by taxpayers, but it does not carry the weight of Treasury Regulations.  Many taxpayers who relied in good faith on reasonable interpretations of the statute and the FAQs should consult their advisors to determine whether—in the midst of the ongoing pandemic—they should file amended employment tax returns to either eliminate or reduce the credit, which they relied upon to keep many Americans employed.