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On May 7, 2020, the IRS released updated FAQs 64 and 65 on the employee retention credit (ERC), allowing employers to treat health care expenses for employees furloughed due to COVID-19 as qualified wages for purposes of the ERC, provided that the expenses are allocable to the time the employees are not providing services. As discussed in Tax Alert 2020-1221, the FAQs are not binding on the IRS or taxpayers but do represent the current thinking of the Treasury Department and IRS, which will be responsible for enforcement.

Background

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 (1) fully or partially suspend operations during any calendar quarter in 2020 due to governmental orders concerning COVID-19, or (2) experience a greater than 50% decline in gross receipts during any calendar quarter in 2020 compared to the same calendar quarter in 2019 (eligible employers). The credit equals 50% of qualified wages, taking into account up to $10,000 of qualified wages, for 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.

Qualified wages include qualified health plan expenses paid or incurred by the employer for group health plan coverage excludable under IRC Section 106(a). Under the CARES Act, these expenses are to be allocated to qualified wages as prescribed by Treasury.

In its explanation (JCX-12R-20 (April 23, 2020)) of the CARES Act, the Joint Committee on Taxation (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. Despite this, the original FAQs, which were published on April 29, 2020 (see Tax Alert 2020-1221), did not treat qualified health expenses as wages when the employees were not being paid.

In a letter to the Treasury Secretary dated May 4, 2020, Senate Finance Committee Ranking Member Ron Wyden (D-Ore.), Senate Finance Committee Chairman Charles Grassley (R-Iowa) and House Ways & Means Committee Chairman Richard E. Neal (D-Mass.), requested that the Treasury Department reverse course. In a reply letter dated May 7, 2020, the Treasury Department stated that it would revise the guidance.

Updated FAQs change treatment of health care expenses

Updated FAQ 64 now permits eligible employers with 100 or fewer full-time employees to treat health plan expenses allocable to the applicable periods as qualified wages even if the employees are not working and not being paid wages. The FAQ had previously treated qualified health plan expenses as qualified wages only if allocable to other qualified wages. The updated FAQ specifically addresses workers who have been furloughed or laid off in the following example:

Employer Z averaged 100 or fewer employees in 2019. Employer Z is subject to a governmental order that suspends the operation of its trade or business. In response to the governmental order, Employer Z lays off or furloughs all of its employees. It does not pay wages to its employees for the time they are laid off or furloughed and not working, but it continues the employees' health care coverage. Employer Z's health plan expenses allocable to the period its operations were partially suspended may be treated as qualified wages for purposes of the Employee Retention Credit.

Updated FAQ 65 allows employers with more than 100 employees to treat the portion of health plan expenses allocable to the time that the employees are not providing services as qualified wages. The updated FAQ includes a similar example:

Employer C is subject to a governmental order that fully suspends the operations of its trade or business. Employer C lays off or furloughs its employees and does not pay wages to the employees, but does continue to cover 100 percent of the employees' health plan expenses. In this case, Employer C may treat as qualified wages the health plan expenses that are allocable to the time that the employees are not providing services.

Implications

Many employers were surprised the original FAQs did not take a cue from JCT's explanation and instead took the position that the ERC could not be claimed for health care coverage provided to employees furloughed due to COVID-19. The updated FAQs are an encouraging sign that the ERC is available to those employers, provided they satisfy the other eligibility conditions. Because the coverage qualifies only if the cost is borne by the employer, via salary reduction or otherwise, however, placing employees on unsubsidized COBRA continuation coverage would not qualify.

Some may view the change in IRS position on health care coverage as an encouraging sign that the positions taken in other FAQs may be reconsidered as well. On the other hand, one might infer that would be unlikely, given the unique circumstances under which the IRS reversed course on this issue.

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