Large or Small
When the COVID-19 related Employee Retention Credit (ERC) was originally enacted in the CARES Act, Congress instituted a significant difference between the treatment of a large or small eligible employer. Eligible employers are entitled to a credit based on a percentage of qualified wages. Qualified wages of large eligible employers are limited to just those wages paid to employees for time that employees were not providing services due to either (1) a full or partial suspension of the employer’s business operations due to a governmental order, or (2) the business experiencing a significant decline in gross receipts (see Notice 2021-20 Q/A 30). Qualified wages for small eligible employers, however, include all taxable wages for all employees during the period in which the employer is considered an eligible employer.
The ERC definition of a large employer is different for 2020 than 2021. While in 2020, an employer is considered large if they averaged more than 100 full-time employees during 2019, in 2021, they are large if they averaged more than 500 full-time employees during 2019.
How are the average number of full-time employees during 2019 calculated for purposes of the ERC? The CARES Act (Section 2301(c)(3)(A)(i)) stipulates: “…in the case of an eligible employer for which the average number of full-time employees (within the meaning of section 4980H of the Internal Revenue Code of 1986 [emphasis added]) employed by such eligible employer during 2019 was greater than 100…” The IRS provides step-by-step instructions for making this determination in Notice 2021-20 Q/A 31:
Question 31: How does an eligible employer identify the average number of fulltime employees employed during 2019? Answer 31: The term “full-time employee” means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month (130 hours of service in a month is treated as the monthly equivalent of at least 30 hours of service per week), as determined in accordance with section 4980H of the Code. An employer that operated its business for the entire 2019 calendar year determines the number of its full-time employees by taking the sum of the number of full-time employees in each calendar month in 2019 and dividing that number by 12.
Additional instructions are provided for employers who were not in existence for all of 2019. The same process is to be followed when counting whether an employer had more than 500 full-time employees in 2019 to determine if they are considered a “2021 large employer.”
Section 4980H of the Code was enacted as part of the Affordable Care Act (ACA), and the section specifically deals with the determination of whether employers are considered “Applicable Large Employers” (ALEs) required to offer full-time employees minimal essential coverage, as defined in section 5000A(f) of the Code. 4980H includes two independent questions concerning full-time employees. First, is an employer considered an ALE? Second, which employees of an ALE are considered full-time and therefore must be offered medical coverage? Regarding these two questions, the section includes two independent definitions of full-time employee:
4980H(c)(2)(E): Full-time equivalents treated as full-time employees. Solely for purposes of determining whether an employer is an applicable large employer under this paragraph, an employer shall, in addition to the number of full-time employees for any month otherwise determined, include for such month a number of full-time employees determined by dividing the aggregate number of hours of service of employees who are not full-time employees for the month by 120.
4980H(c)(4): Full-time employee. (A) In general, The term “full-time employee” means, with respect to any month, an employee who is employed on average at least 30 hours of service per week.
Are employers required to count “full-time equivalents,” (i.e., combining the hours of part-time employees, each of whom individually is not a full-time employee, but who in combination count as one or more full-time employees), when determining if they are a large eligible employer for ERC? The CARES Act legislation doesn’t specify which of these definitions it is referring to when it says, “full-time employees (within the meaning of section 4980H).” IRS Notice 2021-20 isn’t specific either, except that it instructs employers to count employees as full-time for each month the employee had an average of at least 30 hours of service per week, which is consistent with the second definition.
However, the Joint Committee on Taxation in their report, “Description of the Tax Provisions of Public Law 116-136, The Coronavirus Aid, Relief, and Economic Security (‘CARES’) Act,” April 22, 2020, says in footnote 145:
The provision states that the metric is the “average number of full-time employees (within the meaning of section 4980H of the Internal Revenue Code of 1986).” This language includes full-time equivalents as referred to in section 4980H(c)(2)(E), which reads as follows: [see the code section quoted above].
The JCT is an authoritative source of Congressional intent, but the IRS is ultimately responsible for the implementation of the law. To that end, the IRS clarified its position in Notice 2021-23, footnote 3 (emphasis added):
In accordance with section 4980H(c)(4) of the Code and as provided by Notice 2021-20, the term “full-time employee” for purposes of the employee retention credit means an employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month (130 hours of service in a month is treated as the monthly equivalent of at least 30 hours of service per week).
Reference to subsection 4980H(c)(4) specifically points to the full-time employee definition that does not include full-time equivalents. This was apparently still not sufficiently clear, because the IRS once again – and definitively – returned to the question in Notice 2021-49 (emphasis added):
The Treasury Department and the IRS have been asked about the definition of “full-time employee” for the purpose of the employee retention credit, including (i) whether “full-time equivalents” (within the meaning of section 4980H(c)(2)(E) of the Code) are required to be included in the determination of whether an eligible employer is a large eligible employer or small eligible employer and (ii) whether wages paid to employees who are not full-time employees may be treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied. For purposes of determining whether an eligible employer is a large eligible employer or a small eligible employer, eligible employers are not required to include full-time equivalents when determining the average number of full-time employees. However, for purposes of identifying qualified wages, an employee’s status as a full-time employee is irrelevant and wages paid to an employee who is not full-time may be treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied.
Based on this IRS guidance, full-time equivalents should not be included in the 2019 full-time employee count when determining whether an eligible employer is large or small for purposes of ERC.
ACA Counting Methods
The next challenge is understanding the complex question of counting full-time employees in the context of Section 4980H, the ACA.
As alluded to in the two definitions of full-time employees in 4980H, there are two steps: (1) is the employer an ALE? (2) If yes, determining which employees must be offered coverage. When answering the first question, full-time equivalent employees must be included in the calculation. For the second question, ALEs then have more than one option for counting full-time employees that must be offered coverage.
Again, section 4980H(c)(4)(A) states “the term ‘full-time employee’ means, with respect to any month, an employee who is employed on average at least 30 hours of service per week.” The Code goes on to “define” the term “hours of service” by stating “The Secretary, in consultation with the Secretary of Labor, shall prescribe such regulations, rules, and guidance as may be necessary to determine the hours of service of an employee….” We then must look to the regulations to discover the rules for determining “hours of service” and, consequently, status as a “full-time employee”.
This exercise is dealt with at great length in federal regulations (26 CFR § 54.4980H-3), and somewhat simplified in an IRS FAQ. According to answer 20 in that FAQ:
There are two methods for determining whether an employee is a full-time employee:
- Monthly measurement method: Under the monthly measurement method, an employer determines whether an employee is a full-time employee by counting the employee’s hours of service for each month.
- Look-back measurement method: Under the look-back measurement method, an employer determines whether an employee is a full-time employee for a future period (referred to as the stability period), based upon the employee’s hours of service in a prior period (referred to as the measurement period). The look-back measurement method for identifying full-time employees is available only for purposes of determining and computing liability for an employer shared responsibility payment, and not for purposes of determining if the employer is an ALE. The look-back measurement method provides special rules that apply in various circumstances, such as for variable-hour employees, seasonal employees, and employees of educational organizations.
When the IRS Notices for ERC recommend counting employees who worked an average of 30 hours per week or 130 hours per month in 2019, they are simply providing an example of the monthly measurement period. Experian Employer Services has confirmed with the IRS that this does not mean to exclude any other valid method of counting full-time employees allowed under Section 4980H and its regulations. Furthermore, there is no requirement within the ERC to employ a consistent methodology to that used for ACA compliance. The CARES Act and subsequent legislation simply point to 4980H as the source for counting full-time employees, and therefore any method acceptable under 4980H may be used in determining ERC employer size.
Applicable Large Employers must file an IRS information return Form 1094-C annually. Part III of this form includes a monthly count of full-time employees, as defined by Section 4980H(c)(4). The 2019 form, therefore, may be an excellent source for documenting an employer’s size for the ERC. However, employers should make sure that the full-time employee calculations were performed accurately on that form and be aware that an alternative calculation method might yield a more favorable ERC outcome.
Of course, it is critical to remember that ERC’s aggregation rules apply to the employer size determination. Full-time employees of all entities treated as a single employer under sections 52(a), 52(b), 414(m) or 414(o) of the Code must be added together to make the determination. When looking at the 2019 Form 1094-C, other entities within the aggregated group are called “ALE Members,” and should be listed in Part IV. By compiling the Forms 1094-C for all ALE Members and adding the full-time employees indicated on Part III of each form, an employer may be able, given the caveats discussed above, to determine their ERC employer size.
Experian Employer Services tax credits experts can help businesses better understand their eligibility to maximize their ERC when claiming this credit.