As the COVID-19 crisis continues to roil the economy, all eyes seemed to be focused on the Paycheck Protection Program (PPP). But that’s not the only option for relief for struggling small businesses. One opportunity that’s often overlooked is the Employee Retention Credit or ERC. It’s found in the CARES Act, and like the PPP, it’s designed to help businesses keep employees on the payroll.
Unlike the PPP, the ERC isn’t a loan: it’s a refundable tax credit. It’s calculated each calendar quarter for wages paid after March 12, 2020, and before January 1, 2021. That means the ERC is generally available for quarters 2, 3, and 4 for the 2020 year (and part of quarter 1). The amount of the credit is 50% of qualifying wages paid up to $10,000 per employee for all quarters. Qualifying wages may not exceed $5,000 – or 50% of $10,000 – for any employee for all calendar quarters.
That means no applications, no fees, and no waiting. It does, however, have some rules – after all, this is tax. I wrote about the ERC in April, and since then, the Internal Revenue Service (IRS) has changed the rules (I think they like to suggest they clarified them). Here’s what you need to know.
Generally, employers are eligible for the ERC if they:
- Fully or partially suspend operation during any calendar quarter in 2020 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; or
- Experience a significant decline in gross receipts during the calendar quarter.
In late April, the IRS updated its website-based guidance to clarify the treatment of employers who are shut down (wholly or partially) as a result of COVID-19. According to the FAQs, mere statements from a governmental official, including comments made during press conferences or media interviews, do not rise to the level of a governmental order. Additionally, the declaration of a state of emergency by a governmental authority is not sufficient if it does not limit commerce, travel, or group meetings. And, a declaration that does not affect the employer’s operations does not rise to the level of a governmental order for purposes of the ERC.
The IRS also noted that an employer that voluntarily suspends operation of a trade or business or reduces hours and is not subject to any governmental orders is ineligible for the ERC based on the governmental order criteria. But the employer may still be eligible for the ERC if the business experiences a significant decline in gross receipts – remember, that’s the “OR” piece in the qualification above.
A significant decline in gross receipts is figured by determining the first calendar quarter in 2020 in which gross receipts are less than 50% of gross receipts for the same calendar quarter in 2019. The decline is enough: the employer does not need to prove that any significant decrease in gross receipts is related to COVID-19.
Just last week, the IRS updated its website-based guidance again – this time to clarify what constitutes wages for purposes of calculating the ERC. Qualifying wages include payments, as well as a portion of the cost of employer-provided health care. But what happens when an employee is not working due to COVID-19, but still is receiving employer-provided health care coverage?
The IRS clarified that an employer with 100 employees or less may treat health plan expenses as qualified wages even if the employees are not working and are not being paid for the time they are not working (FAQ 64). However, an employer with more than 100 employees may not include health plan expenses if the employees are receiving wages; only the portion of health plan expenses allocable to the time that the employees are not providing services are treated as qualified wages (FAQ 65).
So, for example, let’s say you had 10 employees in 2019 and are now subject to a governmental order that suspends operations. You pay your employees half of their regular wages, and you continue to pay your employees’ health care coverage. Those health plan expenses may be treated as qualified wages for purposes of the ERC.
In contrast, if you had 1000 employees in 2019, it’s a little different. If you pay your employees half of their regular wages as well as their health care expenses, the health plan expenses allocable to the time that employees are not providing services may be treated as qualified wages. But health plan expenses allocable to the time for which the employees are receiving wages for providing services are not qualified wages.
If it’s a little confusing, that’s because while there is no cap on the number of employees, the average number of employees in 2019 affects how the credit is calculated. Check out the examples on the IRS FAQ page for more details.
And… there’s one more update (FAQ 79). Earlier, it was clear that there was a prohibition on taking a PPP loan and claiming the ERC. Now, the IRS has declared that an employer that applied for a PPP loan, received payment, and repays the loan by May 14, 2020, will be treated as though the employer had not received PPP for purposes of the ERC. That makes the employer eligible for the credit if the employer otherwise meets the criteria.
Disagree with the updates? You may not be alone. Earlier this month, Congressional officials, including Senators Grassley (R-IA) and Wyden (D-OR) previously expressed frustration with the IRS’ position regarding ERC and health care expenses. Treasury Mnuchin eventually conceded the point and promised the update.
While you might not have the Senators’ clout, you might be able to argue about it later (I said might – definitely check with your tax or legal professional). The website does have the following helpful language:
This FAQ is not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.
For now, you report the credit on Form 941, Employers QUARTERLY Federal Tax Return. The current form has a helpful note regarding the timing of the credit, but it’s not fully updated. The IRS has released a draft version of the updated form 941 (plus instructions). If you wish, you can submit comments to the IRS about the draft form or instructions at IRS.gov/FormsComments.
Things are happening at a rapid-fire pace these days. Keep checking back for details.