On April 29, 2020, the Internal Revenue Service (IRS) offered additional guidance on the employee retention credit (ERC) by significantly expanding upon a list of Frequently Asked Questions (FAQ) posted on their website. The FAQ covers a vast array of topics, including the determination of eligible employers and qualified wages, and how the credit interacts with other relief provisions provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Families First Coronavirus Response Act (FFCRA).
We have identified some key areas where the IRS provided new or updated guidance on the ERC.
What is the Employee Retention Credit?
The Employee Retention Credit (ERC) is a fully refundable payroll tax credit made available by the CARES Act to employers (including not-for-profits) that had their operations fully or partially suspended as a result of a government order which limited commerce, travel or group meetings (the “suspension test”). The credit is also available to employers who have experienced a greater than 50% reduction in gross quarterly receipts, measured on a year-over-year basis (the “gross receipts test”).
The ERC is equal to 50% of qualified wages, not to exceed $10,000 per employee (resulting in a maximum $5,000 credit per employee), paid by the employer from March 13, 2020 through the end of the calendar year. Qualified wages paid by an employer with 100 or fewer employees generally includes all wages paid during the designated time frame; whereas for employers with more than 100 employees, qualified wages are limited to wages paid to employees while they are not performing services. Qualified wages can include qualified health plan expenses paid by the employer and allocable to qualifying wages.
Key takeaways from the IRS FAQ
1. Eligibility under the suspension test
According to the updated FAQ, 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 suspension of non-essential businesses may affect the employer’s operations. However, there are some exceptions for employers whose:
- Facts and circumstances indicate their operations have effectively been suspended due to the inability to obtain critical goods or materials because their suppliers have been shut down; or
- Hours of operations have been reduced due to a government order.
In addition, the FAQ notes that an essential employer will not qualify under the suspension test solely because its customers are subject to a government stay-at-home order. A more obvious example of this is a gas station. The government guidelines may list it as an essential business; however if it is in a jurisdiction where the community has received orders limiting travel and requiring residents to stay home it may experience a significant negative impact on operations. In this case, the gas station is not eligible for the ERC under the suspension test. However, if it’s gross receipts declined by more than 50%, it could be eligible for the ERC under the gross receipts test.
Furthermore, employers required to close their physical locations, but are able to maintain comparable operations through telework are not considered eligible for the ERC under the suspension test. This particular notion is especially relevant for an employer deemed “non-essential,” but able to continue their operations remotely at a comparable level. It is unclear what constitutes operations comparable to the business’ operations prior to the closure, but a non-essential employer would likely need to show a significant impact on their ability to perform its operations remotely (e.g., entire functions shut down or a significant reduction in the employer’s capacity to perform operations at a normal level).
It is important to note that the IRS repeatedly emphasizes in this section of the FAQ that employers who are ineligible for the credit based on the suspension test may qualify for the ERC if it passes the gross receipts test.
2. Eligibility of Paycheck Protection Program (PPP) loan recipients
In short, recipients of a PPP loan are ineligible for the ERC. The CARES Act provides that taxpayers cannot benefit from both a PPP loan and the ERC, but, prior to the issuance of these FAQ, it was unclear whether the ERC could be claimed for periods prior to borrowing. The FAQ states that PPP loan recipients cannot claim the ERC regardless of the date of the loan and whether the loan is forgiven. Further, if an employer in an aggregated group is a PPP loan recipient, the entire group is rendered ineligible for the credit.
However, as part of a May 7, 2020 update, the FAQ indicates that if an employer applied for a PPP loan, received payment, and repays the loan by May 14, 2020, they will be treated as though they had not received a PPP loan at all for purposes of the ERC. Therefore, the employer will be eligible for the credit if the employer otherwise qualifies as an Eligible Employer.
3. Impact of aggregation
The CARES Act provided that a controlled group of entities as determined under the aggregation rules of the Internal Revenue Code (IRC) will be considered a single employer when determining eligibility for the ERC, but it was unclear on how the facts and circumstances of one or more component controlled group members would affect the group as a whole. The expanded IRS FAQ addresses several questions in this area, as described below.
The FAQ indicates that a single business entity operating in multiple locations whose operations have been suspended in one or more jurisdictions, but not others, will qualify under the suspension test. This could be a considerable plus for employers with a national or regional presence, as they would qualify under the suspension test with respect to all of their operations in all locations.
Furthermore, a single employer in a controlled group qualifying under the suspension test qualifies the entire aggregated group. The FAQ provides that an entire aggregated group’s operations are deemed fully or partially shut down, if merely one of its members’ operations receives a governmental order to suspend operations. For example, if one restaurant in a chain controlled by an aggregated employer group receives government orders to close, the entire chain will be considered an eligible employer under the suspension test, even if multiple locations are located in jurisdictions not subject to any government restrictions.
Moreover, the gross receipts test considers the revenue of the entire aggregated group. Therefore, to qualify as an eligible employer for purposes of the ERC, the employer must account for the gross receipts of all members of the aggregated group. If the group does not experience a significant (50% or more) decline in gross receipts, then no member of the group can claim the ERC on the basis of the gross receipts test.
4. Determination of qualified wages
The updated FAQ provided further clarification of qualified wages for purposes of the ERC.
For employers eligible for the ERC due to a full or partial suspension of operations, qualified wages are limited to the period the order is in force. If the order was effective for only a portion of the calendar quarter, the employer can still claim the credit, but only for wages paid during the period the order is in effect.
Eligible employers who averaged more than 100 full-time employees in 2019 may not treat paid time off for vacations, holidays, sick days, or other leave under pre-existing policies as qualified wages. The IRS reasons these wages were accrued during a prior period in which the employee provided services, and, therefore, cannot be considered wages while the employee did not work. Conversely, eligible employers averaging 100 or fewer full-time employees in 2019 may include pre-existing vacation, sick, and other leave as qualified wages.
Another important note is that the employer may determine qualified wages on a pre-tax basis. Federal income and payroll taxes withheld or imposed do not reduce an employer’s qualified wages paid.
In addition, allocable healthcare expenses may be treated as qualified wages. Employers with 100 or fewer employees can generally allocate health plan expenses to qualifying wages paid and treat such health plan expenses as qualifying wages. (In a May 7, 2020, update to its FAQ, the IRS revised the manner in which employers determine the amount of their qualified healthcare expenses for which the credit can be claimed. In a significant taxpayer-favorable development, eligible employers that continue to provide their employees with healthcare coverage can now claim the ERC for these costs regardless of whether the employees continue to receive a salary.) Therefore, if an employer continues to pay for the healthcare coverage of a furloughed or laid-off employee, but does not continue to pay that employee wages, the healthcare expenses may still be treated as qualified wages for purposes of the ERC.
Eligible employers with more than 100 employees that furlough their workers or reduce their hours, but continue to provide them with healthcare coverage may treat health plan expenses allocable to the time that the employees are not working as qualified wages.
Something to keep in mind
It is important to note that the IRS prefaces each section of the FAQ with the following: “This FAQ is not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.”
Though not a primary authority, the FAQ demonstrates the IRS’ view on certain matters in the absence of official guidance. That said, there is no guarantee that these positions will be the same as those reflected in any formalized guidance. In closing, the IRS recommends taxpayers retain records supporting their ERC computations for at least four years.
How can Squar Milner help?
As part of our commitment to you, our team of tax professionals have made it a top priority to understand all things CARES Act. Our team diligently monitors the latest developments as it comes to the ERC, the PPP, and other components of the coronavirus relief package. We are here to answer your questions and provide practical advice as you continue to fight for your business. Please contact us today to find out if the ERC is a viable option for you.
For more information on the Employee Retention Credit, please check out our recent webinar on the topic here.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.