IRS Issues Additional Employee Retention Credit Guidance

The IRS issued Notice 2021-49 on August 4, 2021, providing long-awaited guidance for employers that have taken or are considering taking the employee retention credit or ERC that was initially made available under the CARES Act (Coronavirus Aid, Relief, and Economic Security Act) and modified and extended under ARPA (American Rescue Plan Act of 2021. Generally, the maximum ERC for 2020 is $5,000 per employee, while the maximum for 2021 is $28,000 per employee.

Applicable Employment Taxes

Notice 2021-49 confirms that, for the third and fourth quarters of 2021, eligible employers can claim the ERC against the employer’s share of Medicare tax (or the portion of Tier 1 tax under the Railroad Retirement Tax Act) after these taxes are reduced by any credits allowed under the ARPA for qualified sick leave wages and qualified family leave wages, with any excess refunded.

Recovery Startup Business

An ERC of up to $50,000 per quarter is available to “recovery startup businesses.” A recovery startup business is an employer that began carrying on a trade or business after February 15, 2020. The notice clarifies that an employer is not considered to have begun carrying on a trade or business until such time as the business has begun to function as a going concern and performed those activities for which it was organized.


The notice also states that a not-for-profit organization can be treated as an eligible employer due to being a recovery startup business based on all of its operations and average annual gross receipts. For ERC purposes, a not-for-profit organization is deemed to be a “trade or business.”

Further, a recovery startup business that has 500 or fewer full-time employees may treat all wages paid with respect to an employee during the quarter as “qualified wages.”


Finally, the aggregation rules apply when determining whether an employer is a recovery startup business, as well as to the $50,000 limitation on the credit. Thus, a recovery startup business would need to apply IRC Sections 52(a) (for related corporations), 52(b) (for related non-corporate entities, such as partnerships, trusts, etc.) and 414(m) (affiliated service group rules).

Qualified Wages

Qualified wages generally are determined differently based on whether the employer is a small or large employer, in that qualified wages for large employers are limited to wages paid to an employee for time the employee is not providing services due to a full or partial suspension of business operations or a decline in the employer’s gross receipts.


The notice clarifies the rule for qualified wages for a “severely financially distressed employer” (SFDE). An SFDE is an employer that, in the third or fourth quarter of 2021, has gross receipts of less than 10% of its gross receipts for the same quarter in 2019. For SFDEs, qualified wages are any wages paid in the quarter, regardless of the size of the employer. This is different from the standard ERC rule, which limits qualified wages for large employers to wages paid while the employee is not performing services.

Full-Time Employees Versus Full-Time Equivalents

Confusion abounds about the definition of “full-time employee” and whether “full-time equivalents” are to be included when determining whether an employer eligible for the ERC is a large or small employer. Notice 2021-49 clarifies that eligible employers are not required to include full-time equivalents when determining the average number of full-time employees. The notice also confirms that wages paid to an employee who is not a full-time employee may be treated as qualified wages if all other requirements are met.

Treatment of Tips and FICA Tip Credit

Considerable confusion has arisen as to whether tips count as qualified wages for the ERC, since customers (not the employer) generally pay the employee the tips. Notice 2021-49 clarifies that cash tips are qualified wages if all other requirements to treat the amounts as qualified wages are met. The notice also confirms that eligible employers are not prevented from receiving both the ERC and the FICA tip tax credit on the same wages.

Timing of Qualified Wages Deduction Disallowance

The IRS has provided guidance on the timing of the disallowance for wage deductions on the employer’s federal tax return relating to qualified wages claimed for the ERC. The IRS previously confirmed that employers must reduce the deduction claimed for employee wages on their federal tax return by the amount of qualified wages claimed under the ERC. Notice 2021-49 confirms that this reduction in the deduction amount must occur in the same tax year the ERC is claimed. Accordingly, if an employer files a claim for the credit for a prior tax year, it must also file an amended federal tax return to reduce the amount of the wage deduction claimed in the corresponding period.

Related Individuals

The IRS previously stated that wages paid to related individuals, as defined by IRC Section 51(i)(1), are not taken into account for ERC purposes. Notice 2021-49 clarifies that, by applying the ownership attribution rules, the definition of a “related individual” includes a majority owner (i.e., a person with more than 50% ownership) of an entity if the majority owner has a brother or sister (whether by whole or half-blood), ancestor or lineal descendant. The spouse of a majority owner is also a related individual for purposes of the ERC if the majority owner has a family member who is a brother or sister (whether by whole or half-blood), ancestor or lineal descendant.


Wages paid to a sole owner or majority owner will rarely qualify for the ERC, according to the guidance provided in Notice 2021-49, because of the way the ownership attribution rules are applied. The owner must have no family other than a spouse in order to treat his or her wages as qualified wages. Members of Congress have voiced their disagreement with this guidance. It is possible the IRS will revise their position regarding related individuals in future guidance.

Alternative Quarter Election for Calendar Quarters in 2021

The Treasury Department and the IRS have been asked whether an eligible employer must consistently use the alternative quarter election once it has been made. The Notice 2021-49 confirms that employers are not required to use the alternative quarter election consistently. For example, an employer may be an eligible employer due to a decline in gross receipts for the second quarter of 2021 using the standard quarter comparison; the employer could then use the alternative quarter election to be an eligible employer for the third quarter of 2021.

Gross Receipts Safe Harbor in Notice 2021-20

Notice 2021-49 confirms that the safe harbor rule that allows an employer to include the gross receipts of an acquired business that it did not own during a calendar quarter in 2019 continues to apply to employers that acquire businesses in 2021 for purposes of measuring whether there was a decline in gross receipts. In addition, an employer that came into existence in 2020 (e.g., the third quarter of 2020) should use that quarter to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2021 and should determine whether it experienced a significant decline in gross receipts by comparing the fourth quarter of 2020 to the fourth quarter of 2021.


Guidance provided in Notice 2021-49 has created several opportunities for certain employers to obtain additional ERCs. For example, some restaurant employers may not have included cash tips as qualified wages for their previous ERC claims. Under the notice, those employers can now file amended returns to claim additional ERCs or employers who did not count amounts paid to full-time equivalent employees as qualified wages for the ERC may now do so. Revenue Procedure 2021-33 has also created an opportunity for certain employers that received PPP loan forgiveness, shuttered venue operator grant or restaurant revitalization grant to obtain additional ERC. Employers should review the contents of the notice and the revenue procedure with their tax advisor to determine if additional ERCs may be available, and if so, employers may file Form 941-X to request the additional credit or refund.


Employers should also determine if they may have claimed more ERC than they were entitled to based on the guidance in Notice 2021-49. For example, some small business owners may not have applied the ownership attribution rules correctly. If necessary, Form 941-X may be filed to correct the error. According to the notice, the IRS will not assess penalties for failure to timely pay or deposit tax if the taxpayer can show reasonable cause and not willful neglect for the failure.

H.R. 3684, the Infrastructure Investment and Jobs Act, proposes to end the ERC on September 30, 2021 rather than December 31 (but recovery startup businesses would remain eligible through year-end). That provision may or may not be included in the infrastructure bill that is eventually signed into law (which is expected in the next month or so).

We continue to monitor pending legislation related to the ERC. Feel free to reach out to us with any questions. You can also visit our COVID-19 Resource Center.

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