End-of-Year Change to the Employee Retention Credit Waiting to Snag Some Employers with Penalties

    The IRS recently issued Notice 2021-65, offering guidance to employer-taxpayers after the Infrastructure Investment and Jobs Act (“Infrastructure Act”) ended the employee retention credit for wages paid by most employers during the fourth quarter of 2021.¹  The Notice also describes circumstances where certain employers may have to repay advance payments of the employee retention credit or be subject to penalties.

Background:
    Section 2301 of the CARES Act provided for an employee retention credit for eligible employers that pay qualified wages, including certain health plan expenses, to some or all employees after March 12, 2020, and before July 1, 2021.²  Eligible employers were allowed to claim a refundable tax credit under the CARES Act for seventy percent of qualified wages paid, limited to $10,000 per employee over all calendar quarters combined in 2020.

    The American Rescue Plan enacted section 3134 of the Code, which provides a substantially similar employee retention credit for qualified wages paid after June 30, 2021, and before January 1, 2022.³  Under that section, eligible employers could claim a refundable tax credit for seventy percent of qualified wages paid, limited to $10,000 per employee per calendar quarter in 2021 for the third and fourth calendar quarters of 2021.

Infrastructure Act
    The Infrastructure Act terminated the employee retention credit for wages paid by most employers during the fourth calendar quarter of 2021. The Infrastructure Act amended Sec. 3134(b) of the Code to limit the availability of the employee retention credit to wages paid after June 30, 2021, and before October 1, 2021.⁴

Recovery Startup Businesses
    Businesses that qualify as a “Recovery Startup Business” are still eligible to claim the employee retention credit for wages paid before January 1, 2022.

    As amended by the Infrastructure Act, a Recovery Startup Business is any employer which began carrying on any trade or business after February 15, 2020 and has average annual gross receipts less than $1,000,000. IRC Sec. 3134(c)(5). The definition no longer requires that a Recovery Startup Business not otherwise be an eligible employer due to a full or partial suspension of operations or a decline in gross receipts.

Repayment of Advance Payments for Employers other than Recovery Startup Businesses
    Employers (not including Recovery Startup Businesses) that requested and received advance payments of the employee retention credit for wages paid in the fourth calendar quarter of 2021 prior to the enactment of the Infrastructure Act must repay the amount of the advance. An advance payment of any portion of the employee retention credit to a taxpayer in excess of the amount to which the taxpayer is entitled is an erroneous refund that the employer must repay.

    Employers who need to repay these excess advance payments of the employee retention credit must do so by the due date for the applicable employment tax return that includes the fourth calendar quarter of 2021. Failure to repay the advance payment by the due date of the applicable employment tax return may result in the imposition of failure-to-pay penalties under section 6651.

Failure to Deposit Penalties for Employers other than Recovery Startup Businesses
    Due to the termination of the employee retention credit for wages paid in the fourth calendar quarter of 2021 for employers that are not Recovery Startup Businesses, the IRS will no longer waive failure to deposit penalties under section 6656 for employers that reduce deposits in anticipation of the employee retention credit after December 20, 2021, unless the employer is a Recovery Startup Business.

Good News

• The employer reduced its deposits in anticipation of the employee retention credit, consistent with the rules provided in section 3.b. of Notice 2021-24;
• The employer deposits the amounts initially retained in anticipation of the employee retention credit on or before the relevant due date for wages paid on December 31, 2021 (regardless of whether the employer actually pays wages on that date); and
• The employer reports the tax liability resulting from the termination of the employer's employee retention credit on the applicable employment tax return or schedule that includes the period from October 1, 2021 through December 31, 2021.

        An employer may still raise a reasonable cause defense if the IRS assesses a penalty under section 6656.

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¹IRS Notice 2021-65, Termination of the Employee Retention Credit Under Section 3134 of the Code (Dec. 6, 2021).
²Pub. L. No. 116-136, 134 Stat. 281 (March 27, 2020), as amended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act), enacted as Division EE of the Appropriations Act, with respect to qualified wages paid with respect to the period beginning January 1, 2021, and ending June 30, 2021.
³Pub. L. No. 117-2, 135 Stat. 4 (March 11, 2021).
⁴Pub. L. 117-58, 135 Stat. 429 (2021), enacted November 15, 2021.