Employers may qualify under the CARES Act to receive a credit (the “credit” sometimes referred to as the “retention credit”) for certain qualified wages paid to its workforce if certain requirements are met. Even though the IRS recently released FAQs about this retention credit program, many questions still remain with respect to which employers qualify for the credit and some employers are still struggling to decide whether they can or should utilize the credit. This provides thoughts about how to mitigate risks associated with utilizing the credit for employers that, despite the release of the FAQs, remain uncertain that they would be considered an “eligible employer” under the program. Ultimately, as long as an employer has a good faith basis for claiming the credit, the benefits associated with claiming the credit likely outweigh the risks associated with being found to be ineligible, particularly if the employee averaged more than 100 full-time employees in 2019.
What is the Retention Credit?
The CARES Act provides a refundable payroll tax credit for 50% of “qualified wages” paid or incurred from March 13, 2020 through December 31, 2020 by any “eligible employer.” Among other limitations, the credit is limited to $10,000 of “qualified wages,” including qualified health plan expenses allocable to wages, per employee, which results in a maximum credit of up to $5,000 per employee.
For “eligible employers” averaging more than 100 full-time employees during 2019, “qualified wages” are generally wages paid to employees during the period in which they are not providing services for the period that the employer is an “eligible employer,” and for eligible employers that averaged 100 or fewer full-time employees during 2019, “qualified wages” are generally wages paid to all employees, regardless of whether an employee is providing services, for the period that the employer is an “eligible employer.
How Does the Credit Work?
For an “eligible employer,” the credits are fully refundable. Thus, for any calendar quarter in which the amount of the credit exceeds the employer’s portion of Social Security tax on all wages paid to all employees, the excess is treated as an overpayment and refunded to the employer. In order to claim the credit and refund, an eligible employer can apply such credit against all federal employment taxes, including taxes withheld on behalf of employees, that are required to be deposited with the IRS with respect to such quarter. If the credit is not able to be funded by accessing the employment tax deposits, an employer can request an advance of the credit from the IRS by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19.
What Constitutes an “Eligible Employer”?
An employer is generally an “eligible employer” if:
- The employer carries on a trade or business in 2020;
- The employer did not receive a loan under the Paycheck Protection Program; and
- One of the following tests is satisfied:
- During any calendar quarter for which the employer’s operations were fully or partially suspended due to orders from a governmental authority limiting commerce, travel or group meetings due to COVID-19 (the “government suspension test”) or
- Beginning with the first calendar quarter after December 31, 2019 for which the employer’s gross receipts are less than 50 percent of the employer’s gross receipts for the same calendar quarter in the prior year and ending with the calendar quarter following the first calendar quarter for which the employer’s gross receipts are greater than 80 percent of the employer’s gross receipts for the same quarter in the prior year.
For purposes of applying the various rules and limitations for this credit, all persons treated as a single employer under Sections 52(a), 52(b), 414(m) or 414(o) of the Internal Revenue Code of 1986, as amended, are treated as a single employer.
Qualified Wages: Can an Eligible Employer Claim the Credit for Qualified Health Plan Expenses for Employees who are Not Otherwise Being Paid?
Based on the language of the CARES Act, many eligible employers have been claiming the credit for qualified health plan expenses of employees who are not otherwise being paid wages (for example, furloughed employees for whom the employer continues to provide medical insurance). However, the FAQs provide that an eligible employer may claim the credit for qualified health plan expenses with respect to the amount that is allocable to the hours for which the employees receive other qualified wages. That means that an eligible employer that lays off or furloughs its employees and continues the employees’ health care coverage, but does not pay the employees any wages for the time they are not working, may not treat the health plan expenses as qualified wages for purposes of the retention credit program.
However, many, including lawmakers and the U.S. Chamber of Commerce, are urging the Treasury Department and IRS to reconsider and revise its guidance on this issue. Given that such position goes against an analysis of the credit previously released by the Staff of the Joint Committee on Taxation (the “JCT”) in its description of the tax provisions in the CARES Act, which was released on April 22, 2020 (the “CARES Act Description”), and that many employers have already claimed the credit for such health plan expenses, we will be closely monitoring this issue to see if the Treasury Department and IRS ultimately change course.
The Government Suspension Test: What Does it Mean to be Fully or Partially Suspended due to Government Orders?
The FAQs provide several examples of employers who meet the government suspension test, including:
- an employer that is required by government order to close its workplace for certain purposes, but remain operational for limited purposes, such as a restaurant, bar or similar establishment that provided full sit-down service or on-site eating facilities in a state in which the governor issued an executive order closing all restaurants, bars and similar establishments other than for carry-out, drive-through or delivery,
- an employer that is required by government order to reduce its operational hours, and
- an employer that operates a trade or business in multiple locations that is subject to a government order requiring full or partial suspension of its operations in some jurisdictions, but not others.
Another example of employers who may meet the government suspension test are essential businesses with suppliers that are unable to make deliveries of critical goods or materials due to a government order that causes the supplier to suspend its operations. However, an essential business is not considered to meet the government suspension test for the sole reason that its customers are subject to a government order requiring them to stay home.
In the CARES Act Description, the JCT provided an example of an employer who meets the government suspension test as an accounting firm that is in a county where accounting firms are among businesses subject to a directive from public health authorities to cease all activities other than minimum basic operations and that closes its offices and does not require employees who cannot work from home (for example, custodial employees or mail room employees) to work or provide other services. Since this example does not discuss or mention the impact of the governmental work from home order on the accounting firm’s business, this example appears to provide support for the conclusion that an employer qualifies for the credit if the employer is paying compensation to employees who are not working, even if the employer’s business may not otherwise be materially impacted by the shutdown. This is bolstered by the fact that the IRS FAQs also include as an example of an employer that meets the government suspension test an employer with a workplace that is closed by government order for certain purposes but that remains open for other purposes or an employer that is able to continue certain operations remotely.
However, the IRS FAQs raise questions as to whether the Treasury Department and the IRS would consider the accounting firm to meet the government suspension test. The IRS FAQs included an answer that an employer did not meet the government suspension test if the employer closes its workplace pursuant to government order but is able to continue operations comparable to the closure by requiring its employees to telework. The example used to illustrate this principle is a software development company that must close its office pursuant to government order that, prior to the order, allowed all of its employees to telework once or twice per week and that, in response to the order, required all of its employees to telework. The example concluded that the software company’s operations are not considered to be fully or partially suspended by the governmental order because its employees may continue to conduct its business operations by teleworking.
Because the example specifically references “all” employees and pertained to a company in which teleworking was a common practice across the entire workforce prior to the governmental order, it is unclear whether this FAQ and example is meant to override the description and the accounting firm example provided by the JCT. This uncertainty surrounding government suspension test leads to the question about the risks to an employer of claiming the credit if such employer is ultimately determined to be ineligible to claim the credit because the employer does not satisfy such test.
What are the Risks of Claiming the Employee Retention Credit if an Employer is Ultimately Deemed Ineligible?
The risk of claiming the credit and ultimately not being deemed an eligible employer is that such employer could be subject to penalties for failure to timely deposit employment taxes and ultimately be required to pay such employment taxes together with any applicable penalties.
Employers are generally required to deposit employment taxes on a monthly or bi-weekly basis and are subject to penalty for any failure to deposit such amounts unless such failure is due to reasonable cause and not due to willful neglect. The CARES Act provides that the Secretary of the Treasury shall waive any such penalty if the Secretary determines that such failure was due to the “reasonable” anticipation of the credit, and IRS Notice 2020-22 provides such relief, specifying that an eligible employer will not be subject to such penalty for failure to deposit employment taxes relating to “qualified wages” in a calendar quarter to the extent the amounts not deposited are equal to or less than the amount of the employer’s anticipated tax credits and the employer does not seek an advance payment of the credit.
How Significant is this Risk?
This answer will depend on what is considered to be “reasonable” when anticipating reliance on the credit. However, this risk may be negligible for certain employers.
For example, any employer that qualifies for the federal payroll deferral tax program pursuant to the CARES Act (see our insight on Key Tax Relief Provisions of the CARES Act where we discuss the deferral program) and whose claimed credit does not exceed the employer’s share of federal Social Security taxes for all of its employees (i.e., such employer is not requesting an advance or refund of the credit and will not miss any federal employment tax deposit deadlines) should not face any significant risk of penalties. Since the deferred payroll taxes will ultimately become due on December 31, 2021 and December 31, 2022, presumably, an employer should have a better understanding as to whether it qualifies as an eligible employer by such time.
Employers that are planning to fund the credit with other federal employment tax deposits and are uncertain whether they qualify as “eligible employers” should take a closer look as to whether their anticipation of relying on the credit seems “reasonable.” Employers that averaged more than 100 full-time employees in 2019 and that are using those amounts to continue to pay employees who are not providing services due to COVID-19 related reasons appear to have a strong argument from a policy perspective that their anticipation is reasonable under the theory that the CARES Act is intended to incentivize employers to continue to pay workers who cannot provide services due to the pandemic. This position is supported by JCT in the accounting firm example and, due to the specific facts set forth in the software development company example in the IRS FAQs, arguably the IRS has not taken a different view at this time.
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