Many U.S. state and local authorities have already begun lifting stay-at-home and business shutdown orders, while others have outlined plans to ease those orders in the near future. Since the novel coronavirus (COVID-19) remains a threat, most authorities plan to lift restrictions in stages, likely continuing social distancing and other measures that preclude a full return to “business as usual.” During this “in-between” stage, can employers continue to take the employee retention tax credit created by Section 2301 of the Coronavirus, Aid, Relief and Economic Security (CARES) Act (Public Law 116-136)?
Insight:
Although the answer depends on each employer’s facts and circumstances, as discussed below, it seems that many employers may still be eligible for the employee retention credit (ERC) as state and local governments re-open their economies in stages.
New IRS FAQ
On April 29, 2020, the IRS posted 94 frequently asked questions (FAQ) on the ERC Several of the FAQs take a narrower approach to interpreting the law than many expected. Employers who relied on a reasonable, good faith determination of the CARES Act and the IRS’s preliminary FAQs on the ERC may want to revisit their position in light of the new FAQs. But the FAQs are not binding guidance and may change, even though they represent the IRS’s current thinking.
Insight:
Employers who already used the ERC (which applies to wages paid up to six weeks ago) should review the new FAQs to determine how they may affect their ERC eligibility and the calculation of the ERC amount.
Background
Eligible employers of all sizes (including tax exempt/non-profit employers) can reduce their federal employment taxes by as much as $5,000 per employee if the employee has “qualified wages” paid from March 13 to December 31, 2020. Certain employers are not eligible for the ERC, such as governmental employers and employers who receive a Paycheck Protection Program (PPP) loan under the CARES Act (although borrowers who returned their PPP loans by May 14 are eligible for the ERC, according to IRS FAQ 80, which was updated on May 4, and PPP FAQ 43, which was updated on May 5). Employers that receive a PPP loan (that is not returned by May 14) may not take the ERC, regardless of whether and when the loan is forgiven. Also, self-employed individuals are not eligible for the ERC for their own self-employment earnings, but they may be able to claim the ERC for wages paid to their employees. Household employers are not considered to operate a trade or business and, therefore, are not eligible for the ERC for wages they pay to their housekeepers, nannies, gardeners, etc.
To be eligible for the ERC, employers must be carrying on a trade or business during 2020 (nonprofit employers are deemed to satisfy that requirement), and during a 2020 calendar quarter, one of the following applies:
- The operation of the trade or business is fully or partially suspended during the calendar quarter 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 (emphasis added).
- Their gross receipts (defined under Code Section 448(c)) for a 2020 quarter are less than 50% of the gross receipts for the same calendar quarter in 2019. In that case, eligibility for the ERC ends with the 2020 calendar quarter following the first calendar quarter beginning after a calendar quarter for which gross receipts of such employer are greater than 80% of gross receipts for the same calendar quarter in 2019. For example, if the employer qualifies for the ERC in the first quarter of 2020, but gross receipts in the third quarter of 2020 exceed 80% of gross receipts for the third quarter of 2019, the employer would still be eligible for the ERC for the second and third quarters of 2020, since eligibility would end as of the start of the fourth quarter of 2020. The IRS plans to issue future guidance addressing how tax-exempt organizations determine their gross receipts for this purpose.
Governmental Orders
What is a governmental order?
IRS FAQ 28 states that orders, proclamations, or decrees from the federal government, or any state or local government, count as “governmental orders” for the ERC if they 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 and are from a state or local government that has jurisdiction over the employer's operations. Statements from a governmental official, including during press conferences or media interviews, do not rise to the level of a governmental order. Also, the mere declaration of a state of emergency by a governmental authority is not (by itself) sufficient if it does not limit commerce, travel, or group meetings in any manner. Declarations that limit commerce, travel, or group meetings, but do not affect the employer's operation do not rise to the level of a governmental order for the ERC.
Governmental orders include:
- An order from the city's mayor stating that all non-essential businesses must close for a specified period.
- A state's emergency proclamation that residents must shelter in place for a specified period, with the exception of residents who are employed by an essential business and may travel to and work at the workplace location.
- An order from a local official imposing a curfew on residents that impacts the operating hours of a trade or business for a specified period.
But the IRS noted that a governmental order allows employers to qualify for the ERC, even if the governmental order is not enforced.
Employers that voluntarily suspend operations or reduce hours but are not subject to any governmental orders that restrict operations are not eligible for the ERC on the basis of a full or partial suspension of operations due to a governmental order (but an employer that voluntarily suspends operations due to COVID-19 may be eligible for the ERC under the gross receipts test).
How does lifting a shutdown order impact ERC eligibility?
Employers are not required to satisfy both of the ERC eligibility requirements. Rather, employers could rely on one condition (i.e., their business is partially suspended during a calendar quarter due to a shutdown order) and then rely on the other condition (i.e., the gross receipts test) for other calendar quarters if their business is no longer subject to a shutdown order.
In addition, it seems that many employers may have a reasonable argument that they are still eligible for the ERC if their business is “partially” shut down due to a gradual lifting of the governmental shutdown or stay-at-home orders. The Joint Committee on Taxation (JCT)’s CARES Act explanation (JCX-12R-20 (April 23, 2020) and the IRS’s FAQs on the ERC confirm that employers are eligible for the ERC if their business is partially shut down and gave examples of restaurants that had to close their dining rooms but remained open for takeout/delivery and retail stores that closed their physical locations but continued on-line sales.
Insight:
According to IRS FAQs, a business that can open (but only with restrictions) would still be “partially” shut down due to a governmental order. For example, if a restaurant dining room normally has 100 tables, but due to “social distancing” orders, the restaurant is only permitted to have 50 tables, the employer is still subject to a partial shutdown order and would be eligible for the ERC. However, if there is no order (just a “recommendation”) then the employer’s eligibility for the ERC would expire at the end of the calendar quarter when the “order” is lifted (unless the employer satisfies the gross receipts test for the next quarter), such that “qualified wages” paid after the order is lifted would not count towards the ERC.
Potential bad news if employees are working from home.
IRS FAQ 33 significantly narrows ERC eligibility for employers who have switched to telework. Specifically, the IRS now says that an employer that is required to close its workplace as a result of a governmental order is not considered to have a partial suspension of its operations “if the employer is able to continue operations comparable to its operations prior to the closure by requiring employees to telework.” The scope of what is “comparable” remains unclear. The IRS gave an example of a software company in which employees normally teleworked once or twice per week. The IRS FAQs concluded that mandatory telework and limiting client meetings to telephone calls and video conferences due to a shutdown order was not a partial suspension of the employer’s business for the ERC.
Essential vs. non-essential businesses.
IRS FAQ 30 drew a sharp distinction between essential and non-essential businesses with respect to eligibility for the ERC based on a governmental order. Specifically, an essential business (such as a grocery store) that reduces its hours or places restrictions on customers would not be considered to have a partial suspension of its business based on an order closing non-essential businesses even if the employer had a decline in revenue (but not a 50% decline in gross receipts), since the essential employer can remain open under the order. Such employers would be ineligible for the ERC because (under the FAQs) the IRS does not consider their business partially suspended, even if they experience significant declines in demand due to stay-at-home orders.
Insight:
The IRS’s FAQs did not address whether governmental orders requiring customers to wear face coverings or mandating reduced store capacity by requiring adequate social distancing standards would result in a partial suspension of operations for essential or non-essential businesses.
IRS FAQ 31 clarifies that if a supplier to an essential business suspends operations due to a governmental order that results in a full or partial suspension of the essential business’s operations (i.e., the employer is permitted to remain open), the essential business would be eligible for ERC. For example, an essential business that partially suspends its operations because its suppliers are ordered to fully or partially suspend their businesses would be eligible for the ERC. But the FAQs do not address whether the essential employer would be eligible for the ERC if it partially or fully suspends operations because the stores who buy its products are required by governmental order to suspend operations.
IRS FAQ 32 noted that employers that operate an essential business that is not required to suspend its operations are not considered to have a full or partial suspension of their operations for the sole reason that their customers are subject to a government order requiring them to stay at home. But such employers may be eligible for the ERC if they satisfy the decline in gross receipts test.
Controlled and affiliated service group rules.
For ERC purposes, organizations that are under common control (using IRC Section 52(a) and (b)) or that are a member of an affiliated service group (using IRC Section 414(m) and (o)) are treated as a single employer. IRS FAQ 26 clarified that the controlled group rules apply for all purposes of the ERC, including whether a trade or business has been fully or partially suspended, whether the employer has a significant decline in gross receipts, whether the employer has more than 100 full-time employees, and whether a member of the controlled group is not eligible for the ERC because another member of the controlled group received a PPP loan. The ERC must be apportioned among members of the aggregated group on the basis of each member's proportionate share of the qualified wages giving rise to the ERC.
Insight:
- This is problematic for employers who were ineligible (or who did not apply) for PPP loans but who are aggregated with employers who received a PPP loan, since that makes the employers who did not receive the PPP loan ineligible for the ERC.
- National employers who are not subject to shutdown orders at all locations may still be partially suspended at all locations. IRS FAQs 36 and 37 confirm that all members of an aggregated group are deemed eligible for the ERC if one member is eligible. For example, if a controlled group has locations in California and Nevada and the Nevada locations are not subject to a shutdown order, but the California locations are subject to a shutdown order, it appears that all locations would qualify for the ERC since the entire controlled group (when treated as a single employer) is under a shutdown order. Or viewed another way, the single employer is under a “partial” shutdown order since its California locations are unable to open.
Qualifying Wages
The wages that can be used to calculate the ERC differ based on the employer’s average number of employees in 2019. For employers with 100 or more full-time employees on average during 2019, only wages paid to employees who are not providing services qualify for the ERC. But for employers with a 2019 average of less than 100 full-time employees, all wages paid to employees, regardless of whether the employees are providing services, qualify for the ERC. A full-time employee is an individual hired for a full time position or who works an average of 30 hours per week.
Qualified wages are based on the definition of wages used for FICA taxes, plus the amount paid by the employer for health plan expenses (which generally includes both the employer and employee portion of the cost, including the cost paid by the employee with pre-tax salary reduction contributions). But the wages cannot exceed what the employee would have been paid for working an equivalent amount of time during the preceding 30 days. In other words, wage increases do not qualify for the ERC.
Any federally mandated sick or childcare leave paid under the Families First Coronavirus Response Act (FFCRA) is specifically excluded from “qualified wages” for the ERC, since employers receive a dollar-for-dollar tax credit for such paid leave wages.
Insight:
The determination of continued eligibility might not be critical for employers with a stable workforce once the credit has been taken on the $10,000 maximum per employee wage. However, an employer that continues to have wages paid to new employees will need to determine exactly when they are no longer an eligible employer.
Also, although eligibility for the ERC is determined on a “calendar quarter-by-calendar quarter” basis, the IRS FAQs clarify that “qualified wages” only exist for dates under an order. IRS FAQ 38 gave the following example:
State Y issued a governmental order for all non-essential businesses to close from March 10 through April 30 and the governmental order was not extended. Pursuant to the order, Employer H, which operates a non-essential business in State Y, closes from March 10 through April 30. Employer H is an “eligible employer” for the ERC in the first quarter (for wages paid from March 13, the effective date of the ERC, through March 31) and the second quarter (for wages paid from April 1 through April 30).
Insight:
If an employer with a 2019 average of over 100 full-time employees voluntarily closed on March 16 (based on non-binding federal recommendations), then the state governor issued a mandatory shutdown order on March 23, the employer could not count wages paid to employees not rendering services from March 16 to March 22 as “qualified wages” for the ERC, even though the voluntary closure and the governmental shutdown order both occurred during the same calendar quarter.
Reduced work schedules and lost productivity.
IRS FAQs 54 and 55 clarify that “qualified: wages” for the ERC for employers with 100 or more employees means wages paid to employees on a reduced schedule for time not worked, but does not include wages paid to employees merely because they are less productive while working. In other words, “idle time” can count for the ERC if the employer can prove the employee was paid for not working. But employers cannot claim the ERC for “lost productivity” based on a general assumption that employees are not doing as much work, or doing “different” work.
PTO and severance.
IRS FAQ 56 provides that “qualified wages” for the ERC for employers with an average of 100 or more full-time employees in 2019 does not include paid time off (PTO) earned and used pursuant to a pre-existing company policy, since the IRS views PTO as having been earned for past services. But for employers who averaged 100 or fewer full-time employees in 2019, PTO would be “qualified wages” for the ERC (unless the wages qualified for FFCRA tax credits for qualified paid sick or child care leave). IRS FAQ 57 states that severance payments would not be “qualified wages” for the ERC because the individual is no longer an employee (and the ERC is only available for “retaining” employees) and (similar to PTO), severance pay is based on the past employment relationship.
No wages paid, but employer continued health care coverage.
Initially, the IRS FAQs 64 and 65 surprised many by stating that if an employer does not pay its employees any wages for time that the employees are not providing services (i.e., employees were furloughed or laid off), but the employer continues paying the employees’ health care coverage, the employer may not treat any portion of its health plan expenses as “qualified wages” for ERC purposes because no portion of the health plan expenses are allocable to wages paid to its employees. But on May 7, the IRS reversed that position. Now, revised FAQs 64 and 65 say that employers who furloughed employees without pay but continued paying their health care coverage will be allowed to claim the ERC for those health plan expenses.
Insight:
Congressional tax leaders and trade associations like the U.S. Chamber of Commerce and others sent letters to the Treasury asking IRS to reverse this position, since it was contrary to the intent of the CARES Act.
Wages paid to family members.
IRS FAQ 59 states that wages paid to employees who are “related individuals” are not “qualified wages” for ERC purposes. A related individual is any employee who has of any of the following relationships to the employer:
- A child or a descendant of a child
- A brother, sister, stepbrother, or stepsister
- The father or mother, or an ancestor of either
- A stepfather or stepmother
- A niece or nephew
- An aunt or uncle
- A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
If the employer is a corporation, then a related individual is any person that bears a relationship described above with an individual owning, directly or indirectly, more than 50% in value of the corporation’s outstanding stock. If the employer is an entity other than a corporation, then a related individual is any person that bears a relationship described above with an individual owning, directly or indirectly, more than 50% of the capital and profits interests in the entity. If the employer is an estate or trust, then a related individual includes a grantor, beneficiary, or fiduciary of the estate or trust, or any person that bears a relationship described above with an individual who is a grantor, beneficiary, or fiduciary of the estate or trust.
Next Steps for Employers
Employers may want to re-evaluate their operations and workforce based on the IRS’s FAQs and the lifting of governmental orders. Employers need to track which governmental orders impact their specific locations and operations, noting the dates and scope of each order imposed or lifted. Employers should track and be able to substantiate reduced-hours (such as “idle time”), focusing on which employees continue to perform “comparable” services and which employees had significant changes. The tracking should be done on a quarter-by-quarter basis for the ERC. Depending on facts and circumstances, employers that may have been eligible for the ERC in the first quarter of 2020 may be ineligible for some or all of the second quarter of 2020.
