IRS Guidance on Employee Retention Credit Requires Employers to Pay Back Advances in Full

Author: Rena Pirsos, Brightmine Legal Editor

December 9, 2021

After the Biden Infrastructure law ended the Employee Retention Credit (ERC) early for most employers, the ERC remains applicable only to wages an employer paid to employees before October 1, 2021, unless the employer is a recovery startup business. The early repeal of the ERC, therefore, left most employers vulnerable to potential penalties.

This week, the IRS issued Notice Notice 2021-65 providing penalty relief to employers that received advance payments of the ERC, or reduced their payroll tax deposits in anticipation of claiming the ERC for the fourth quarter of 2021 but that are now ineligible to claim the credit. The Notice also provides guidance about the rules that apply to recovery startup businesses for the fourth quarter of 2021.

Paying Back ERC Advances

An advance payment of any portion of the ERC received by an employer in excess of the amount to which the employer is entitled is an erroneous refund that the employer must repay. An employer could receive an advance of the ERC in anticipation of claiming the credit on their quarterly Form 941 by either:

  • Filing Form 7200; or
  • Reducing its payroll tax deposits.

According to the Notice, an employer that filed Form 7200 must pay back the full amount of the advance received by the time the fourth-quarter Form 941 is due - January 31, 2022. An employer that fails to repay the advance by that date may be subject to failure-to-pay penalties.

However, the IRS will waive failure-to-deposit penalties for an employer that reduced its payroll tax deposits in anticipation of the ERC before December 20, 2021, but only if the employer:

  • Reduced its deposits in anticipation of the ERC for the fourth quarter of 2021;
  • In accordance with its payroll tax deposit schedule, deposits the full amounts initially retained in anticipation of the ERC by the deposit date for wages paid on December 31, 2021, regardless of whether the employer actually pays wages on that date; and
  • Reports the tax liability resulting from the ERC's termination on its fourth-quarter Form 941.

The Notice also provides that the next-day deposit rule applies to an employer that retained $100,000 or more in anticipation of the ERC. For wages paid on December 31, 2021, the next-day deposit would be due on January 3, 2022.

An employer that receives a penalty notice from the IRS, but that does not qualify for the relief provided by Notice 2021-65, may reply to the IRS with an explanation and the agency will consider whether the employer qualifies for reasonable cause penalty relief.

Recovery Startup Businesses

Generally, a recovery startup business is a business that began operating after February 15, 2020 (i.e., it began to function as a going concern and performed the activities for which it is organized), and its average annual gross receipts did not exceed $1 million.

Before the Infrastructure law, a special rule applied to recovery startup businesses that allowed them to claim the ERC even if they did not experience the required full or partial suspension of operations or a decline in gross receipts.

The Infrastructure law, however, eliminated this special rule for the fourth quarter of 2021. As a result, the rule no longer applies to recovery startup businesses in the fourth quarter of 2021. Therefore, recovery startup businesses must meet the ERC's requirement of full or partial suspension of operations or a decline in gross receipts in order to claim the credit on their fourth quarter Forms 941.