Frequently Asked Questions: Employee Retention Credit
On April 29, 2020, the IRS released additional frequently asked questions (FAQ) on the Employee Retention Credit (ERC). In light of this new guidance, we’ve compiled the top questions we’ve received on the ERC.
The ERC is a fully refundable tax credit for employers equal to 50 percent of qualified wages (including allocable qualified health plan expenses) that eligible employers pay their employees. This credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000; therefore, the maximum credit for an eligible employer for qualified wages paid to any employee is $5,000.
1. How do I know if my business has been fully or partially suspended due to a governmental order?
According to IRS FAQ 28, orders, proclamations or decrees from the federal government or any state or local government are considered “orders from an appropriate governmental authority” if they limit commerce, travel or group meetings due to the SARS-CoV-2 virus and incidence of COVID-19 in a manner that affects an employer’s operation of its trade or business. This includes orders that limit hours of operation from a state or local government that has jurisdiction over the employer’s operations.
Governmental orders include:
- An order from the city’s mayor stating that all nonessential businesses must close for a specified period
- A state’s emergency proclamation that residents must shelter in place for a specified period, other than residents who are employed by an essential business and may travel to and work at the workplace location
- An order from a local official imposing a curfew on residents that affects the operating hours of a trade or business for a specified period
Note that statements from a governmental official, including comments made during press conferences or media interviews, don’t rise to the level of a governmental order for purposes of the ERC. In addition, a state of emergency declaration by a governmental authority isn’t sufficient to rise to the level of a governmental order if it doesn’t limit commerce, travel or group meetings in any manner.
If a governmental order closes an employer’s workplace, but the employer is able to continue operations comparable to its operations before the closure by requiring its employees to telework, the employer’s operations aren’t considered to have been fully or partially suspended as a consequence of a governmental order (IRS FAQ 33). Alternatively, if the employer’s workplace remains open for other purposes or the employer is able to continue certain operations remotely, the employer’s operations would be considered to be partially suspended (IRS FAQ 34).
An employer that reduces its operating hours due to a governmental order is considered to have partially suspended its operations since the employer’s operations have been limited by a governmental order (IRS FAQ 35).
The IRS FAQs provide examples for restaurant and retail businesses (see IRS FAQ 34), where it appears the key is that even though a business may be able to continue operating in some fashion, e.g., delivery service or online, the fact that a government order limits the business’s ability to operate as it normally would, e.g., no dine-in service or closing a retail store, should qualify an employer for the credit.
According to IRS FAQ 30, an essential business isn’t considered to have a full or partial suspension of operations if the government order allows the employer to remain open, even though the governmental order requiring nonessential businesses to close may have an effect on the essential business’s operations. However, an employer with an essential business may be considered to have a full or partial suspension of operations if the business’s suppliers are unable to make deliveries of critical goods or materials due to a governmental order that causes the supplier to suspend its operations (IRS FAQ 31).
If an employer with an essential business can’t be considered an eligible employer as a result of a full or partial suspension of its operations due to a governmental order, the employer still may be considered an eligible employer if it experiences a significant decline in gross receipts. For more information on what constitutes a significant decline in gross receipts, see the IRS FAQs on determining when an employer is considered to have a significant decline in gross receipts.
2. May an eligible employer that averaged more than 100 full-time employees during 2019 treat the wages paid to employees for hours for which they are not providing services as qualified wages for purposes of the ERC?
Yes. For an eligible employer that averaged more than 100 full-time employees in 2019, wages paid to hourly and nonexempt salaried employees for hours that the employees weren’t providing services would be considered qualified wages for the purposes of the ERC. An employer may use any reasonable method to determine the number of hours that an employee isn’t providing services. For more guidance on reasonable methods, see IRS FAQ 54 for hourly and nonexempt salaried employees and IRS FAQ 55 for salaried employees.
Note that it’s not reasonable for an employer to treat an employee’s hours as having been reduced based on an assessment of the employee’s productivity levels during the hours the employee is working. Wages paid to employees for hours for which they provided services aren’t considered qualified wages for purposes of the ERC.
3. May an eligible employer treat wages paid to employees pursuant to a pre-existing vacation, sick and other personal leave policy as qualified wages for purposes of the ERC?
According to IRS FAQ 56, if an employer averaged more than 100 full-time employees in 2019, the employer may not treat amounts paid to employees for paid time off for vacations, holidays, sick days and other days off as qualified wages. However, if the employer averaged 100 or fewer full-time employees 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 vacation, sick and other leave policy, may be qualified wages for purposes of the ERC (unless the wages are qualified sick and/or family leave wages under sections 7001 and 7003 of the Families First Coronavirus Response Act (FFCRA)).
4. How are the quarterly gross receipts determined for ERC eligibility, if gross receipts vary each quarter?
The ERC is claimed on a quarterly basis, so an employer’s eligibility for the credit and the credit amount will vary by quarter. Per the example in IRS FAQ 39, assume an employer’s gross receipts were $100,000, $190,000 and $230,000 in the first, second and third calendar quarters of 2020, respectively. Its gross receipts were $210,000, $230,000 and $250,000 in the first, second and third calendar quarters of 2019, respectively. Thus, the employer’s 2020 first-, second- and third-quarter gross receipts were approximately 48 percent, 83 percent and 92 percent of its 2019 first-, second- and third-quarter gross receipts, respectively.
Accordingly, the employer had a significant decline in gross receipts commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50 percent of the same quarter in 2019) and ending on the first day of the third calendar quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80 percent of the same quarter in 2019). Thus, the employer is entitled to a retention credit with respect to the first and second calendar quarters.
5. May an eligible employer receive both the ERC and a Small Business Interruption Loan under the Paycheck Protection Program (PPP) that is authorized under the CARES Act?
No. An eligible employer may not receive the ERC if the employer receives a Small Business Interruption Loan under the PPP that is authorized under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). An eligible employer that receives a PPP loan shouldn’t claim the ERC. IRS FAQ 81 further clarifies that even after a PPP loan is forgiven, the employer may not receive an ERC, regardless of whether and when the loan is forgiven.
Note, on May 7, 2020, the IRS released guidance in FAQ #79 that a business that applied for a PPP loan, received payment and repaid the loan by May 14, 2020, is eligible for the ERC.
6. If I’m eligible for the SBA PPP and the ERC, which option is best for my business?
With all the different cash flow and tax relief options available through recent COVID-19 legislation, businesses should consult with their financial and tax advisors to determine the best options available to their circumstances and business needs. We’ve put together this flowchart to help provide an overview of your options. Our COVID-19 Response Guide also provides further guidance for business leaders on the best response options during this global pandemic.
When deciding between the ERC and the PPP loan, keep in mind that if an employer has 100 or fewer employees, the ERC can be more beneficial as you can take 50 percent of wages (subject to a $10,000 wage limit per employee) on all employees. If an employer has more than 100 employees, the ERC is only available for wages paid to an employee who cannot provide services to the employer due to an economic hardship.
7. How should the ERC be reported?
According to IRS FAQ 73, eligible employers will report their total qualified wages for purposes of the ERC for each calendar quarter on their Form 941, Employer’s Quarterly Federal Tax Return.
Eligible employers that paid any qualified wages between March 13, 2020, and March 31, 2020, inclusive, should include 50 percent of those wages together with 50 percent of any qualified wages paid during the second quarter of 2020 on their second quarter Form 941, 941-SS or 941-PR to claim the ERC. Employers shouldn’t include the credit on their first quarter Form 941, 941-SS or 941-PR.
On April 29, 2020, the IRS released a draft updated Form 941, which includes lines for claiming the payroll tax credits under the CARES Act and the FFCRA. Draft form instructions for the updated Form 941 can be found here.
In anticipation of receiving the ERC, eligible employers can fund qualified wages by: (1) accessing federal employment taxes, including withheld taxes that are required to be deposited with the IRS and (2) requesting an advance of the credit from the IRS for the amount of the credit that isn’t funded by accessing the federal employment tax deposits by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19.
8. Does an eligible employer receiving an ERC for qualified wages need to include any portion of the credit in income?
No. An employer receiving a tax credit for qualified wages, including allocable qualified health plan expenses, doesn’t include the credit in gross income for federal income tax purposes. Neither the portion of the credit that reduces the employer’s applicable employment taxes nor the refundable portion of the credit is included in the employer’s gross income.
However, Section 2301(e) of the CARES Act provides that rules similar to section 280C(a) apply for purposes of applying the ERC. Section 280C(a) of the Code generally disallows a deduction for the portion of wages paid equal to the sum of certain credits determined for the taxable year. Accordingly, a similar deduction disallowance would apply under the ERC, such that an employer's aggregate deductions would be reduced by the amount of the credit as result of this disallowance rule.
9. If an employer sponsors a self-insured group health plan, how are the qualified health plan expenses of that plan allocated to the qualified wages?
An eligible employer that sponsors a self-insured group health plan may use any reasonable method to determine and allocate the health plan expenses, including (1) the COBRA applicable premium for the employee typically available from the administrator or (2) any reasonable actuarial method to determine the plan’s estimated annual expenses.
If the eligible employer uses a reasonable actuarial method to determine the estimated annual expenses of the plan, then rules similar to the rules for insured plans are used to determine the amount of health plan expenses allocated to an employee. That is, the estimated annual expense is divided by the number of employees covered by the plan, and that amount is divided by the average number of workdays during the year by the employees (treating days of paid leave as workdays and any day on which an employee performs any work as workdays). The resulting amount is the amount allocated to each day of qualified wages. Adjustments should be made for employee after-tax contributions.
10. May an employer treat its health plan expenses as qualified wages if it continues the employees' health care coverage but doesn’t pay the employees' wages for the time for which the employees aren’t providing services?
On May 7, 2020, the IRS updated FAQ 65 to clarify that an eligible employer with more than 100 full-time employees may treat its health plan expenses paid or incurred, after March 12, 2020, and before January 1, 2021, allocable to the time that the employees are not providing services as qualified wages. However, an eligible employer may not treat health plan expenses allocable to the time for which the employees are receiving wages for providing services as qualified wages; only the portion of health plan expenses allocable to the time that the employees are not providing services is treated as qualified wages.
For eligible employers with 100 or fewer full-time employees, health plan expenses also may be treated as allocable to the applicable periods as qualified wages even if the employees are not working and the eligible employer does not pay the employees any wages for the time they are not working.
Previously, IRS guidance indicated that employers could not treat health plan expenses as qualified wages for purposes of the ERC if the employer was not paying any wages to the employee.
Note that the IRS FAQ aren’t official guidance and, therefore, may not be relied on as legal authority. As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication.
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