Victory for Restaurants: IRS Permits Tips to be Treated as Qualifying Wages for the Employee Retention Credit

By now, most restaurant operators are familiar with the Employee Retention Credit (ERC). As we discussed in a previous blog post, the ERC is a fully refundable payroll tax credit designed to encourage businesses to retain and compensate employees during periods in which businesses are not fully operational. 
 
The ERC was enhanced considerably for the 2021 tax year. Among the enhancements made were increases to the maximum creditable wages per employee (from $10,000 per year to $10,000 per quarter) and to the credit (from 50% of eligible wages to 70% of eligible wages). These enhancements are applicable for the remainder of 2021.
 
Perhaps the 2021 enhancement with the greatest impact was the change in the threshold to be considered a “large employer” from 100 full time employees (FTEs) to 500 FTEs (using 2019 headcounts). This favorable change broadened the number of restaurants that were considered small enough to claim the ERC for all wages paid to employees and resulted in a sizable uptick in the number of restaurants that filed claims for ERC credits for quarters beginning January 1, 2021.
 
Despite these welcome changes, important questions remained regarding the computation of the ERC for restaurants. Topping this list was the question of whether tips count as wages for purposes of computing the ERC. The IRS put this issue to bed in Notice 2021-49. While the notice contains guidance on a variety of topics, this blog will focus solely on three topics that are most relevant to restaurants.
 
Read on to learn more…
 

Quick bites: 3 things restaurants need to know about Notice 2021-49

Tips count as eligible wages

Notice 2021-49 is a home run for the restaurant industry, as it confirms the IRS’ position that any cash tips* reportable for payroll tax purposes are treated as wages eligible for 2020 and 2021 ERCs (provided all other requirements are met).  An employee’s tips are reportable for payroll tax purposes to the extent they exceed $20 in a calendar month.

*The term “cash tips” includes credit card tips.

The same tips can be used for the computation of both the ERC and FICA credit

Notice 2021-49 specifically states that eligible employers “are not prevented from receiving both the ERC and the IRC Section 45B credit for the same wages.” This guidance, effective for both 2020 and 2021 ERCs, is welcome news for the restaurant industry, which is the primary beneficiary of the 45B credit.

As a reminder, taxpayers that claim the ERC and the FICA credit must forego tax deductions for the amounts that give rise to these credits. In the case of the ERC, this means foregoing a tax deduction for the amount of qualified wages (including qualified health plan expenses) equal to the ERC. In the case of the FICA credit, the deduction for payroll tax is reduced by the amount claimed as a FICA credit.

Notice 2021-49 sets forth the IRS’ position that when a taxpayer claims the ERC, the qualifying wages deduction disallowance should be made in the same year that the wages were paid or incurred. As a result of this language, restaurants that amend tax year 2020 Form 941 filings to claim the ERC may also need to amend their 2020 business income tax returns to reflect the appropriate amount of wage disallowance.

The determination of “large employer” status is made using FTE counts, not FTEE (full-time equivalents)

The determination of whether a restaurant is a large employer for purposes of the ERC is critical to the credit’s computation.
 
Eligible restaurants that are large employers can only claim the ERC for wages paid to employees for the time they are not providing services. This aligns with the purpose of the ERC, which is to encourage employers to retain and compensate employees during periods in which businesses are not fully operational. Smaller eligible restaurants, on the other hand, can claim a credit for all wages paid to employees.
 
Notice 2021-49 confirms that large employer status is determined by counting the average number of FTEs (rather than FTEEs) employed during 2019. For this purpose, FTE means an employee who, with respect to any calendar month in 2019, worked an average of at least 30 hours per week or 130 hours in the month. This guidance is effective for tax year 2020 and 2021 credits. 

Small tastes: Other guidance provided by Notice 2021-49

Notice 2021-49 contains guidance on various other topics that are beyond the scope of this article, including:
  • Clarification of the “related individual” rules used to determine whether wages paid to certain owners and their spouses can be treated as qualified wages for purposes of the ERC.
  • Clarification of the rules applicable to Recovery Startup Businesses.
BDO’s team of experts can help you compute and maximize your ERC. Don’t hesitate to reach out to Lisa Haffer for more information.

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