In the third quarter of 2020, the restaurant/deli operated by the client was subject to a mandatory administrative order issued by the state government, limiting occupancy to 50%. Does this situation constitute a "partial suspension" within the meaning of the Internal Revenue Code, thereby qualifying the employer to claim the Employee Retention Credit (ERC) on an amended Form 941 (Employer's Quarterly Federal Tax Return)? If eligible, for employees who are primarily waitstaff—who both report tip income and receive base wages—should the tip portion be included in qualified wages for which the credit can be claimed? The following provides an analysis based on key rules.

I. Core Standards for Determining Partial Suspension

Under the CARES Act of 2020 and subsequent amended guidance, the Employee Retention Credit applies to employers whose operations have beenfully or partially suspendeddue to orders from a governmental authority (such as restrictions on business operations, travel, or group meetings). The key determination for partial suspension is whether the government order has amore than nominal effecton the employer's ability to operate, and whether that effect is directly related to the order.

For the food service industry, a state-mandated 50% occupancy limit is generally considered a substantial reduction in a restaurant's capacity—because seating capacity directly determines the number of customers that can be served, thereby affecting revenue and staffing needs. However, it should be noted that if the restaurant was still able to maintain a "significant portion of normal operations" during the restriction period through delivery, takeout, or outdoor seating, it may not be deemed partially suspended. Therefore, it is recommended that the client retain copies of government orders, daily occupancy records, and revenue comparison data to demonstrate the actual impact of the restrictions.

II. Scope of Qualified Wages: Whether Tips Are Included

If a partial suspension is established, qualified wages generally refer to compensation paid by the employer to employees during the suspension period that has not been used to claim other wage credits (such as the paid family leave credit). According to IRS Notice 2020-22 and the Form 941 instructions,tip income is generally not included in qualified wagesunless the tips are "reported tips" controlled by the employer and the employer has paid the corresponding employer share of Social Security tax on them.

In restaurant industry practice, tips reported by waitstaff (e.g., via IRS Form 4070) are included in total wages for FICA tax calculation, but the definition of qualified wages for the ERC references the concept of "wages" under the Federal Unemployment Tax Act (FUTA), and FUTA wages explicitly exclude tips. Therefore, even if employees report tips on Form 941, that portion generallycannotbe claimed as qualified wages for the credit. Only base wages, hourly pay, or fixed salaries directly paid by the employer, subject to the per-employee cap of $10,000 per quarter (applicable for 2020), may be included in the calculation.

III. Operational Recommendations and Considerations

  • Documentation Retention: Organize state government orders, operational logs, seating capacity adjustment records, and financial statements for IRS review.
  • Wage Classification: Distinguish between "base wages" and "tip income" in the payroll system, using only the former for ERC calculations.
  • Amended Filing: If the original Form 941 has already been filed, use the amended Form 941-X to make a retroactive claim, and be mindful of the 3-year statute of limitations.
  • Related Rules: If the employer also applied for Paycheck Protection Program (PPP) loan forgiveness, ensure that the same wages are not claimed for both credits.

IV. Conclusion

In summary, the state's 50% occupancy limit likely constitutes a partial suspension, but this must be determined based on specific operational facts. Tip income generally does not meet the definition of qualified wages, except in rare circumstances (such as when the employer has paid additional tax on tips and the IRS has explicitly recognized it). It is recommended that the client consult with a tax professional and carefully file the amended Form 941 based on complete payroll records and evidence of the suspension.