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Pursuant to the federal Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), enacted on March 27, 2020, eligible employers are granted an employee retention tax credit against applicable employment taxes (the "Retention Credit"). The United States Internal Revenue Service (the "IRS") has been issuing new and, in some instances, revised Q&A guidance on a rolling basis, which provides several important clarifications to the Retention Credit.
Overview of the Retention Credit
The CARES Act creates an employee retention tax credit for employers of any size negatively affected by the coronavirus pandemic. Specifically, eligible employers are allowed an optional credit against applicable employment taxes for each calendar quarter in an amount equal to 50% of qualified wages (up to $10,000 in wages for all calendar quarters) for each employee (i.e., not more than $5,000 of credit per employee for all calendar quarters). This credit is up to an amount equal to the applicable employment taxes for the calendar quarter (reduced by any credits allowed for paid family leave or paid sick leave under the Families First Coronavirus Response Act (the Response Act)) on the wages paid for all employees during the calendar quarter. If the credit amount exceeds this limitation for any calendar quarter, the excess will be treated as an overpayment that will be refunded to the employer. Employers who receive a loan (whether or not forgiven) under the Payroll Protection Program (the PPP) will not be eligible to benefit from the Retention Credit.
Eligible employers include any employer who: (i) carries on a trade or business during calendar year 2020, and (ii) suffers with respect to any calendar quarter in either of the following ways: (x) the operation of that trade or business is fully or partially suspended 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 (y) gross receipts for the calendar quarter (beginning with the first calendar quarter after December 31, 2019) are less than 50% of gross receipts for the same calendar quarter in the prior year (until gross receipts exceed 80% of gross receipts for the same calendar quarter in the prior year).
For employers with more than 100 full-time employees (FTEs) during 2019 on average, qualified wages eligible for the credit are wages paid to employees who are not providing services due to the suspension of the business or drop in gross receipts. For employers with 100 or fewer FTEs during 2019 on average, all wages paid qualify for the credit. In both cases, regardless of employee count, qualified wages will not include wages taken into account for the purposes of payroll tax credits corresponding to paid family leave or paid sick leave under the Response Act. Additionally, qualified wages include allocable qualified health plan expenses incurred by the eligible employer (to the extent such amounts are excluded from the gross income of employees). The employee retention credit is effective for wages paid after March 12, 2020, and before January 1, 2021.
IRS Q&A Guidance: Key Takeaways
The following is a summary of key portions of the revised IRS Q&A guidance to date on the Retention Credit:
Applicable Employment Taxes Subject to the Retention Credit:
The IRS clarifies that the Retention Credit is allowed against the employer's share of social security taxes and the portion of taxes imposed on railroad employers that corresponds to social security taxes.
The Retention Credit is considered fully refundable because the eligible employer may get a refund if the amount of the Retention Credit is more than the applicable employment taxes owed by the eligible employer. The IRS states that if, for any calendar quarter, the amount of the credit exceeds the employer's share of the social security tax on all wages paid to all employees, then the excess is treated as an overpayment and refunded to the employer. Consistent with this treatment as an overpayment, (1) the excess will be applied to offset any remaining tax liability on the employer's employment tax return, and (2) the amount of any remaining excess will be reflected as an overpayment on the return. Like other overpayments of federal taxes, the overpayment will be subject to offset prior to being refunded to the employer. Employers should consult the IRS guidance here for details on applicable forms and submission instructions.
Related Employer Aggregation for Purposes of the Retention Credit:
For purposes of determining the Retention Credit's application, the IRS states that all entities that are treated as a "single employer" under Sections 52(a) or (b), or Sections 414(m) or (o), of the Internal Revenue Code (the "Code") are considered one employer under the Retention Credit. Generally, the Section 52(a) and (b) aggregation rules apply to determine when related entities are treated as a single employer for purposes of tax credit application under Section 51 of the Code, as well as certain other provisions, via a parent-subsidiary controlled group, a brother-sister controlled group, or a combined group of corporations. Generally, the Section 414(m) and (o) aggregation rules apply to determine when related entities, including affiliated service groups, are treated as a single employer for purposes of retirement and other employee benefit rules under the Code, as well as certain other provisions.
As a result, employers must be aggregated as members of a controlled group of corporations or a group of entities under common control under Sections 52(a) or (b) of the Code, members of an affiliated service group under Section 414(m) of the Code, or otherwise aggregated under Section 414(o) of the Code, for purposes of the following Retention Credit rules:
- Determining whether the employer has a trade or business operation that was fully or partially suspended due to orders related to COVID-19 from an appropriate governmental authority (as discussed below).
- Determining whether the employer has a significant decline in gross receipts (in such case, the employer must take into account the gross receipts of all members of the aggregated group; if the aggregated group does not experience a significant decline in gross receipts, then no member of the group may claim the Retention Credit on that basis).
- Determining whether the employer has more than 100 FTEs (as discussed below).
- The application of the rules that preclude an employer from claiming the Retention Credit if any member of the aggregated group received a PPP loan (as discussed below).
The amount of the Retention Credit must then 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 credit. Each eligible employer will report its apportioned Retention Credit on its employment tax return (or on its third party payer's employment tax return) without regard to its aggregation with other entities.
When a Business is "Fully or Partially Suspended":
The IRS guidance clarifies when a business is fully or partially suspended due to a governmental authority imposing restrictions on the employer's operations by limiting commerce, travel, or group meetings due to COVID-19 such that the employer cannot continue all of its typical operations. Specifically, the IRS guidance provides that when a governmental order requires non-essential businesses to suspend operations, but allows essential businesses to continue operations, an essential business is then not considered to have a full or partial suspension of operations if the governmental order allows such essential business to remain open (even though the order requiring non-essential businesses to close may have an effect on the employer's operations). Furthermore, if a governmental order causes the customers of a business to stay at home, but the essential business is permitted to continue operations, the essential business is not considered to have a full or partial suspension of operations. In addition, if a governmental order requires an employer to close its workplace, 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. In all such instances, however, the employer may still be eligible for the Retention Credit if it experiences a significant decline in gross receipts.
In contrast, if a governmental order causes the suppliers to an essential business to suspend their operations, the 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 (which, according to the IRS, will be determined on a facts and circumstances basis). Additionally, if a governmental order requires an employer to close its workplace for certain purposes, but the workplace may remain operational for other limited purposes (e.g., a restaurant open for take-out or delivery only), the employer's operations are considered to be partially suspended. Similarly, if a governmental order requires that an employer reduce its operating hours, then the employer's operations are considered to have been partially suspended. The IRS further clarifies that if an employer operates a trade or business in multiple locations and is subject to a governmental order requiring full or partial suspension of its operations in some (but not all) jurisdictions, the employer is still considered to have a partial suspension of operations.
In any such case, if an employer is subject to a governmental order to fully or partially suspend its operations but the order is subsequently lifted, then the eligible employer may only claim the Retention Credit for wages paid during periods of the calendar quarter when the order is in effect.
As noted above, members of an aggregated group are treated as a single employer for purposes of the Retention Credit. Therefore, if the operations of a trade or business of one member of an aggregated group are fully or partially suspended by a governmental order, then all members of the aggregated group are considered to have their operations partially suspended, even if another member of the group is in a jurisdiction that is not subject to a governmental order.
Determining "Qualified Wages":
The definition of qualified wages depends, in part, on the average number of FTEs employed by the eligible employer during 2019. If the employer averaged more than 100 FTEs 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. For an eligible employer that averaged 100 or fewer FTEs in 2019, qualified wages are all wages paid to any employee during any period in the calendar quarter in which the business is experiencing economic hardship as described in (1) or (2) above.
If the eligible employer averaged more than 100 FTEs in 2019, the employer may not treat as qualified wages amounts paid to employees for paid time off for vacations, holidays, sick days and other days off as these wages are paid pursuant to existing leave policies for benefits accrued during a prior period in which the employees provided services, and are not wages paid for time in which the employees are not providing services. However, if the employer averaged 100 or fewer FTEs in 2019, all wages paid to employees during the period of the full or partial suspension of operations or the significant decline in gross receipts, even if under a pre-existing leave policy, may be qualified wages for purposes of the Retention Credit (unless the wages are qualified sick and/or family leave wages under the Response Act, in which case such wages shall not, under any circumstances, be considered qualified wages for the Retention Credit).
The term "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 (130 hours of service in a month is treated as the monthly equivalent of at least 30 hours of service per week), as determined in accordance with Section 4980H of the Code. As noted above, members of an aggregated group are treated as a single employer for purposes of determining the employer's average number of employees.
Determining the Amount of Allocable Qualified Health Plan Expenses:
Generally, qualified wages include an allocable portion of the qualified health plan expenses paid or incurred by an eligible employer to provide and maintain a group health plan, but only to the extent that such amounts are excluded from the gross income of employees. The amount of qualified health plan expenses taken into account in determining the amount of qualified wages generally includes both the employer portion of costs paid and the pre-tax salary reduction portion from employees.
The qualified health plan expense is generally the amount that is allocable to the hours for which the employees receive other qualified wages. After significant bipartisan criticism, including letters from the leaders of the congressional tax-writing committees, the IRS has revised their Q&A guidance to clarify this application to mean:
- For an employer that averaged more than 100 FTEs in 2019: Allocable health plan expenses correspond to the time that the employees are not providing services during any period in a calendar quarter in which the employer's business operations are fully or partially suspended due to an applicable governmental order or a calendar quarter in which the employer experiences a significant decline in gross receipts (subject to the maximum of $10,000 per employee for all calendar quarters for all qualified wages). Such health plan expenses include those corresponding to laid off or furloughed employees who receive continued employer health plan coverage, even if they are not actually receiving wages. For clarity, and consistent with the definition of qualified wages, an employer may not include health plan expenses allocable to the time for which the employees are receiving wages for providing services.
- For an employer that averaged 100 or fewer FTEs in 2019: Allocable health plan expenses include all such expenses paid or incurred, after March 12, 2020, and before January 1, 2021, during any period in a calendar quarter in which the employer's business operations are fully or partially suspended due to an applicable governmental order or a calendar quarter in which the employer experiences a significant decline in gross receipts (subject to the maximum of $10,000 per employee for all calendar quarters for all qualified wages). Such health plan expenses include those corresponding to laid off or furloughed employees who receive continued employer health plan coverage, even if they are not actually receiving wages.
As noted, wages for which an employer may claim the Retention Credit do not include the qualified sick and/or family leave wages for which it claims credit under the Response Act. This exclusion also applies to the qualified health plan expenses that are allocable to such qualified leave wages.
Clarification Regarding Interaction with the PPP:
An employer may not receive the Retention Credit if the employer receives a PPP loan authorized under the CARES Act. As of the most recently updated Q&A guidance, the IRS excepts from this ineligibility an employer that applied for a PPP loan, received payment, and repaid the loan by May 14, 2020, with such employer to be treated as though the employer had not received a covered loan under the PPP for purposes of the Retention Credit. The updated IRS guidance also clarifies that if multiple entities are treated as a single employer under the aggregation rules, and even one of the aggregated entities received a PPP loan, then none of the other aggregated entities may receive the Retention Credit.
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