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New IRS Guidance Offers Tax Windfall to Employers With Part-Time Workers

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What You Need to Know

  • The IRS provides a substantial tax benefit for employers that rely heavily on part-time staff yet have relatively few full-time workers.
  • A full-time equivalent employee is defined based on the employee's scheduled work hours divided by the employer's hours for a full-time workweek.
  • Employers are not required to include full-time equivalent employees when determining their average number of full-time workers.

Even as it remains uncertain whether the employee retention tax credit (ERTC) will survive to the end of 2021, the IRS has continued to release guidance that employers can use to claim the tax credit in the third and fourth quarters of 2021.

In the most recent guidance, the IRS provided a substantial benefit for employers that rely heavily on part-time workers yet have relatively few full-time employees.

The Affordable Care Act (ACA) created the concept of the “full-time equivalent” (FTE) employee, which subjected many larger employers with part-time workers to the ACA employer mandate. The IRS recently confirmed that this concept does not extend to the ERTC — meaning that small-business clients that do exceed the threshold for obtaining “large business” status based on FTEs, but not based on full-time employees, should reevaluate their credit eligibility for 2021.

Employee Retention Tax Credit Basics

Initially, the ERTC created a refundable tax credit designed to help employers that retained employees during the COVID-19 health crisis. The credit, taken against employment taxes, was equal to 50% of the first $10,000 of “qualified wages” paid to the employee in 2020 and 70% of the first $10,000 in quarterly qualified wages paid in 2021.

The definition of “qualified wages” depended upon whether the employer was classified as a large or small employer. Large employers were originally defined as those with more than 100 “employees,” but for 2021, the large employer rules apply only to those with more than 500 employees under the Consolidated Appropriations Act of 2021. 

If the employer was classified as a small employer, the amount of credit-eligible qualified wages includes wages paid during a quarter when COVID-19 affected the business. That included situations where the employees continue to provide services for payment in the relevant period and when employees are paid, but not working. Businesses with 500 or fewer employees also have the option of advancing the credit at any point in the quarter, and the credit is estimated based on 70% of the average quarterly wages the employer paid in 2019. 

For large employers, the wages counted toward the credit include only those paid while the employee was not working for the employer because of a government order or decline in gross receipts.

Notice 2021-49 Guidance on Part-Time Workers

Since the ERTC was created, there’s been confusion over whether the relevant number of 2019 employees included FTEs or only full-time employees. The definition of FTE is based on the employee’s scheduled work hours divided by the employer’s number of hours for a full-time workweek.

For example, if the employer uses a 40-hour workweek, each employee scheduled to work 40 hours a week counts as 1.0 FTE. An employee scheduled to work half that time, or 20 hours per week, counts as a 0.5 FTE.

Notice 2021-49 clarifies the issue when it comes to claiming the 2021 ERTC. 

In a somewhat surprising move, the IRS announced that for purposes of determining whether a credit-eligible employer is a large employer or a small employer, employers are not required to include full-time equivalent employees when determining their average number of full-time employees. 

Therefore, if the business had fewer than 100 employees (for 2020 purposes) or 500 employees (for 2021 credit purposes) during the 2019 tax year, it will be treated as a small employer when claiming the ERTC. In other words, the employer can take the credit with respect to wages paid to employees who have continued working.

For purposes of identifying qualified wages, an employee’s status as a full-time employee is irrelevant. Wages paid to a part-time employee may be treated as qualified wages if all other ERTC claiming requirements are satisfied. Further, any cash tips treated as wages within the definition of IRC Section 3121(a) or compensation within the definition of IRC Section 3231(e)(3) are treated as qualified wages if all other ERTC claiming requirements are satisfied. 

Additionally, according to IRS reasoning, eligible employers are not prevented from receiving both the employee retention credit and the Section 45B credit for the same wages because the CARES Act and subsequent legislation do not reference Section 45B in areas where a “no double dipping” rule applies.

Conclusion

This has been a gray area for employers since the ERTC was created in 2020. But unless Congress acts to reverse the new rule, the taxpayer-friendly IRS guidance can provide a powerful tax break for small-business clients that rely heavily on part-time workers.

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