IRS Provides Updated Guidance on Employee Retention Credit
May 7, 2020
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) included a provision under which employers that suffered economic hardship related to COVID-19 can take a tax credit for 50% of payroll costs of its employees. The amount of the credit is capped at $5,000 per employee. Not only can an employer receive this credit (known as the Employee Retention Credit – ERC) against its payroll taxes, including taxes withheld from its employees, but the credit is “refundable.” This means that the employer can receive money directly from the IRS if the credit amount for any quarter exceeds the employment taxes owed for that quarter.
On April 29, the IRS came out with additional guidance in the form of expanded Frequently Asked Questions (FAQs) addressing many of the ambiguities in this law.
What Employers May Claim the Credit?
Eligible Employers are any companies that carry on a trade or business during calendar year 2020, including a tax-exempt organization, if either of the following conditions apply:
- The employer “fully or partially suspended operation” during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19; OR
- The employer experienced a significant decline in gross receipts during the calendar quarter.
Self-employed persons cannot claim the credit with respect to amounts paid to themselves.
Parent-subsidiary and brother-sister companies are aggregated for purposes of applying the credit.
A major exception is that the credit is NOT available to any employer that receives a loan under the Payroll Protection Program (PPP).
Full or Partial Suspension of a Trade or Business
The operation of a trade or business will be considered partially suspended if an appropriate governmental authority imposes restrictions on its business operations by limiting commerce, travel or group meetings due to COVID-19 such that the operation can still continue to operate but “not at its normal capacity.”
Statements from a governmental official, including comments made during press conferences or in interviews with the media, do not rise to the level of a governmental order. Furthermore, the declaration of a state of emergency by a governmental authority is not in itself sufficient to rise to the level of a governmental order. If an employer’s workplace is closed by a governmental order, but the employer is able to continue operations comparable to its operations prior to the closure by requiring its employees to telework, the employer’s operations are not considered to have been fully or partially suspended as a consequence of a governmental order.
The FAQs have clarified that an employer that operates an essential business is not considered to have a full or partial suspension of operations if the governmental order allows the employer to remain open, even though the governmental order requiring non-essential businesses to close may have an effect on the employer’s operations. However, the FAQS recognize an exception – an employer with an essential business may be considered to have a full or partial suspension of operations if the business’ suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations. The same is not the case, however, with respect to the effect of a governmental shutdown on a business’ customers – an employer that operates an essential business that is not required to close its physical locations or otherwise suspend its operations is not considered to have a full or partial suspension of its operations for the sole reason that its customers are subject to a government order requiring them to stay at home.
Example – Partial Shutdown: A state governor issues an executive order closing all restaurants, bars, and similar establishments in the state in order to reduce the spread of COVID-19. However, the executive order allows those establishments to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis. This will qualify as a partial suspension of business operations due to governmental order with respect to any restaurants bars, and similar establishments in the state that provided full sit-down service, a dining room or other on-site eating facilities for customers prior to the executive order.
A significant decline in gross receipts begins with the first quarter in which an employer’s gross receipts for a calendar quarter in 2020 are less than 50% of its gross receipts for the same calendar quarter in 2019.
The significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter for which the employer’s 2020 gross receipts for the quarter are greater than 80% of its gross receipts for the same calendar quarter during 2019.
If a group of companies are aggregated, whether there has been a significant decline in gross receipts is tested on an aggregate basis. For example, if six companies having approximately the same gross receipts in the prior 2019 quarter were aggregated, with one company having had an 80% decline in gross receipts while the other 5 had no decline, the aggregated group would not qualify for the ERC.
The FAQs make it clear that there is no need to show that the decline in gross revenues was due to COVID-19 or a governmental order
Example – Decline in Gross Receipts: An employer’s gross receipts were $100,000, $190,000, and $230,000 in the first, second, and third calendar quarters of 2020, respectively. Its gross receipts were $210,000, $230,000, and $250,000 in the first, second, and third calendar quarters of 2019, respectively. Thus, the employer’s 2020 first, second, and third quarter gross receipts were approximately 48%, 83%, and 92% of its 2019 first, second, and third quarter gross receipts, respectively. Accordingly, the employer had a significant decline in gross receipts commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50% of the same quarter in 2019) and ending on the first day of the third calendar quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80% of the same quarter in 2019). Thus the employer is entitled to a retention credit with respect to the first and second calendar quarters.
The credit equals 50% of the qualified wages (including qualified health plan expenses) that an Eligible Employer pays in a calendar quarter. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000, so that the maximum credit for qualified wages paid to any employee is $5,000.
Example – Maximum Credit: Employer pays Employee B $8,000 in qualified wages in Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to the Employer for the qualified wages paid to Employee B is $4,000 in Q2 and $1,000 in Q3 due to the overall limit of $10,000 on qualified wages per employee for all calendar quarters.
The credit can be claimed for wages paid to employees after March 12, 2020, and before January 1, 2021. Qualified wages also include qualified health plan expenses that are properly allocable to the wages.
The employee payments that can be taken into account for the ERC are very different for employers with an average number of full-time equivalent employees (FTEs) in 2019 of more than 100 than for smaller employers. An FTE is an employee who, during 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.
For employers with 100 or fewer FTEs in 2019, all employee wages are eligible, even wages paid to employees who have not been prevented from providing services.
If the employer averaged more than 100 FTEs in 2019, qualified wages include only wages paid to an employee for time that the employee is not providing services due to either (1) a full or partial suspension of operations by government order or (2) a significant decline in gross receipts. For these employers, qualified wages taken into account for an employee may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
Example – Increased Hourly Pay: A grocery store chain employer that averaged more than 100 FTEs in 2019 is subject to a governmental order limiting store hours. In response, the employer reduces the hours each employee works, but in order to incentivize those employees who continue to provide services, the employer increases the employees’ rate of pay by $1 an hour. Only the amounts paid to employees for time they are not providing services, and at the rate of pay in effect prior to the increase, would be considered qualified wages.
Wages for which the employer received a credit for paid sick leave or paid family leave under the Families First Coronavirus Response Act (FFCRA) cannot be taken into account for the ERC.
Payments paid to employees that are related to the employer are not eligible for the credit. An individual will be treated as related to the employer if he or she, together with family members and other individuals deemed related under attribution rules, own more than 50% of the stock of a corporate employer or more than 50% of the equity or profits interests in a non-corporate entity employer.
Employer Paid Health Care Expenses
Subject to certain limitations, the amount of qualified health plan expenses is taken into account in determining the amount of qualified wages. This generally includes both the portion of the cost paid by the employer and the portion of the cost paid by the employee with pre-tax salary reduction contributions. However, the qualified health plan expenses do not include amounts that the employee paid for with after-tax contributions.
Although the FAQs have generally taken a practical, pro-taxpayer approach, one provision elicited immediate, strong criticism from business groups and legislators, who have stressed that the IRS’ position will discourage employers from continuing health care coverage for furloughed workers. The FAQs provide that generally, health plan expenses will be treated as wages for purposes of the ERC to the extent they are allocable to the hours for which the employees receive other qualified wages. If the employer lays off or furloughs its employees, paying them no wages, but continuing the employees’ health care coverage, the employer may not treat any portion of the health plan expenses as qualified wages for purposes of the ERC. If the employer pays a reduced amount of wages to its employees and continues health plan coverage, the treatment of health plan expenses for purposes of the ERC differs depending on whether the 100 FTE threshold is exceeded.
The FAQs provide the following four examples:
Example – No Wages Paid; Health Plan Expenses Not Allowed: In response to a governmental order that partially suspended its operation, Employer Z lays off or furloughs all of its employees. Employer Z does not pay any wages to its employees for the time they are laid off or furloughed but it continues the employees’ health care coverage. Employer Z may not treat any portion of its health plan expenses as qualified wages for purposes of the ERC.
Example – ≤100 FTEs; Reduced Hours; All Health Plan Expenses Allowed: Employer Y averaged ≤100 FTEs in 2019. In response to a governmental order that partially suspended its operation, Employer Y reduces all employees’ hours by 50%. Employer Y pays wages to the employees only for the time they are providing services but continues to provide the employees with full health plan coverage. Because all amounts paid to employees by an employer ≤100 FTEs are treated as qualified wages, all of Employer Y’s health plan expenses may be treated as qualified wages for purposes of the ERC.
Example – >100 FTEs; Reduced Hours; Health Plan Expenses Not Allowed: Employer B averaged more than 100 FTEs in 2019. In response to a governmental order partially suspending its business operation, Employer B reduces all employees’ hours to 50% and pays wages to its employees only for the time that the employees are providing services, but continues to provide the employees with full health plan coverage. Because qualified wages for employers with >100 FTEs do not include amounts paid to employees for the hours they are performing services and Employer B is, therefore, not paying any wages to its employees for time that the employees are not providing services, and it may not treat any portion of the health plan expenses as qualified wages.
Example – >100 FTEs; Reduced Wages; Health Plan Expenses Allowed: Employer C averaged more than 100 FTEs in 2019. Employer C is subject to a governmental order that fully suspends its business operations. Employer C furloughs its employees but continues to pay 25% of the employees’ wages and 100% of the employees’ health plan expenses. Because the employer is paying qualified wages (at the 25% reduced rate) for hours that the employees are not performing services, Employer C may treat as qualified wages: (i) the 25% of the wages that it pays its furloughed employees plus (ii) 100% of the health plan expenses.
The contents of this Alert are for informational purposes only and do not constitute legal advice. If you have any questions about this Alert, please contact the Shulman Rogers attorney with whom you regularly work or a member of the Shulman Rogers Tax Group.