Early sunset of the employee retention credit gets penalty relief

By Paul Bonner

Employers that received an advance payment of the employee retention credit (ERC) or reduced their employment tax deposits in anticipation of receiving the ERC for the fourth calendar quarter of 2021 may repay or deposit the taxes without penalty under guidance issued Monday by the IRS (Notice 2021-65).

The guidance became necessary when the ERC was terminated a quarter early by the enactment of the Infrastructure Investment and Jobs Act, P.L. 117-58, at the end of the third calendar quarter of 2021 (for employers other than recovery startup businesses under Sec. 3134(c)(2)).

Section 80604 of the Infrastructure Act amended Sec. 3134(n) to provide that the ERC under Sec. 3134 applies to wages paid after June 30, 2021, and before Oct. 1, 2021, or in the case of wages paid by an eligible employer that is a recovery startup business, Jan. 1, 2022. As originally enacted by the American Rescue Plan Act, P.L. 117-2, Dec. 31, 2021, was the end point for wages paid by all eligible employers.

An advance payment of any portion of the ERC in excess of the amount to which a taxpayer is entitled is an erroneous refund that the employer must repay and, but for Monday's notice, is subject to penalties for failure to pay the corresponding employment taxes. Employers that received such advance payments may repay them by the due date of their applicable employment tax return that includes the fourth calendar quarter of 2021 and so avoid failure-to-pay penalties.

Likewise, employers that reduced their deposits due with respect to wages paid on or after Oct. 1, 2021, but before Jan. 1, 2022, by the amount of an ERC they expected to claim (and are not recovery startup businesses) must deposit those taxes. They may have penalties waived for failing to deposit those taxes, but only with respect to deposits due before Dec. 20, 2021.

The IRS will not waive failure-to-deposit penalties for such reductions after Dec. 20, 2021.

The waiver of failure-to-deposit penalties is also subject to three other conditions:

  • The employer reduced its deposits in anticipation of the ERC, consistent with the rules provided in Section 3.b. of Notice 2021-24;
  • The employer deposits the amounts it had retained in anticipation of claiming the ERC on or before the relevant due date for employment taxes with respect to wages paid on Dec. 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 ERC on the applicable employment tax return or schedule that includes the period from Oct. 1, 2021, through Dec. 31, 2021.

For employers that do not qualify for relief, the IRS will consider reasonable cause relief if the employers reply to a notice about a penalty with an explanation.

In a letter to congressional tax-writing leaders on Oct. 26, before the enactment of the Infrastructure Act, the AICPA noted that sunsetting provisions in pending legislation like the Infrastructure Act causes confusion among employers and practitioners. If the legislation were enacted with the sunset of the ERC, the letter said, Congress should direct the IRS and Treasury to waive any penalties "and provide a reasonable, practical method" to pay the employment taxes due.

The IRS notice appears to provide the reasonable, practical guidance requested in the letter, its signer, Jan F. Lewis, CPA, chair of the AICPA Tax Executive Committee and a tax partner with Haddox Reid Eubank Betts PLLC, said Monday.

"We are relieved and appreciate the IRS's quick response," Lewis said. "It gives clarity as to how taxpayers should pay back the taxes and avoid penalties."

Paul Bonner (Paul.Bonner@aicpa-cima.com) is a Tax Adviser senior editor.

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