Congress created the employee retention credit (ERC) as part of the CARES Act. Although at first relatively small in scope, subsequent expansions and extensions of the ERC have resulted in the ERC becoming a source of significant COVID relief, on par with or greater than the PPP loan for many businesses. In Notice 2021‑49, the IRS amplified prior guidance on the subject and confirmed that part-time employees do not count towards ERC limitations based on the average number of employees a business had in 2019. Businesses that exceed the appliable limit (100 for the 2020 ERC and 500 for the 2021 ERC) based on full-time equivalents (FTEs), but not full-time employees, should look into obtaining the ERC. This guidance differs from an interpretation by the Congressional Joint Committee on Taxation, but is in fact consistent with the plain language in the statute. The ERC currently is scheduled to be available for all of 2021, but the bipartisan infrastructure bill that the Senate passed (H.R. 3684) would end the ERC after the third quarter of 2021.
We have published articles and a table summarizing various changes to the ERC. The ERC is a refundable payroll tax credit claimed on the Form 941, Employer’s Quarterly Federal Tax Return (or Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, if applicable). For 2020, the ERC is 50 percent of annual “qualified wages” up to $10,000 — which translates into a credit of up to $5,000 per employee. For 2021, the ERC is 70 percent of quarterly “qualified wages” up to $10,000 — a credit of up to $7,000 per employee per quarter. A business generally can qualify for the ERC pursuant to a variety of tests:
Even if a business qualifies for the ERC, the ERC only applies to “qualified wages” (compensation and healthcare costs). The definition of “qualified wages” depends on whether the business is treated as a small employer or large employer for ERC purposes:
Pursuant to the CARES Act, treatment as a large employer or small employer depends on whether “the average number of full-time employees (within the meaning of section 4980H of the Internal Revenue Code of 1986) employed by such eligible employer during 2019 was greater than” the applicable threshold amount. (Emphasis added.) The “applicable threshold amount,” in turn, depends on the calendar year: 100 for the 2020 ERC and 500 for the 2021 ERC. That is, the CARES Act looks to pre‑pandemic (2019) employment numbers to determine whether a business is a large employer or a small employer. However, rather than define “full-time employees” for purposes of the ERC, Congress referred to IRC § 4980H, a provision added by the Affordable Care Act.
IRC § 4980H(c)(4) provides a definition of a full-time employee — an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month. Separately, IRC § 4980H(c)(2)(E) incorporates an FTE concept, but “[s]olely for purposes of determining whether an employer is an applicable large employer under this paragraph.” That is, an FTE concept applies for purposes of IRC § 4980H(c)(2), but not all of IRC § 4980H.
Accordingly, because (1) the CARES Act references full-time employee (without an FTE concept), (2) IRC § 4980H contains a specific definition of “full-time employee” that does not include an FTE concept, and (3) the use of an FTE concept in IRC § 4980H is limited to the definition of “applicable large employer” for Affordable Care Act purposes, it generally appeared that an FTE concept did not apply for ERC purposes. Despite this, the summary of the CARES Act prepared by the Staff of the Joint Committee on Taxation states in footnote 143:
The provision states that the metric is the “average number of full-time employees (within the meaning of section 4980H of the Internal Revenue Code of 1986).” This language includes full-time equivalents as referred to in section 4980H(c)(2)(E).
In the footnote, the summary quotes IRC § 4980H(c)(2)(E), but apparently disregards the “[s]olely for purposes” preface.
We have been advising clients for months that, for purposes of determining whether an employer is a large or small employer (and thus whether the ERC can be claimed for wages paid to employees providing services), the employer only needs to count full-time employees and not FTEs. In Notice 2021-49, the IRS resolved the ambiguity created by the footnote in the Joint Committee Report by ruling in favor of taxpayers (and a plain reading of the text of a statute): “For purposes of determining whether an eligible employer is a large eligible employer or a small eligible employer, eligible employers are not required to include full-time equivalents when determining the average number of full-time employees.” Accordingly, a business that in 2019 averaged less than 100 (2020 ERC) or 500 (2021 ERC) full-time employees, but more than 100/500 FTEs, is considered a small employer for ERC purposes. Remember, for small employers, the definition of qualified wages includes all wages paid to each employee (including part-time employees) for providing services.
Although we do not like to complain about Congressional or IRS largess, as a policy matter, we are not sure it makes sense to ignore FTEs. For example, these rules treat a business that in 2019 had 100 full-time employees and 810 half-time employees (i.e., 505 FTEs) differently for ERC purposes than a business that in 2019 had 505 full-time employees. However, that is the appropriate result that flows from the plain text of the CARES Act, as passed by Congress and signed by former President Trump. We applaud the IRS for adhering to that text, rather than adopting the Joint Committee’s unsupported interpretation, which inevitably would have led to litigation.
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