Paycheck Protection Program (PPP) loans have received the most attention – both positive about the benefits they provide and negative about borrowers now fearing that they are no longer considered eligible. The employee retention credit (ER Credit) has received far less attention but for many it will prove more valuable than the PPP. On April 29, the IRS updated its FAQs about the ER Credit to add dozens more. (There are now a total of 94 FAQs, proving that nothing involving tax is ever clear from the face of the statute.) The most significant FAQs appear to effectively eviscerate one of the two ways by which an employer can be eligible for the ER Credit.
As discussed in a recent Lane Powell article, the federal government's ER Credit will provide up to $5,000 per employee in the form of a refundable credit (rather than a forgivable loan, like the PPP loan).1 The credit is calculated as 50 percent of Qualified Wages – a term that has the distinction of having a different definition depending on whether the Eligible Employer averages more or less than 100 full-time employees. Because nothing could be clearer than the IRS's own explanation in their FAQ 6, here is how the agency initially explained it:
6. What Are "Qualified Wages"?
Qualified wages are wages (as defined in section 3121(a) of the Internal Revenue Code (the Code)) and compensation (as defined in section 3231(e) of the Code) paid by an Eligible Employer to some or all employees after March 12, 2020, and before January 1, 2021. Qualified wages include the Eligible Employer's qualified health plan expenses that are properly allocable to the wages.
The definition of qualified wages depends, in part, on the average number of full-time employees (as defined in section 4980H of the Code) employed by the Eligible Employer during 2019.
If the Eligible Employer averaged more than 100 full-time employees in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services due to an economic hardship, specifically, either (1) a full or partial suspension of operations by order of a governmental authority due to COVID-19, 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 described in (1) or (2) above.
If the Eligible Employer averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during any period of economic hardship described in (1) or (2) above.
In contrast to FAQ 6, the ER Credit provision of the CARES Act was actually written in English, basically defining an eligible employer as any employer that was carrying on a trade or business during 2020 that had a period either:
- For which operations were fully or partially suspended by government order due to COVID-19, or
- Beginning with the first calendar quarter starting after December 31, 2019, in which gross receipts dropped by more than 50 percent compared to the same quarter in the prior year and ending with the calendar quarter in which gross receipts are greater than 80 percent of the same gross receipt for the same quarter in the prior year.
We previously viewed the ER Credit as key relief for two types of businesses: those with too many employees to receive a PPP loan and those that could not get a PPP loan because the money ran out. In light of all the uncertainty about the uncertainty certification, we now add a third category: PPP eligible businesses that have determined not to apply for or keep a PPP loan because of the risks of becoming a target for bad press or an SBA audit.2
The new IRS FAQs materially limit eligibility under the first test by narrowing the circumstances in which a government shut-down order would be deemed to fully or partially shut down a particular business. FAQs 30 and 32 interpret the statutory language in a way that might surprise those who just read the statute: there is no suspension in the operations for essential businesses that can continue to operate during the order, even if customers must stay at home because of the order. (However, FAQ 31 provides that a suspension has occurred if a supplier of an essential business had to suspend its operations so that the essential business cannot receive "critical" goods or materials – there is no guidance on the meaning of "critical.")
Similarly, FAQ 33 provides that there is no suspension in operations for non-essential businesses that can continue "comparable" operations with telework. No guidance is given for the meaning of "comparable."
Finally, FAQ 38 tells us that the suspension in operations ends once the order has been lifted.
No doubt many businesses can qualify because of a government order without a 50 percent decrease in gross revenue, such as restaurants, retailers, manufacturing facilities and essential businesses that cannot obtain "critical" supplies. However, the new guidance effectively requires many other businesses, including most knowledge or service businesses, to suffer a 50 percent decrease in gross revenue to be eligible for the ER Credit.
Other highlights of the updated FAQs include:
Significant Decline in Gross Receipts
FAQs 39-46 provide guidance for determining whether an employer has had a significant decline in gross receipts. This includes confirmation that an employer can obtain the ER Credit by filing an amended Form 941 if the employer does not make the determination about the decline in gross receipts until after January 1, 2021 (FAQ 42). It also includes guidance for businesses started in 2019 (FAQ 44) and businesses acquired in 2020 (FAQ 45). The IRS will issue additional guidance for how a tax-exempt employer determines a significant decline in gross receipts (FAQ 46).
Meaning of Government Order Due to COVID-19
The applicable government orders are "[o]rders, proclamations, or decrees from the Federal government, or any State or local government [that] * * * limit commerce, travel, or group meetings due to COVID-19 in a manner that affects an employer's operation of its trade or business, including orders that limit hours of operation." State or local orders must come from a state or local government that has jurisdiction over the employer's operation. Statements made by government officials (e.g., a press conference or interview) are not orders (FAQ 28). The FAQ lists orders from a city mayor and state as government orders. The FAQ does not provide guidance for when a federal or state order overrules a city order. However, an employer voluntarily suspended operations due to COVID-19 is not subject to a government order (FAQ 29).
Operations Suspended Because of a Government Order
Situations in which a government orders results in a suspension of operations include the following circumstances:
- The government order requires the business to close its workplace for certain purposes, but not all purposes (FAQ 34).
- The business must reduce its hours of operations (FAQ 35).
- The business operates in multiple locations, but not all locations are subject to an order (FAQ 36).
- The business operations of any member of the aggregated group are suspended.
Wages Paid for Not Providing Services
The IRS guidance for whether an employer pays wages to an employee for not providing services includes:
- An employer can use "any reasonable method" to determine the hours for which an employee is not providing services. Making an assessment based on productivity is not a reasonable method. However, reasonable methods include adopting a policy of reduced hours with full pay or determining the percentage of time an employee is not providing services (FAQs 54 and 55).
- A payment of accrued personal leave (e.g., vacation or sick leave) is not a payment for not providing services.
Limitation on Qualified Wages
Qualified wages do not include severance (FAQ 57) or wages exempt from social security and Medicare tax (FAQ 58). The IRS also provided guidance on the statutory exclusion of wages paid to related employees (FAQ 59).
Inclusion of Qualified Healthcare Expenses in Qualified Wages
Qualified healthcare expenses include both employer healthcare contributions and pre-tax employee healthcare contributions, to the extent allocable to the hours for which an employee receives qualified wages (FAQ 63). However, if an employer lays off or furloughs employees, but continues to provide healthcare coverage, the amounts paid are not qualified healthcare expense (FAQs 64 and 65). In the Joint Committee of Taxation (JCT) summary of the CARES Act released on April 22, the JCT specifically described how the IRS had the authority to "to treat qualified health plan expenses as qualified wages in a situation where no other qualified wages are paid." We do not understand why the IRS chose not to use this authority for out-of-pocket costs incurred by an employer to maintain healthcare benefits. FAQs 67-71 provide guidance for different types of healthcare plans.
Aggregation of Businesses
The IRS provided guidance on the treatment of more than one business as a single employer (FAQ 25). This impacts whether the employer (1) has a trade or business operation that was suspended by COVID-19 orders or a sufficient decline in gross receipts, (2) has more than 100 full-time employees, or (3) is precluded from claiming an ER Credit because of receipt of a PPP loan (FAQ 26). Members of an aggregated group must apportion the ER Credit based on each member's proportionate share of the qualified wages resulting in the ER Credit (FAQ 27).
Meaning of Full-Time Employee
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. If a business operated in each month of 2019, it determines the number of its full-time employees by dividing the sum of the number of full-time employees in each month by 12. A different calculation applies to businesses started in 2019 or 2020 (FAQ 49).
Equivalent Duration Limitation
Wages paid by an eligible employer with more than 100 full-time employees cannot exceed the amount such employee would have been paid for working an equivalent duration during the 30-day period immediately preceding when the employer became an eligible employer. As we anticipated, this provision of the CARES Act prevents getting to $10,000 of wages faster with salary increases. The IRS has provided guidance on this, including that an employer can use "any reasonable method" for applying this limitation to a variable hour employee (FAQ 53).
Impact of ER Credit on Employer's Deductions
An employer must reduce otherwise allowable deductions by the amount of the ER credit (FAQ 85). However, the employer does not have income from the ER credit (FAQ 86).
Impact of Eligible Wages on Employee's Income
Eligible wages are included in an employee's income. The IRS specifically determined that eligible wages cannot be treated as qualified disaster relief payments that are excludible from the employees income pursuant to IRC § 139 (FAQ 84).
Self-Employed Individuals
Self-employed individuals may not claim an ER Credit for themselves, but can for their employees (FAQ 24).
1 Our COVID-19 Resource Center has the guidance issued about PPP loans, a spreadsheet for PPP loan application and forgiveness calculations and several articles, including our most recent article in a series about the required certification regarding a borrower’s need for their PPP loan given the uncertainty of current economic conditions.
2 The PPP loan application contains a paragraph about the Freedom of Information Act allowing disclosure by the SBA of “the names of the borrowers (and their officers, directors, stockholders or partners).” Because Congress structured the ER Credit as a refundable credit, the taxpayer information confidentiality rules of IRC § 6103 generally should apply to protect taxpayers claiming the credit from the prying eyes of the press and watchdog groups. However, businesses subject to disclosure requirements may need to disclose the anticipated benefits of the ER Credit as it affects their effective tax rate.