Tips Permitted 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 increased 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.
 

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.

BDO Insight:

The inclusion of tips as wages eligible for the ERC is expected to create considerable additional credits for restaurants with tipped employees. Although this new guidance is applicable to the ERC in both 2020 and 2021, it will likely have the greatest impact on 2021 credits, since changes to the “large employer” threshold, discussed below, substantially increased the number of restaurants that can claim the ERC for all wages paid to employees. Restaurants with 500 or less FTEs that have tipped employees and that otherwise are eligible for the ERC are encouraged to consider claiming ERC credits for quarters 1 and 2 of 2021.

Restaurants that have already claimed ERC credits without including tips should consider filing Form 941-X for any quarter in which the inclusion of tips would result in additional credits. Restaurants that previously filed Form 941-X to claim the ERC without tips can file a second Form 941-X for the same quarter. To avoid confusion, restaurants that want to file a second Form 941-X to include tips should wait until receipt of the refund from the first Form 941-X.

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.

BDO Insight:

Unlike salaries paid to employees, tips left by customers are not included in salary and wage expenses on a restaurant’s business income tax return. This could lead to the favorable interpretation that the portion of a restaurant’s ERC attributable to using tips as qualified wages does not need to be included in the restaurant’s wage disallowance. Practitioners and restaurants alike welcome expanded IRS guidance, including examples, on this important topic.

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. 

BDO Insight:

Confirmation that FTEs, rather than FTEEs, are used in the determination of large employer status is advantageous for the restaurant industry, which typically employs a large number of part-time employees. Omitting part-time employees from the large employer computation will result in more restaurants having 500 or less FTEs and therefore that are able to claim the ERC for all wages paid to employees in 2021 (assuming the restaurants are otherwise eligible for the ERC). 

An employee’s status as an FTE is used solely to determine whether an employer has 500 or more employees. Once this determination is made, an employee’s full or part-time status becomes meaningless. Wages paid to both full-time and part-time employees can be used to compute the ERC according to the applicable rules based on whether the employer is considered a large employer.
 

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.

This article originally appeared in BDO USA, LLP’s “Selections” Blog (August 10, 2021). Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com