Key takeaways
- The employee retention credit (ERC) expired in the fourth quarter of 2021, but employers have one to two more years to file amended returns if they qualify.
- Both the ERC and R&D credits can be claimed in the same quarter. Just make sure you understand the timing and ordering rules.
- Many businesses and practitioners were confused when the ERC and R&D ordering rules changed in mid-2021.
Ever since the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, was enacted in March 2020, there's been plenty of confusion about the ERC. As most readers know, the ERC was intended to provide relief for employers that faced direct economic hardship as a result of COVID-19. To qualify for the credit, a business must have suffered a significant decline in revenue or have faced a full or partial suspension under government orders. This included any actual closures, as well as restrictions on hours or capacity.
One misconception many businesses have is that it is no longer worth pursuing ERC credits since the ERC provision sunset in the fourth quarter of 2021. Not true. They still have until April 2024 to file the 2020 amended Forms 941, Employer's Quarterly Federal Tax Return, and until April 2025 to file the 2021 amended Forms 941.
ERC + R&D = opportunity + confusion
Buried within two pieces of IRS guidance on the ERC (Notices 2021-23 and 2021-49) was some verbiage about the interplay between the ERC and the widely used research and development (R&D) tax credit, among other credits. The intent was to prevent employers from double dipping on wages. Unfortunately, the guidance took one form for the first six months of 2021 and then changed shape for the second half of 2021. That's right, the rules for these heavily used and much talked about credits were changed dramatically midyear, as described in more detail next.
Claiming R&D credits along with the ERC
Notice 2021-23, which was released in the spring of 2021, explained that wages used in calculating the ERC could not also be used to calculate credits associated with other wage-based credits defined under Secs. 41, 45A, 45P, 45S, 51, 1396, 3131, and 3132. The initial guidance instructed businesses to assign qualifying wages to the ERC first and then use any leftover wages for R&D or other credits.
But, when Notice 2021-49 was released in the summer of 2021, the guidance reversed course for the third and fourth quarters of 2021. Rather than using wages first for the ERC, which is a more valuable credit, employers were suddenly expected to use wages for R&D (and other credits) first, and then apply any wages left over for the ERC. The net effect of that rule change was to shrink the taxpayer's benefit overall. Amazingly, nobody talked about the impact of these changes in Notice 2021-49 at the time it was introduced.
And when the new Form 6765, Credit for Increasing Research Activities, and its instructions were released, the interplay between the R&D credit and ERC in the third and fourth quarters was clearly different from the first two quarters of 2021. The guidance did not address how the rule change would affect qualified research expenses needed for inclusion in the base period calculation.
Here's why that's so important: In the first two quarters of 2021, if ERC wages were not eligible to be considered R&D wages, then it would seem these wages would not be qualified research expenses for the base period. In the second half of the year, it seems qualified research expenses would need to be used in the base period even if a taxpayer chose not to use those wages for R&D tax credit purposes.
To make matters even more confusing, a taxpayer may have claimed a third quarter 2021 ERC as early as October 2021. If this claim included wages for individuals who also performed R&D activities, would they need to go back and amend the ERC filing to reduce the eligible wages? More likely the taxpayer would consider ignoring those wages for R&D purposes since the ERC is a more valuable benefit than the R&D credit in this case.
The IRS needs to provide more guidance on treatment of wage-related credits to clear up the confusion.
In addition, this guidance came out after the third quarter ERCs were already being claimed. Taxpayers were claiming the ERC credit with wages that could have qualified as R&D. Based on that notice, taxpayers were led to believe they could not calculate their third quarter ERC until they knew what their R&D tax credit wages were. Again, that's because they were told they had to use R&D tax credit wages first.
Practitioners should keep in mind these potential issues involving the interplay between the ERC and the R&D credit.
— Randy Crabtree, CPA, co-founder and partner of Tri-Merit Specialty Tax Professionals, is an author, lecturer, and host of The Unique CPA podcast. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld at David.Strausfeld@aicpa-cima.com.
