Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.
The Internal Revenue Service (IRS) and Joint Committee on Taxation have issued new guidance to help clarify employer requirements for claiming the Employee Retention Credit (ERC) under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The ERC provides a 50% credit against the employer’s portion of Social Security taxes (Old Age, Survivors, and Disability Insurance) on up to $10,000 of “qualified wages” per employee. The credit may be applied to the employment taxes for all employees of the employer. To claim the ERC, the company needs to be an “Eligible Employer.”
Eligible Employers and Qualified Wages
Eligible Employers are those experiencing financial hardship because of COVID-19. To qualify, the employer must experience: (a) a full or partial shutdown because of a government order related to COVID-19, or (b) a decline in gross receipts by 50% or more in any quarter of 2020 compared to the same quarter of previous year.
Qualified Wages are those meeting certain criteria:
- Must be paid between 3/13/2020 and 12/31/2020
- For companies that employed 100 or fewer full-time or full-time equivalent employees, qualified wages are all wages paid to employees
- For companies that employed more than 100 full-time or full-time equivalent employees in 2019, qualified wages are wages paid to employees not providing services because of reasons (a) or (b). The amount of qualified wages cannot exceed wages paid to the employee in the 30-day period immediately preceding the period of economic hardship
- For all employers, “qualified wages” include qualified health care expenses
As employers seeking to claim the credit began to consider how best to do so, the limited guidance issued by the IRS in the form of FAQs left many questions unanswered. Moreover, FAQs do not carry the force of law and cannot be relied upon to support a legal position. Fortunately, the Joint Committee on Taxation has published its Description of the Tax Provisions of the CARES Act.1 Such committee reports are recognized as a type of authority on which a taxpayer can rely, at least with respect to defending against certain tax penalties.2 In addition, the IRS has now issued 94 total FAQs that are consistent with the Committee report. Thus, the combined effect of this new guidance serves to clarify a number of outstanding questions.
Partial Suspension of Operations Includes Even Non-Revenue-Generating Operations
Businesses are eligible to claim the ERC if they meet one of two tests. First, a business is eligible if it experiences a significant decline in gross receipts, defined as a decrease greater than 50% relative to the same quarter in the prior year. Second, a business is eligible if it experiences a full or partial suspension of operations due to a governmental order limiting commerce, travel or group meetings due to COVID-19 (the “governmental order test”). In its initial FAQs explaining the meaning of “partial suspension of operations,” the IRS provided an example of a restaurant that continued to offer carry-out service but could no longer offer dine-in service due to a governmental order restricting dine-in service. This guidance suggested the term would be applied with respect to the revenue-generating aspects of an employer’s business.
The new guidance explains, however, that this provision is applied broadly. The governmental order test is to be applied as if it referred to all operations of the organization, and not merely to those treated as its trade or business. Take the example of an accounting firm required to close an office due to a governmental order. The firm is able to continue its revenue-generating operations because all of its accountants and many administrative assistants are able to work remotely. However, if the firm also employed a few workers whose duties cannot be performed remotely, such as mail room or custodial workers, then it would be eligible to claim the ERC under the governmental order test. Depending on the size of the firm, it would be able to claim the ERC as to some or all employees. Essential businesses that are exempted from governmental orders, such as grocery stores, are not eligible, even if there operations are limited in terms of the number of customers that can be served at one time.
Wages Paid “With Respect to Which an Employee is Not Providing Services” Includes Wages Paid to Employees With Respect to the Hours Not Worked
Employers previously had to speculate as to what “not providing services” meant. The IRS initially published contradictory statements. A March 31, 2020, news release posted on the IRS website stated: “If the employer had more than 100 employees on average in 2019, then the credit is allowed only for wages paid to employees who did not work during the calendar quarter.” This language implied that a larger employer could only claim the credit for wages paid to workers who were not working at all. In its later-issued FAQs, the agency defined qualified wages as “wages paid to an employee for time that the employee is not providing services.” This language implied that the ERC could be claimed on wages paid to employees for time not worked, even if the employees performed some work during a quarter. Both definitions vary slightly from the actual text of the CARES Act, which provides that qualified wages are wages “paid by such eligible employer with respect to which an employee is not providing services.”
As a result, larger employers interested in using the ERC as a tool to continue to pay full-time wages to employees who were no longer working full-time had no assurance that the portion of wages paid for the hours not worked could be treated as “qualified wages.” The new guidance finally clarifies that, with respect to employees who work some hours, wages paid for additional hours not worked are “qualified wages” on which the ERC can be claimed. For example, if a larger employer continues paying an employee for 40 hours of work in a week, but only requires the employee to work 15 hours, then the wages paid for the 25 hours not worked are “qualified wages.”
Qualified Health Plan Expenses
Qualified wages under the ERC include certain qualified health plan expenses. Some employers have asked whether the ERC can be claimed on the amounts expended to maintain group health coverage for employees who are either working fewer hours or not working at all. Such employers reason that if they are paying health plan expenses to employees who are not working then those must be qualified wages, even if the employee receives no cash remuneration.
The CARES Act ERC provisions contain a broad grant of authority permitting the Secretary of the Treasury (or the Secretary’s delegate) to treat qualified health plan expenses as qualified wages in a situation where no other qualified wages are paid by the eligible employer or to the particular employee to which such expenses are allocable. However, as of now, the Secretary has done the opposite. The new guidance provides, “[g]enerally, the qualified health plan expense is the amount that is allocable to the hours for which the employees receive other qualified wages.” The FAQs now specifically address this question and clarify that a larger employer (one with an average of more than 100 full-time equivalent employees in 2019), that continues health plan benefits but does not pay the employees’ wages for the time they are not providing services, may not treat its health plan expenses as qualified wages because no portion of the health plan expenses would be allocable to wages paid to employees. In other words, some cash compensation needs to be paid in order to claim the healthcare expenses as qualified wages.
However, a larger employer that pays some wages allocable to the time its employees are not providing services may treat its health plan expenses as qualified wages. Consider, for example, an employer eligible for the credit due to a governmental order that fully suspends the operations of its trade or business. The employer furloughs its employees but continues to pay 25 percent of the employees' wages and continues to cover 100 percent of the employees' health plan expenses. In this case, the employer may treat 100% of the health plan expenses that are allocable to the time that the employees are not providing services as qualified wages. This employer may also treat the 25% of wages that it pays its employees for time the furloughed employees are not providing services.
Employers seeking to take advantage of this incentive should review available guidance and consult with experienced counsel.
1 Joint Committee on Taxation, Description of the Tax Provisions of Public Law 116-136, the Coronavirus Aid, Relief, and Economic Security (CARES) Act (JCX-12R-20), April 23, 2020 (The Joint Committee Staff oversees the tax system by monitoring the substantive positions taken by the Treasury Department and the IRS to ensure that those positions are consistent with the legislative intent of the Congress).
2 26 C.F.R. § 1.6662–4(d)(3)(iii).