Locke Lord QuickStudy: CARES Act Guide: Overview of IRS Guidance Regarding the Employee Retention Credit

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law on March 27, 2020. Section 2301 of the CARES Act provides for a refundable payroll tax credit (the “Retention Credit”) for 50% of “qualified wages” paid by “eligible employers” to employees from March 13, 2020 through December 31, 2020. The Retention Credit is designed to incentivize employers to retain employees during suspended or ‎declining business operations due to the COVID-19 crisis.

For Locke Lord’s initial summary of the Retention Credit, and an overview of other key business tax provisions in the CARES Act, please see Locke Lord Quick Study: UPDATE: CARES Act Guide: Overview of Key Business Tax Provisions. On April 29, 2020, the IRS released additional guidance regarding the Retention Credit in the form of “Frequently Asked Questions” ‎(hereinafter referred to as the “FAQ”).¹ This QuickStudy is intended to expand upon our previous QuickStudy and to provide a summary of this recent IRS guidance.

Eligible Employers

In General

Generally, the Retention Credit is available to employers that carry on a “trade or business” ‎during the 2020 calendar year (including tax-exempt organizations) that either:  ‎

🠊Fully or partially suspend operations during any calendar quarter in 2020 due to orders from an ‎appropriate governmental authority; or

🠊Experience a significant decline in gross receipts during the calendar quarter. ‎

Certain “aggregation rules” apply in determining which entities are eligible employers.  In addition, a ‎tax-exempt organization described in Section 501(c) of the Internal Revenue Code, as amended (the “Code”) is deemed to be engaged in a “trade or business” with respect to all ‎operations of the organization. 

FAQ Highlights:

• General income tax principles apply to determine whether an activity qualifies as a “trade or ‎business” for purposes of the Retention Credit. ‎
• All entities that are treated as a single employer under Section 52(a) or (b) of the Code or Section 414(m) or (o) of the Code are considered one employer, or an “aggregated group,” for purposes of the Retention Credit.  If an employer group with multiple payrolls applies for the Retention Credit, the amount of the Retention Credit must be apportioned among members of the aggregated group on the basis of each member’s proportionate share of the qualified wages giving rise to the credit.

Excluded Employers

The CARES Act states that certain employers are not eligible employers for purposes of the ‎Retention Credit, including the federal government, the governments of any state or political subdivision thereof, any ‎agency or instrumentality of those governments, and self-employed individuals. 

FAQ Highlights:

🠊If a tribe or tribal entity operates a trade or business, the tribe or tribal ‎entity may be an Eligible Employer.

🠊Although self-employed individuals are not eligible for the Retention Credit with respect to their own self-‎employment earnings, they may be eligible for the Retention Credit with respect to wages paid to other employees.

🠊Household employers are not considered to operate a trade or business and, therefore, are not eligible for the Retention Credit with respect to their household employees. ‎

Fully or Partially Suspended Operations

An employer may be treated as an eligible employer for purposes of the Retention Credit if its operations are fully or partially suspended during a calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19. 

FAQ Highlights:

🠊The operation of a trade or business is “partially suspended” if an appropriate governmental authority imposes restrictions on the employer’s operations such that the employer can still continue some, but not all, of its typical operations.

• An employer that is forced to reduce its operating hours due to a governmental order is considered to have partially suspended its operations.
• Employers who voluntarily suspend operation of a trade or business or reduces hours are not eligible for the Retention Credit on the basis of a fully or partial suspension of its operations.
• If an employer’s workplace is closed by a governmental order, but the employer is able to continue operations by requiring its employees to work remotely, the employer’s operations are not considered to have been fully or partially suspended.

🠊Orders, proclamations, or decrees from the federal government, or a state or local government are considered “orders from an appropriate governmental authority” if they limit commerce, travel, or group meetings due to COVID-19 in a manner that affects an employer's operation of its trade or business.

• For an order issued by a state or local government to apply to an employer, that state or local government must have jurisdiction over the employer’s operations.
• Statements such as comments made during press conferences do not rise to the level of a governmental order for purposes of the Retention Credit.
• Generally, if a business is allowed to stay open under a governmental order, the effect that other business closures have on an employer’s operations will not be considered to be a full or partial suspension of operations for purposes of the Retention Credit.
• An employer may be considered to have a full or partial suspension of operations if the business’ suppliers are unable to make deliveries of critical goods or materials due to a governmental order.

🠊If an employer’s workplace is closed for certain purposes, but is allowed to remain open for other purposes, the employer’s operations may be considered partially suspended.

🠊Employers that operate a trade or business in multiple locations and are subject to a governmental order requiring full or partial suspension of its operations in some jurisdiction, but not in others may be considered to have a partial suspension of operations.

🠊If a trade or business is operated by multiple members of an aggregated group and if the operations of one member of the aggregated group are suspended by a governmental order, then all members of the aggregated group will be considered to have their operations partially suspended, even if another member of the group is in a jurisdiction that is not subject to a governmental order.

Significant Decline in Gross Income

An employer may be entitled to the Retention Credit if it has experienced a significant decline in gross receipts.

FAQ Highlights:

🠊An employer is considered to have a significant decline in gross receipts for the period beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50% of the gross receipts from the same calendar quarter in 2019 and ending with the earlier of (i) the first calendar quarter after the quarter for which gross receipts are greater than 80% of the gross receipts for the same calendar quarter in 2019, or (ii) January 1, 2021.

🠊While the significant decline in gross receipts must occur during the 2020 calendar year, an employer may still claim the credit even if the employer doesn’t make a determination that such a significant decline occurred until after December 31, 2020.

🠊If an employer is part of an aggregated group, then all members of the aggregated group must be accounted for when determining whether a significant decline has occurred.

🠊There is no requirement that the significant decline in receipts must be related to COVID-19.  Employers should generally keep records for the relevant calendar quarters in 2019 and 2020 to document that a significant decline in gross receipts occurred. These records should be retained for four years.  

Example of a Significant Decline:

Employer A’s gross receipts were $210,000, $230,000, and $250,000 in the first, second, and third calendar quarters of 2019, respectively. In 2020, its gross receipts were $100,000, $190,000, and $230,000 in the first, second, and third calendar quarter, respectively. Thus, Employer A’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.

• Employer A had a significant decline in gross receipts commencing on the first calendar quarter of 2020 (i.e. the first calendar quarter for which gross receipts were less than 50 percent of the same quarter in 2019).
• The period of significant declines ends on the first day of the third quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80 percent of the same quarter in 2019).

Employer A is entitled to a Retention Credit with respect to the first and second calendar quarters of 2020.

Special Rules for New and Acquired Businesses. 

The FAQ provides special rules for businesses which started during 2019 and businesses involved mergers and acquisitions. 

• New Businesses:If a business was started during 2019, it may use the calendar quarter during 2019 in which it commenced operations as the base period to determine whether it experienced a significant decline in gross receipts for that calendar quarter or any prior calendar quarter (i.e., an employer that started a business in the third quarter of 2019 would use that quarter as the base period to determine whether it experienced a significant decline in gross receipts for the first three quarters in 2020). If a business commenced operations in the middle of a calendar quarter, the employer should estimate the gross receipts it would have had for the entire quarter based on the gross receipts for the portion of the quarter for which the business was in operation.
• Acquired Businesses.If a business was involved in an acquisition (an asset purchase, stock purchase, or any other form of acquisition), then gross receipts from the acquired businesses during 2020 must be included in the gross receipts computation for each calendar quarter that such business is owned and operated. But the employer, utilizing a safe harbor under the FAQ, may include the receipts from such businesses for the same calendar quarter in 2019, regardless of the fact that the employer did not own the acquired business during that 2019 calendar quarter. If an employer elects to use this safe harbor, and acquired the business in the middle of a quarter, the employer must estimate the gross receipts that it would have had from the acquired business for the entire quarter based on the gross receipts for the portion of the quarter that it owned and operated the acquired business. However, an employer that chooses not to use this safe harbor approach is only required to include the gross receipts from the acquired business for the portion of the quarter that it owned and operated the acquired business.

Calculation of Qualified Wages

In general

Eligible employers are entitled to a Retention Credit based on the qualified wages paid to their employees. Qualified wages are wages and compensation paid by an eligible employer to some or all of its employees after March 12, 2020 and before January 1, 2020. Qualified wages also include the eligible employer’s qualified health plan expenses that are properly allocable to the wages. 

FAQ Highlights:

🠊For an eligible employer that averaged more than 100 full-time employees in 2019 (“Large Employer”), qualified wages are limited to wages paid to an employee for time the employee is not providing services.

🠊For eligible employers that averaged 100 or fewer full-time employees in 2019, qualified wages are all wages paid to an employee, regardless of whether the employee is providing services. 

🠊The term “wages” is defined using general employment tax principles, and therefore, excludes amounts paid to current employees that are exempt from social security and Medicare taxes.

🠊Wages paid to related individuals (as defined in Section 51(i)(1) of the Code) are not taken into account for purposes of the Retention Credit.

🠊Payments made to former employees following termination of employment (i.e., severance payments) are not considered qualified wages for purposes of the Retention Credit.

🠊The term “full-time employee” is determined using the Affordable Care Act’s definition of full-time, which includes any employee who, with respect to any calendar month in 2019, had an average of at least 30 hours of service per week or 130 hours of service in the month. An employer that started its business operations during 2019 determines the number of its full-time employees by taking the sum of the number of full-time employees in each full calendar month in 2019 in which the employer operated its business and dividing by that number of months. An employer that started its business operations during 2020 must take the sum of the number of full-time employees in each full calendar month in 2020 in which the employer operated its business and dividing by that number of months.

🠊An employer with more than 100-full time employees in 2019 may not treat as qualified wages amounts paid to employees for paid time off for vacations, holidays, sick days and other days off. However, if the eligible employer averages 100 of fewer full-time employees in 2019, all wages paid to employees may be qualified wages, even if under a pre-existing vacation, sick and other leave policy.

Changes in Hourly Rates and Hours Worked

🠊For Large Employers, qualified wages paid to an employee may not exceed the amount the employee would have been paid for working an equivalent duration during either (i) the 30 days immediately preceding the commencement of the full or partial suspension of the operation of the trade or business, or (ii) the first day of the calendar quarter in which the employer experienced a significant decline in gross receipts. For a variable hour employee, the amount paid for working an equivalent duration during that 30-day period may be determined using any reasonable method.

🠊For Large Employers, if hours for hourly and non-exempt salaried employees have been reduced, but such employees are still paid 100 percent of their normal hourly wages, any wages paid for hours that the employees were not providing services would be considered qualified wages.

• Example: Assume an employer reduces staff hours by 40 percent but continues to pay hourly employees at 100 percent of their normal hourly wage rates. The employer may treat the 40 percent of wages paid for time that these employees are not providing services as qualified wages for purposes of the Retention Credit.

If wages are paid to exempt salaried employees for time that they are not providing services, such wages would be considered qualified wages. An employer may use any reasonable method to determine the number of hours that a salaried employee is not providing services, but for which the employee receives wages.

• Example: Assume that an employer’s business is closed due to COVID-19 circumstances, but there is still sufficient administrative work to occupy staff for what is determined to be 10 percent of their typical work hours using a reasonable method. If the employer continues to pay these employees 100 percent of their regular salaries, then 90 percent of those wages are qualified wages.

🠊An eligible employer may calculate qualified wages using a “reasonable method.”  ‎For this purpose, reasonable methods include the method (or methods) the employer uses ‎to measure exempt employees' ‎entitlement to leave on an intermittent or reduced leave schedule ‎under the Family and Medical Leave Act, or ‎the method the employer uses to measure exempt ‎employees’ entitlement to and usage of paid leave under the ‎employer’s usual practices.

• Note: the FAQ states that it is not reasonable for an employer to treat an employee’s hours as having been reduced based on the employer’s determination that the employee’s level of productivity during normal business hours is reduced due to COVID-19 circumstances.
  
  
• An employer may determine it is prudent to direct administrative employees who are working from home and are underutilized to work a reduced number of hours each day.Alternatively, an employer might consider having employees self-report the number of hours worked each day or each week.

Qualified Health Plan Expenses

Qualified wages include an allocable portion of the qualified health plan expenses paid or incurred by an eligible employer, as well as the portion of the health care expenses paid by the employee with pre-tax salary reduction contributions. Qualified health plan expenses are amounts paid or incurred by the eligible employer to provide and maintain a group health plan (as defined in Section 5000(b)(1) of the Code)), but only to the extent that those amounts are excluded from the gross income of employees by reason of Section 106(a) of the Code. 

FAQ Highlights:

🠊Generally, the qualified health plan expense is the amount that is allocable to the hours for which the employees receives other qualified wages and should be allocated on a pro rata basis.

🠊If an eligible employer lays off or furloughs its employees and continues the employee’s health care coverage, but does not pay the employees any wages for the time they are not working, the employer may not treat any portion of the health plan expense as qualified wages.

🠊If an eligible employer that pays wages to its employees for hours that the employees are not providing services may treat the portion of the health plan expenses allocated to the time that the employees are not being paid, but not providing services, as qualified wages.

🠊Eligible employers who sponsor more than one plan for its employees must determine the qualified health plan expenses separately for each plan. The expenses for each plan are then allocated to the employees who participate in that plan. In the case of an employee who participates in more than one plan, the allocated expenses of each plan in which the employee participates are aggregated for that employee.