COVID Regulatory and Tax Updates
Additional Clarification: CARES Act Employee Retention Credit
- The IRS recently added FAQs to address several questions specific to the employee retention credit.
- Employers that repay a PPP loan by May 7, 2020 are eligible for the credit.
- Essential businesses are generally not suspended; employers able to continue comparable operations are not suspended.
- You can claim the credit retroactively.
Unsure how the employee retention credit applies?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act created the employee retention credit to help employers during the COVID-19 pandemic. Could the credit help you?
We’ve summarized the employee retention credit and the frequently asked questions (FAQs) recently released by the IRS to address widespread questions.
The fundamentals of the CARES Act employee retention credit
The CARES Act added a refundable payroll tax credit equal to 50% of certain compensation paid from March 13, 2020, to December 31, 2020. To qualify, your organization must either have had its:
- Operations fully or partially suspended due to a COVID-19-related shutdown order, or
- Gross receipts decline by more than 50% when compared to the same quarter of the prior year.
If your organization has more than 100 employees, the credit is available only for compensation paid to employees who are not working as a result of one of the two situations listed above. If your organization has 100 or fewer employees, any compensation paid during the period when the operations were affected by one of the two scenarios is eligible for the credit, even if it’s paid to an employee who is still working.
The credit is limited to the first $10,000 of compensation paid to a particular worker. The credit is not available for compensation taken into account in computing the sick leave or family medical leave credits under the Families First Coronavirus Response Act (FFCRA). Similarly, the credit is not available to employers who take advantage of a small business interruption loan under the Paycheck Protection Program (PPP).
Additional IRS FAQs
Employers that repay a PPP loan by May 7 are eligible for the credit
The Treasury is allowing employers to repay a PPP loan by May 7, 2020. Employers that repay a PPP loan by that deadline will be considered to have made the initial certification of need in good faith. According to the IRS, employers that repay a PPP loan by the May 7 deadline will be eligible for the employee retention credit if they otherwise meet the eligibility requirements for the credit.
IRS clarifies definition of fully or partially suspended
Essential businesses are generally not suspended
Many questions have surfaced regarding whether an employer’s operations are fully or partially suspended due to a COVID-19 related shutdown order. In the recently issued FAQs, the IRS confirms essential businesses subject to a governmental order do not meet the fully or partially suspended qualification. The IRS reminds employers that even if they do not meet the full or partial suspense of operations test, the employer may qualify on the basis of the more than 50% decline in gross receipts test.
The IRS also clarifies there are specific facts and circumstances that may cause an essential business to be fully or partially suspended. If a governmental order causes a supplier to be unable to make deliveries of critical goods or materials to an essential business, the essential business may meet the fully or partially suspended qualification. An employer required to reduce its operating hours due to a governmental order could be considered partially suspended.
Employers able to continue comparable operations are not suspended
Consider whether you are able to continue operations comparable to operations before the governmental shutdown order went into effect. Even if you had to close your workplace, if requiring employees to telework allows you to continue operations comparable to operations prior to the closure, your organization is not considered fully or partially suspended.
Only wages paid during order qualify
Eligibility for the employee retention credit is determined on a quarterly basis. What happens when a governmental shutdown order is lifted? According to the IRS, when an order is lifted, the employer only gets the credit in the calendar quarters in which the trade or business operations were fully or partially suspended. However, if the order was effective for a portion of the calendar quarter, the employer is eligible for the entire quarter but can only claim a credit for wages paid during the period the order is in force.
The IRS provides the following example:
Example: State Y issued a governmental order for all non-essential businesses to close from March 10 through April 30 and the governmental order was not extended. Pursuant to the order, Employer H, which operates a non-essential business in State Y, closes from March 10 through April 30. Employer H is an Eligible Employer in the first quarter (for wages paid from March 13, the effective date of section 2301 of the CARES Act, through March 31) and the second quarter (for wages paid from April 1 through April 30).
IRS clarifies decline in gross receipts
The IRS clarifies that “gross receipts” generally include total sales (net of returns and allowances) and all amounts received for services. Gross receipts may also include income from investments and from incidental or outside sources. The IRS includes the following examples of gross receipts:
The IRS cautions that gross receipts are generally not reduced by cost of goods sold, but are generally reduced by the adjusted basis in capital assets sold. Items not considered gross receipts include repayment of a loan or amounts received with respect to sales tax remitted to a taxing ity.
How the credit is determined on a quarterly basis
The IRS example below highlights that the maximum credit must be determined on a quarterly basis.
Example: Employer N pays $8,000 in qualified wages to Employee B in the second quarter 2020 and $8,000 in qualified wages in the third quarter 2020. The credit available to Employer N for the qualified wages paid to Employee B is equal to $4,000 in the second quarter and $1,000 in the third quarter due to the overall limit of 50 percent of $10,000 of qualified wages per employee for all calendar quarters.
When qualified health plan expenses are not qualified wages
The IRS confirms that when an employer does not pay wages to its employees for the time they are not working, but continues paying for health care coverage for the employees, the health plan expenses are not qualified wages. For example, an employer furloughs all its employees but continues health coverage for the employees. The employer cannot claim an employee retention credit based solely on the qualified health plan expenses, because there are no wages to which expenses are allocated.
Credit reduces federal income tax deductions
The IRS confirms that an employer that claims an employee retention credit will be disallowed a deduction equal to the amount of the credit. That means the employer’s aggregate deductions will be reduced by the amount of the credit. An employer, likewise, will not include the credit in gross income for federal income tax purposes.
Claiming the credit for the first quarter of 2020
The credit applies to qualified wages paid starting March 13, 2020. An employer may be eligible for the credit in the first quarter of 2020. The IRS clarifies that an employer that pays qualified wages in the first quarter of 2020 should report those wages on the Form 941, Employer’s Quarterly Federal Tax Return for the second quarter of 2020 for purposes of calculating the employee retention credit.
Employer can claim the credit retroactively
Some employers have asked whether they can claim the employee retention credit retroactively. For example, an employer may not determine until the third quarter of 2020 that its gross receipts declined by more than 50% in the second quarter of 2020 compared to the second quarter of 2019. The IRS says in this scenario, the employer can file a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund for the second quarter of 2020 to claim the credit.
How we can help
Unforeseen disruptions — from the coronavirus (COVID-19) to natural disasters — can create many uncertainties. CLA has developed resources to help you lay out a strategy to put your organization on its toes versus its heels. Bookmark our financial management and disaster relief resource page to stay current on these issues.
- Chastity Wilson
- Managing Principal of Tax