What Do Stay-at-Home Order Expirations Mean for COVID-19 Tax Credits?
As states and local governments begin to lift stay-at-home orders, businesses are reopening their doors and employees are heading back to work. What does this mean for the tax relief provisions under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)? Are employers still eligible for payroll tax credits? Can employees still take paid sick leave under the Families First Coronavirus Response Act (FFCRA) after quarantine orders are lifted?
For an overview of available cash flow and tax relief options related to the SARS-CoV-2 virus and the incidence of COVID-19, click here. In this article, we’ll review the effect expirations of quarantine orders have on various COVID-19 tax relief provisions. We’ll also share some recent guidance from the IRS and U.S. Department of the Treasury (Treasury) that employers may consider to help their employees during this uncertain time.
Employee Retention Credit
The Employee Retention Credit (ERC) under the CARES Act encourages businesses to keep employees on their payroll. The refundable tax credit is 50 percent of up to $10,000 in wages paid by an eligible employer whose business has been financially affected by COVID-19. This credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021.
There are two ways to qualify for the ERC:
- The employer’s business operations are fully or partially suspended due to a governmental order
- The employer is experiencing a significant decline in gross receipts
In general, the first qualification is based on governmental orders that limit commerce, travel or group meetings due to COVID-19, including shelter-at-home orders. Therefore, as states and local governments begin to lift stay-at-home orders, the application of the ERC is expected to apply in more limited circumstances, i.e., primarily as a result of an employer experiencing a significant decline in gross receipts.
However, many state and local jurisdictions are lifting government orders in phases. That means even though businesses are opening back up, some municipalities are still limiting business hours of operation. Under IRS guidance to date, 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.
Therefore, businesses should review the language of all levels of government orders that may apply (city, county, state and federal) and compare those to the IRS guidance on what constitutes partial or full shutdowns due to government orders.
Alternatively, businesses also may continue to rely on the significant decline in gross receipts test for the remainder of 2020 to qualify for the employee retention credit. An employer is considered to have a significant decline in gross receipts beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50 percent of gross receipts from the same calendar quarter in 2019. The period of significant decline ends the earlier of January 1, 2021, or the first calendar quarter after the quarter for which gross receipts are greater than 80 percent of gross receipts for the same calendar quarter in 2019. This means if an employer qualifies for the ERC in the first, second or third quarter based on the significant decline in gross receipts test, it will automatically qualify for the subsequent as well.
Paid Sick Leave & Family Leave Tax Credits
The paid sick leave and expanded family medical leave tax credits are available to subsidize amounts paid by employers for employee leave taken due to COVID-19 reasons through December 31, 2020. There are six types of qualifying leave related to paid sick leave; however, only two of the qualifying reasons relate directly to a federal, state or local quarantine or isolation order: (1) The employee is unable to work or telework due to a quarantine order, or (2) the employee is unable to work or telework because they’re caring for someone who’s subject to a quarantine order. Thus, eligible employers may continue to provide paid sick leave and family medical leave for qualifying employees even after stay-at-home orders expire. Keep in mind, a quarantine order imposed on a specific person differs from a stay-at-home order imposed on an entire community.
Payroll Tax Deferral
Under the CARES Act, employers may defer the deposit and payment of the employer’s share of Social Security taxes and self-employed individuals may defer payment of certain self-employment taxes until 2021 and 2022. Since eligibility isn’t dependent on stay-at-home orders, businesses may continue to take advantage of these provisions through December 31, 2020, to help with cash flow needs during the COVID-19 crisis.
Nevertheless, employers should consider other tax implications of deferring payroll taxes into 2021 and 2022. In general, accrual basis taxpayers must meet the requirements of the all events test under Treasury Regulation Section 1.461-1(a)(2)(i) to make an accrued expense, like payroll taxes, deductible for tax purposes. As such, a taxpayer who chooses to defer payroll tax payments would likely not meet the all events test until the tax is paid in future tax years, i.e., 2021 or 2022, even though the tax was initially due in 2020 and would have otherwise been deducted on a company’s 2020 tax return had the taxes not been deferred.
Therefore, taxpayers who want to use this deferral opportunity for tax planning purposes other than, or in addition to, generating cash flow during the COVID-19 pandemic should consider paying a portion of or the full deferred amount in 2021 within the 8.5-month period allowed under the recurring item exception. This would allow the taxpayer to take the deduction on his or her 2020 tax return.
For example, this strategy could be beneficial for a corporation where the tax payment creates or increases a 2020 net operating loss (NOL) that can be carried back to a pre-2018 tax year with a potential tax rate of 34 percent. In some instances, this may be more beneficial than the time value of money savings on essentially having an interest-free loan by deferring the payroll taxes until December 31, 2021, and December 31, 2022, which comes at 21 percent tax benefit for the deduction.
As a refresher, the CARES Act suspends the 80 percent NOL limitation for tax years beginning in 2018 through 2020, and NOLs generated during that same period may be carried back up to five years. This means that businesses may be able to take advantage of a variety of tax planning opportunities to generate or increase NOLs. For example, some taxpayers can file accounting method changes for expenses like accrued bonuses or prepaid expenses, so the cumulative balance of qualifying expenses are deducted in the year of change.
Allowance for Midyear Changes to Health Coverage & Dependent Care Elections
As employees make their way back to the workplace, employers also may be considering other ways to help their teams during this uncertain time. Due to the nature of the public health emergency posed by COVID-19 and unanticipated changes in the need for medical care or dependent care assistance programs, some employers have indicated a willingness to offer employees the ability to adjust elections related to employer-sponsored health coverage and dependent care benefits. Under normal circumstances, elections regarding qualified benefits under a §125 cafeteria plan (including employer-provided health plans, health FSAs and dependent care assistance programs) must be irrevocable and made prior to the first day of the plan year.
In response to employers’ concerns, the IRS and Treasury recently issued Notice 2020-29, which permits employers to voluntarily amend their §125 cafeteria plans to allow employees to:
- Make a new election for employer-sponsored health coverage on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage
- Revoke an existing election for employer-sponsored health coverage and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis
- Revoke an existing election for employer-sponsored health coverage on a prospective basis, provided the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer
- Revoke, make or modify an election regarding a health FSA on a prospective basis
- Revoke, make or modify an existing election regarding a dependent care assistance program on a prospective basis
Notice 2020-29 also provides additional flexibility for employees to apply unused amounts in health FSAs or dependent care assistance programs to eligible expenses incurred through December 31, 2020. The IRS and Treasury also released Notice 2020-33, which allows employers to amend their §125 cafeteria plans to increase the maximum carryover amount for a plan year from $500 to $550.
Employers seeking to amend their §125 cafeteria plans for the 2020 plan year must adopt their changes on or before December 31, 2021. Such changes may be effective retroactively to January 1, 2020, provided the plan operates in accordance with Notice 2020-29 or Notice 2020-33, as applicable. Employers also must inform all employees eligible to participate in the plan of any changes made. Finally, employers must ensure any amendments to their §125 cafeteria plans maintain compliance with other applicable laws, such as Title I of the Employee Retirement Income Security Act of 1974.
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. Reach out to your BKD Trusted Advisor™ or use the Contact Us form below if you have questions about these changes to the §125 cafeteria plan rules or for help determining which of the above-mentioned planning strategies may be beneficial for your business.