The IRS's Notice 2021-20 provides comprehensive guidance about the Employee Retention Credit (ERC) for 2020 (but not for the 2021 ERC) but imposes a harsh rule that treats similarly situated businesses differently. The IRS distinguishes between businesses based on whether the business submitted Paycheck Protection Program (PPP) loan forgiveness applications that included surplus forgivable nonpayroll costs, including nonpayroll costs that became forgivable after the borrower submitted its PPP loan forgiveness application because of retroactive changes to the PPP. Under Notice 2021-20, the IRS will deny a business the benefit of claiming ERC for otherwise qualified wages merely because the business elected not to list actual forgivable nonpayroll costs on its forgiveness application, even if it could not have done so under the rules at the time the business submitted the forgiveness application. This manifestly unfair rule should not survive a court challenge, but for now, the guidance has created a needless trap for the unwary.


The CARES Act, as originally enacted, did not allow businesses that received a PPP loan to claim the ERC. As we previously discussed, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Relief Act) included in the Consolidated Authorizations Act, 2021, retroactively removed this restriction. The Disaster Relief Act also retroactively added four new categories of expenses that result in PPP loan forgiveness (operations expenditures,1 property damage costs, supplier costs and worker protection expenditures) to the four original costs that result in PPP loan forgiveness (payroll costs, mortgage interest, rent and utilities). Accordingly, PPP borrowers can obtain PPP loan forgiveness for payroll costs and seven types of nonpayroll costs.

In retroactively allowing PPP borrowers to claim the ERC, Congress included a "no double-dipping" rule that prevents businesses from using the same payroll costs to obtain PPP loan forgiveness and an ERC. This makes sense because employers should not receive a tax credit based on an amount paid for with proceeds from a forgiven loan. Unfortunately, although the no double-dipping rule makes sense in theory, the application by the IRS is seriously problematic.

Ultimately, the question becomes how one determines whether the same payroll costs are used twice - whether this is based on actual expenses paid by the PPP borrower or only the expenses listed on the PPP loan forgiveness application. Because 75 percent of a PPP loan covered eight weeks of payroll costs at pre-pandemic levels, many PPP borrowers could obtain full PPP loan forgiveness based on only payroll costs once Congress extended the covered period for incurring forgivable costs to 24 weeks. Many PPP borrowers decided not to expend the time and resources necessary to calculate forgivable nonpayroll costs - a perfectly reasonable decision in light of the time and attention needed to keep operating during a pandemic. Further, many PPP borrowers, eager for the certainty that comes with PPP loan forgiveness, submitted their PPP loan forgiveness applications in 2020, before Congress passed the Disaster Relief Act. These borrowers never had a chance to list the four new expenditures retroactively added by the Disaster Relief Act.

IRS's Harsh No Double-Dipping Rule - ERC and PPP

To implement the no double-dipping rule, the Disaster Relief Act provides that ERC-eligible wages do not include amounts that a PPP borrower elects to exclude, pursuant to rules determined by the IRS. We refer to this as the "Election." In Q/A 49 of Notice 2021-20 (and again in Q/A 56), the IRS provides these rules and deems PPP borrowers to have made the Election based on the costs listed in the PPP loan forgiveness application, rather than actual costs.

Q/A 57 provides several examples demonstrating that, for ERC purposes, PPP borrowers are bound by the forgivable costs listed on the PPP loan forgiveness application, even if the PPP borrower had unreported nonpayroll costs. These include: 

  • Example 2: which clarifies that the employer can obtain an ERC for listed payroll costs in excess of the PPP. In the example, the employer received a PPP loan of $200,000 and listed $250,000 of payroll costs. The example does not discuss nonpayroll costs. The IRS deems the employer to have made the Election for $200,000 of the $250,000 of listed payroll costs. The IRS also confirms that the employer has $50,000 of eligible wages for ERC purposes.
  • Examples 3 and 4: which confirm that the employer cannot use unlisted nonpayroll costs to "free up" payroll costs. In the examples, the employer received a PPP loan of $200,000 and paid $200,000 of payroll costs and $70,000 of nonpayroll costs. In Example 3, the employer only listed the $200,000 of payroll costs on the PPP loan forgiveness application. The IRS deems the employer to have made the Election for all $200,000 of payroll costs so that the employer has no eligible wages for ERC purposes. In Example 4, however, the employer listed both the $200,000 of payroll costs and the $70,000 of nonpayroll costs on the PPP loan forgiveness application. The IRS deems the employer to have made the Election only for $130,000 of the wages. Thus, the employer in example 4 has $70,000 of eligible wages for ERC purposes.

On the one hand, the IRS position makes us look good because we have encouraged our clients to list all covered expenses when applying for forgiveness - just in case. On the other hand, the IRS has created a trap for the unwary without a good policy reason to do so. Indeed, basing the deemed Election on amounts listed on the PPP loan forgiveness application strikes us as particularly unfair, especially in light of a program that Congress keeps changing retroactively. Further, it contradicts general tax practices. For example, when the IRS audits an income tax return, it allows deductions not claimed on the original return to offset adjustments made by the IRS. As we previously discussed, businesses successfully challenged the Small Business Administration when it took aggressive and unfair positions with respect to the PPP. We believe courts would do the same to the IRS if someone challenges the deemed Election rules of Notice 2021-20.


1 This only applies to "a payment for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses." It thus does not cover most expenditures for "operations," based on the normal usage of the word, making this a poorly-defined term. It would have been clearer if Congress used the term "software/cloud computing expenditures."   

Originally published April 5, 2021

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