IRS Helps Taxpayers Avoid Tax Penalties Caused by Retroactive Termination Of Employee Retention Credit

December 9, 2021

The Employee Retention Credit (the “ERC”) was created by the CARES Act to encourage businesses to retain employees on their payroll by providing a refundable tax credit equal to 50% of qualified wages.  This credit was initially available for wages paid between March 12, 2020, and January 1, 2021. Subsequent Acts extended the availability of these credits until January 1, 2022.  However, the Infrastructure Investment and Jobs Act, which was enacted on November 15th, retroactively terminated the ERC as of October 1, 2021. This retroactive termination applies to all employers except employers of a recovery startup business.

Employers (other than employers of a recovery startup business) who relied on the ERC for wages paid after September 30, 2021, were left in a lurch. By November 15th, many eligible employers had already received advance payments of the ERC or reduced employment tax deposits in anticipation of the credit for the 4th quarter of 2021. As of result of the retroactive termination, these employers will be subject to tax penalties for failure to pay/deposit their employment taxes. Earlier this week, the IRS offered up leniency to these employers by issuing guidance to avoid these tax penalties. 

Repayment of Advance Payments for the ERC.

The IRS provided that employers that received advance payments of the ERC for wages paid in the 4th quarter of 2021 will avoid tax penalties if such employers repay those amounts by the due date of their applicable employment tax returns. 

Safe Harbor for Reduced Employment Tax Deposits.

Further, the IRS provided that for employment tax deposits due on or before December 20, 2021, for wages paid between October 1, 2021, and January 1, 2022, an employer will not be subject to the failure to deposit penalty if:

  1. The employer reduced its deposits in anticipation of the ERC consistent with Notice 2021-24;
  2. The employer deposits the amounts initially retained in anticipation of the ERC on or before the relevant due date for wages paid on December 31, 2021; and
  3. 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 October 1, 2021, through December 31, 2021.

Employers that do not qualify for this safe harbor relief and receive a notice of penalty should respond to the notice of penalty with an explanation of why they failed to deposit employment tax.  The IRS indicated that it will consider reasonable cause when determining penalty relief.  Of course, the IRS did not specify what explanations would qualify as reasonable cause. 

To take advantage of this guidance, employers are required to pay the amount of the expected ERC, an expense that was not included in their year-end budget.  Because the law was changed retroactive and the IRS did not issue guidance until the 2nd week of December, many employers will be scrambling to come up with the necessary funds to avoid the tax penalties.  Other employers will miss the deadlines due to other year-end obligations and still, others will simply be unaware of this change in the law because the law was changed retroactively.  Employers will be grateful for this leniency, but the timing could not have been worse. 

The information contained in this publication should not be construed as legal advice, is not a substitute for legal counsel, and should not be relied on as such. For legal advice or answers to specific questions, please contact one of our attorneys.