May 6, 2020 IRS FAQs reveal Treasury and IRS thinking on employee retention credit The IRS posted long-awaited FAQs on the employee retention credit (ERC) enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. While the FAQs are not binding on the IRS or taxpayers, they do reveal the current thinking of the Treasury Department and the IRS. The ERC, as discussed in Tax Alert 2020-0761, is a refundable employment tax credit for qualified wages paid from March 13, 2020 through December 31, 2020, by employers that during any calendar quarter in 2020 (1) fully or partially suspend operations due to governmental orders concerning COVID-19, or (2) experience a 50% decline in gross receipts compared to the same calendar quarter in 2019 (eligible employers). The credit amount is 50% of qualified wages, taking into account up to $10,000 of qualified wages, yielding a maximum credit of $5,000 per employee. For eligible employers with more than 100 employees (large employers), qualified wages are wages paid to an employee for "not providing services" due to a full or partial shutdown or a significant decline in gross receipts. For eligible employers with 100 or fewer employees (small employers), qualified wages are wages paid during a calendar quarter due to a full or partial shutdown or a significant decline in gross receipts. The original 94 FAQs address various aspects of the ERC, including what constitutes qualified wages, when a business is partially suspended, and when an employee is not providing services. An additional FAQ was added on May 4 to address employers that repay a Paycheck Protection Program (PPP) loan by May 7. Suspension of operations due to a governmental order Definition of "governmental order" A governmental order includes orders, proclamations or decrees from the federal government, or state or local governments with jurisdiction over the employer's operations, 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." A governmental order does not include statements from governmental officials, comments made during press conferences or in interviews, or state of emergency declarations. Partial Suspension An employer is eligible for the ERC when its business is partially suspended due to COVID-19. (Employers that do not meet these guidelines might still be eligible due to a significant decline in gross receipts.) The FAQs state that a business may be partially suspended if a governmental order allows the employer to continue some, but not all, of its typical operations. Of particular interest to many businesses is the fact pattern set out in FAQ 33, which concludes that even though a software developer's workplace is closed by a governmental order, the employer can continue comparable operations by requiring its employees to telework and, therefore, the business is not considered to have a full or partial suspension of operations. Because the FAQ examples are specific to their facts, other FAQs may be relevant to determining whether a business is partially suspended even if certain activities can be conducted through telework. For example, other FAQs indicate that an employer's operations would be considered partially suspended if (1) its workplace is closed by a governmental order for certain purposes, but may remain open for other purposes, or (2) the employer can continue certain operations remotely. Similarly, the FAQs state that an employer that reduces its operating hours due to a governmental order is considered to have partially suspended its operations. The FAQs acknowledge that employers with locations in several states, where governmental orders may vary, may choose to close all locations to operate in a consistent manner in all jurisdictions. If these employers have a policy that complies with the local governmental orders, as well as the Centers for Disease Control and Prevention and Department of Homeland Security guidelines, the employer would still be considered to have partially suspended operations. As examples of partial suspension, the FAQs cite a restaurant that can only offer carryout instead of sit-down service and a retail store that closed its stores but continues to fulfill online orders. Treatment of essential businesses Most governmental orders allow essential businesses to remain open. An essential business is generally not considered to have a full or partial suspension of operations to the extent the business is not subject to a governmental order (although it could potentially be eligible for the ERC if it meets the gross receipts test.) Notwithstanding, the FAQs appear to acknowledge that not all operations of a business may be essential and that at least a partial suspension of an essential business remains possible. Under the principles articulated in the FAQs, an essential business may be an eligible employer under the partial suspension rules if:
or
Qualified wages For large employers, qualified wages are those wages paid to an employee for the time the employee is not providing services due to either the employer's reduction in gross receipts or the partial suspension making the employer an eligible employer. For this purpose, the wages may not exceed what the employee would have been paid for working the equivalent time during the 30 days immediately preceding the applicable period. Determining employer size In its explanation (JCX-12R-20 (April 23, 2020)) of the CARES Act, the Joint Committee on Taxation (JCT) stated that both full-time and full-time equivalent employees should be counted in determining the number of full-time employees, a nuance that is not apparent in the statutory text. Although the IRS FAQs do not expressly reject this statement, the FAQs appear to confine the count to full-time employees. Not providing services The FAQs clarify that large employers may treat wages paid to hourly and non-exempt salaried employees for hours that the employees were not providing services as qualified wages. For example, if an hourly employee works 25 hours per week instead of his or her normal 40 but continues to receive full pay for 40 hours, wages for the 15 hours when the employee is not providing services are qualified wages. Large employers may also treat wages paid to exempt salaried employees for the time that they are not providing services as qualified wages. In identifying hours for which a salaried employee is not providing services, employers may use any reasonable method, which include those used to measure entitlement to intermittent or reduced schedule leave under the Family and Medical Leave Act, or the employer's usual practices for accruing paid leave. The FAQs, however, state that an employer's assessment of productivity levels during working hours is not a reasonable method. Accrued paid time off The FAQs state that a large employer may not treat previously accrued paid time off (PTO) for vacations, holidays, sick days and other days off as qualified wages. According to the FAQs, these wages are paid pursuant to existing leave policies that represent benefits accrued during a prior period in which the employees provided services and, as a result, are not wages paid for time in which the employees are not providing services. Severance The FAQs state that employers may not treat payments, including severance payments, made to former employees after termination of employment as qualified wages. Implications The FAQs illustrate that the definition of an eligible employer under the partial suspension test is essentially a fact and circumstances analysis. Some of the examples in the FAQs adopt a seemingly narrow view of what constitutes a suspension of the business due to governmental orders limiting commerce, travel, and group meetings. The FAQ concluding that there is no partial suspension of the business if "comparable" activities may be performed by teleworkers raises questions as to what aspects of an operation may be performed without in-person interactions with colleagues and clients. With respect to what constitutes qualifying wages, the FAQs also illustrate a more granular analysis of employees' activities based upon time records because productivity is not deemed to be an appropriate measurement of "not providing services." Businesses will need to consider their specific facts, the statutory text, and whether the FAQs address all the particular factors that may be relevant to their calculation of the ERC. Qualified health plan expenses Qualified wages include qualified health plan expenses paid or incurred by the employer for group health plan coverage excludable under IRC Section 106(a). These expenses are to be allocated to qualified wages as prescribed by Treasury. In its description of the CARES Act, JCT noted that Treasury's authority in this regard includes the authority to treat qualified health expenses as qualified wages even in the absence of other wages. Some may have viewed the JCT description as indicating that the CARES Act does not require taxable wages in order for health plan expenses to be counted as qualifying wages. The IRS FAQs appear to decline the authority identified by JCT, instead providing that qualified health plan expenses are qualified wages only if allocable to other qualified wages. As a result, if an employer is paying no wages to an employee but has continued to provide health care coverage, the FAQs state that the employer may not treat the health plan expenses as qualified wages. In the event that qualified health plan expenses do exist, however, the FAQs provide that the amount includes the employer's portion of the cost and the employee's portion of the cost paid with pre-tax salary reduction contributions (but not after-tax contributions). Implications The FAQs' treatment of qualified health plan expenses may be a surprising outcome to many businesses. Some employers have furloughed employees but, rather than merely providing their employees COBRA continuation coverage funded solely by the employee, have voluntarily continued to provide employer-paid coverage. The FAQ's conclusion this coverage does not count as qualified wages may be particularly surprising, given that a minimal taxable payment to furloughed employees would appear to comport with the FAQ, which was released more than six weeks after the CARES Act was enacted. Aggregation For purposes of the ERC, all members of an aggregated group under IRC Sections 52(a) or (b), or IRC Sections 414(m) or (o) are treated as a single employer. The FAQs clarify that this aggregation will impact:
Implications It was widely anticipated that the aggregation rules would apply for the purposes identified in the FAQs. The fact that the aggregated group is disqualified from the ERC if a member receives a PPP loan is significant. A FAQ was added by the IRS specifically providing that an employer who repays a loan by May 7 will be eligible for the ERC if the employer qualifies. The PPP repayment date has been automatically extended to May 14 by Small Business Administration FAQ 43, but as of this writing the FAQ on the ERC continues to refer to the May 7 repayment date. ———————————————
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