Nearly 18 months into the pandemic, the IRS continues to issue guidance on the employee retention credit, a credit that was adopted in March 2020 and has been addressed in a number of articles on the Tax Withholding & Reporting Blog, most recently on August 3, 2021.
The latest guidance takes the form of Notice 2021-49 and Revenue Procedure 2021-33, which together address a range of topics, including how employers should treat cash tips for purposes of determining the amount of qualified wages, whether the credit may be claimed with respect to the same wages for which the employer receives the Code Section 45B credit, how the related individual rules work for determining qualified wages, and whether employers are required to file amended tax returns if they claim the employee retention credit retroactively. The Service has also outlined a safe harbor that employers may apply to exclude from gross receipts the amount of the forgiveness of any PPP loans or the amount of shuttered venue operator grants or restaurant revitalization grants.
Cash Tips May Be Treated as Qualified Wages
In Notice 2021-49, the IRS concedes that cash tips received by employees from customers should generally be treated as qualified wages, and bases that conclusion on the Internal Revenue Code’s inclusion of cash tips greater than $20 a month in the definition of wages and compensation under Sections 3121(a)(12) and 3231(e)(3), respectively, as well as Section 3121(q), which deems tips received by employees as wages paid by the employer for purposes of subsections (a) and (b) of Section 3111 (the employer share of FICA taxes).
The IRS’s decision to include cash tips in qualified wages is surprising in light of the IRS’s prior determination that remuneration in excess of the Social Security wage base could be included in determining qualified wages even though such amounts were excluded from the definition of “wages” under section 3121(a). Nonetheless, the decision is a welcome one to employers with tipped employees. As we have discussed previously, qualified wages for purposes of the employee retention credit are wages (as defined in Section 3121(a) of the Code) and compensation (as defined in Section 3231(e) of the Code) that are paid by an eligible employer to some or all of its employees. In contrast, cash tips, are paid by customers rather than by employers.
Nonetheless, the IRS concluded that Section 3121(q) (which deems tips paid by the employer for purposes of subsections (a) and (b) of Section 3111) results in such amounts being deemed as paid by the employer for purposes of Section 2301 of the CARES Act and Section 3134 of the Code (and presumably the qualified disaster employee retention credit claimed on Form 5884-A). By treating cash tips as qualified wages, Notice 2021-49 permits employers to calculate the credit by reference to amounts the employer never paid out of pocket. Query whether other wages not paid by the employer may also be included in qualified wages, such as incidental non-cash fringe benefits provided by a third-party.
Impact of Cash Tips Rule on PPP Guidance
The IRS’s approach to tipped wages also raises questions with respect to the Payroll Protection Program (PPP) — should cash tips also be treated as payroll costs for purposes of PPP loan forgiveness?
The SBA Interim Final Rule from April 15, 2020, defines “payroll costs” broadly to mean compensation to employees, inclusive of salary, wages, or cash tips. The program uses the same definition of payroll costs for purposes of determining the maximum loan amount and the amount of the loan that can be forgiven. Accordingly, employers were permitted to rely on the amount of cash tips reported by their employees to determine the maximum amount of a PPP loan. However, both the statutory language and the interim final rule provide that for amounts to be forgiven, the expenses must be incurred by the employer. As a result, some practitioners reasonably concluded that employers could not obtain forgiveness with respect to cash tips, since they are paid by customers of a business, and the employer therefore never incurs any expense with respect to such amounts.
Now that the Service has concluded that eligible employers do in fact pay the cash tips left by customers for their employees for purposes of calculating qualified wages, it remains to be seen whether PPP loan forgiveness may also be permitted with respect to cash tips that constitute wages.
Employers May Double-Dip with Section 45B Credit
Section 45B provides a business tax credit in the amount of the restaurant employer’s FICA tax obligations attributable to employee tips in excess of those treated as wages for purposes of meeting federal minimum wage requirements. (Even though the federal minimum wage rate has increased since Section 45B was added to the Code, the FICA tax tip credit continues to be determined based on a minimum wage rate of $5.15 per hour.) As amended, the credit applies to establishments providing food and beverage (regardless of whether or not the food and beverage are consumed on the employer’s premises) with respect to which the tipping, by customers, of employees serving food or beverage is customary.
In another piece of welcome news for the restaurant industry, Notice 2021-49 clarifies that an eligible employer may claim both the employee retention credit and the Section 45B FICA tax tip credit with respect to the qualified wages used to determine the employee retention credit.
IRS Clarifies Related Individual Rules
Notice 2021-49 clarifies how the related individual rules affect the determination of whether wages paid to a majority owner of a corporation (including an LLC taxed as a corporation) or the owner’s spouse constitute qualified wages under the rules. In short, the majority owner is a related individual, whose wages are not qualified wages, but only if the majority owner has a living brother or sister (whether by whole blood or half-blood), ancestor, or lineal descendant. The spouse of a majority owner may also be a related individual, but only if the spouse bears certain relationships to those family members. Although this result caught some practitioners by surprise, it is a relatively straightforward reading of the statute.
The Service reached this conclusion with respect to related individuals based on the statutory language of Sections 51, 152, and 267 of the Code. The employee retention credit provides that rules similar to those contained in Section 51(i)(1) of the Code apply. Those rules, relying on Section 152, preclude the claiming of the Work Opportunity Tax Credit for wages paid to the majority shareholder’s child or a descendant of a child; brother, sister, stepbrother, or stepsister; father or mother, or an ancestor of either; stepfather or stepmother; niece or nephew; aunt or uncle; son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; or an individual (other than a spouse, determined without regard to section 7703, of the taxpayer) who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household. (These relationships are set forth in Section 152(d)(A)-(H).) However, for purposes of determining who is a majority shareholder, the constructive ownership rules under section 267(c) apply. Under those rules, an individual is considered to own the stock owned, directly or indirectly, by or for the individual’s family. For purposes of these rules, an individual’s family is defined to mean their brothers and sisters (whether by whole or half-blood), spouse, ancestors, and lineal descendants.
Applying these rules, Notice 2021-49 concludes that the majority owner of a corporation will be a related individual, whose wages are not qualified wages, if the majority owner has a brother or sister (whether by whole blood or half-blood), ancestor, or lineal descendant. Under the 267(c) rules, the majority owner’s ownership share will first be attributed to the owner’s brother or sister (whether by whole blood or half-blood), ancestor, or lineal descendant. The direct majority owner of the corporation would then have a relationship as defined in paragraphs (A) through (D) of Section 152(d)(2) to their brother or sister (whether by whole blood or half-blood), ancestor, or lineal descendant, who is a constructive majority owner under Code Section 267(c). Under this same approach, the spouse of a majority owner may also be a related individual, but only if the spouse bears a relationship described in Section 152(d)(2) to a family member of the business owner.
Employers Claiming the Credit Retroactively May be Required to File Amended Returns
Employers claiming the employee retention credit are required to reduce their deduction for employee wages by the amount of the credit received. Given that the employee retention credit has evolved and expanded over the past 18 months, many employers are claiming the credit on a Form 941-X some period of time after the end of the quarter for which the credit is claimed. This raised questions regarding which year the employer must reduce its wage deduction to reflect the credit: the year for which the credit is claimed or the year in which the credit is claimed/received.
Notice 2021-49 provides that an employer should file an amended federal income tax return for its business for the taxable year in which the qualified wages were paid or incurred (i.e., the taxable year containing the calendar quarter for which the employee retention credit was claimed). As a result, an employer with a calendar year tax year that files a Form 941-X in 2021 for a 2020 calendar quarter must file an amended 2020 business tax return to reflect the reduced reduction in wages. This may create cash flow issues for the employer who will be required to pay the additional tax resulting from the amendment at a time when many refunds owing to the employee retention credit have been delayed by months due to internal IRS processing issues. In addition, pass-through entities such as partnerships and S-corporations will need to issue amended Schedules K-1 resulting in their partners and shareholders needing to file amended individual income tax returns.
Gross Receipts Safe Harbor
In Revenue Procedure 2021-33, the IRS has addressed another thorny question related to the employee retention credit: should an employer include in its gross receipts the amount of forgiveness of a PPP loan or certain other benefits received by an employer under COVID-related grant programs? In general, gross receipts is defined very broadly and would seem to include forgiven PPP loans and COVID-related grants even though such amounts may not be taxable income.
The IRS recognized that treating such amounts as gross receipts would frustrate Congress’s clear intent to allow employers to take advantage of the employee retention credit in addition to other COVID-relief measures, subject to certain restrictions to prohibit double-counting. Accordingly, Rev. Proc. 2021-33 permits an employer to exclude from gross receipts the amount of the forgiveness of any PPP loans or the amount of shuttered venue operator grants or restaurant revitalization grants for all calendar quarters. To take this approach, the IRS requires employers to apply it consistently. Therefore, an employer is required to exclude these other relief programs from gross receipts for each calendar quarter in which gross receipts are relevant to determining eligibility to claim the credit. Employers are also required to apply the safe harbor to all entities treated as a single employer under the employee retention credit aggregation rules.