Exploring the Contours of the Employee Retention Credit
In an effort to incentivize businesses to retain employees during the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law by President Trump on March 27, 2020, offers incentives to businesses in the form of fully refundable tax credits.
The Internal Revenue Service has provided guidance on the new credits through Notice 2020-22 (the Notice) and through Frequently Asked Questions (FAQs). In this client alert, we have synthesized in a question-and-answer format information from the CARES Act, the Notice and the FAQs.
What are the eligibility requirements for employee retention credits?
To be eligible to receive employee retention credits, employers must satisfy the following requirements:
- Cannot have obtained a Paycheck Protection Program (PPP) “forgivable” loan;
- Must be carrying on a trade or business during 2020; and
- Operations of the employer are fully or partially suspended as a result of a governmental order that limits commerce, travel or group meetings (for commercial, social, religious or other purposes) in any calendar quarter as a result of the pandemic or
- The employer experiences a “significant decline in gross receipts” during the calendar quarter.
Nonprofit organizations are eligible for this relief and are also not subject to the significant decline in gross receipts requirement.
Neither governmental employers nor self-employed individuals, with respect to their own self-employment income, are eligible for employee retention credits.
When are operations suspended by a governmental authority?
What it means to have operations fully or partially suspended by a governmental authority is not particularly clear. One of the FAQs indicates that an employer may suffer from a partial suspension of operations even if the business can still continue to operate but not at its normal capacity. That FAQ then considers an arguably obvious example whereby a state governor issues an executive order closing all restaurants, bars, and similar establishments to reduce the spread of COVID-19 but those establishments are permitted to continue food or beverage sales to the public on a carry-out, drive-through or delivery basis. Less clear are cases in which a business shifts to a remote-work setting as a result of a governmental stay-at-home or similar order (such as the March 23, 2020 order to Massachusetts businesses issued by Governor Baker) but that are continuing to operate. It may be telling that the IRS used the dining example rather than other examples that have been used in similar situations in the past. Additional clarity would certainly be appreciated.
How is a "significant decline in gross receipts" measured?
A significant decline in gross receipts occurs in the first calendar quarter of 2020 in which the business’s gross receipts are less than 50% of the gross receipts for that same calendar quarter of 2019. The business is no longer considered to have a significant decline in gross receipts after a 2020 calendar quarter in which gross receipts are in excess of 80% of the gross receipts for that same calendar quarter in 2019.
How are employee retention credits claimed?
An employer can claim employee retention credits for an applicable quarter by not depositing the employer portion of Social Security taxes (6.2% of wages up to the 2020 Taxable Wage Base of $137,700) in an amount equal to 50% of an employee’s "qualified wages." (Note that the employer must still deposit the employer share of Medicare taxes, and federal income and Social Security and Medicare taxes withheld from the employee.)
The maximum amount of qualified wages that an employer can take into account for all quarters is $10,000 per employee. As a result, the maximum credit available to an employer with respect to any individual employee is the lesser of $5,000 or 50% of the employee’s qualified wages.
If the amount of employee retention credits that an employer is entitled to is more than the corresponding quarterly employer portion of Social Security taxes, the excess is treated as an overpayment. An employer can obtain a refund of this amount, after first applying any excess to the employer’s remaining quarterly employment tax liability, by filing new Form 7200. Form 7200 is the same form that is used to obtain a refund for the new Emergency Family and Medical Leave and Paid Sick Leave credits that were enacted as part of the Families First Coronavirus Response Act (FFCRA).
Alternatively, the Notice provides that an employer can use all withheld amounts within a quarter (including the employer share of Medicare taxes, and federal income and Social Security and Medicare taxes withheld from employees) to fund qualified wages so long as those wages are paid prior to the time the deposit of the withheld amounts would otherwise be required without any failure to deposit penalty provided the requirements of the Notice are satisfied.
What are qualified wages?
The starting point for qualified wages is the definition of wages used for purposes of the Social Security tax (Box 3 of Form W-2). The following adjustments are then made –
- Only amounts paid after March 12, 2020 and before January 1, 2021 may be included.
- "Qualified health plan expenses," such as the employer’s cost of coverage, are included (or, stated differently, added back to the Box 3 amount).
- An employer must exclude any wages taken into account for purposes of determining Emergency Family and Medical Leave and Paid Sick Leave tax credits under FFCRA. (An employer can benefit from employee retention credits and the tax credits provided in FFCRA, but, not surprisingly, not for the same wages. Other limitations also exist, such as the prohibition of the credit with respect to wages for which the Work Opportunity Credit is claimed.)
For employers who employed on average 100 or less full-time employees in 2019 (full-time meaning for this purpose that the individual was employed on average at least 30 hours per week), the qualified wages of all employees are available for purposes of claiming the credit.
For larger employers, only the qualified wages of employees who are not providing services as a result of a suspension of the employer’s operations resulting from the pandemic or due to a significant decline in gross receipts are available for purposes of claiming the credit, and in this situation the amount cannot exceed what the employee would have been paid for working for an equivalent duration during the 30 days immediately preceding the economic hardship.
In determining whether an employer is small or large for this purpose, an expansive aggregation rule applies that can result in parent-subsidiary and brother-sister affiliations using a more than 50% ownership test (rather than an at least 80% ownership test). The affiliated service group rules of Internal Revenue Code Section 414(m), as well as the anti-abuse rules of Internal Revenue Code Section 414(o), also apply.
The following chart may be helpful in determining whether and how employee retention credits might apply.
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Sullivan has developed a rapid response team of attorneys to help our clients and our communities cope with the impact of the COVID-19 pandemic and understand the implications of the CARES Act and other actions taken by state governments and the federal government. Please refer to Sullivan’s newly launched resource center at www.sullivanlaw.com/COVID19 for more information and for access to Sullivan’s library of related advisories.
Please know that Sullivan is focusing substantial efforts to provide assistance to businesses and individuals affected by COVID-19 and benefited by the CARES Act. If you have questions about how to move forward and navigate the novel legal issues raised by COVID-19 and/or the CARES Act, please contact your primary Sullivan attorney or send a message to CARES@sullivanlaw.com.