COVID-19 Tax Relief: IRS Issues New Guidance on the Employee Retention Credit and Deduction of Expenses Funded with Paycheck Protection Program Loans

Wilson Sonsini Goodrich & Rosati
Contact

Wilson Sonsini Goodrich & Rosati

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted several key measures intended to provide tax and financial relief to businesses navigating the COVID-19 crisis. Those measures included the Employee Retention Credit, a new refundable payroll tax credit to assist employers that retain employees through the COVID-19 crisis (see Wilson Sonsini Alert), and the Small Business Administration Paycheck Protection Program loans (PPP Loans) for qualifying businesses (see Wilson Sonsini Alert). On April 30, 2020, the Internal Revenue Service (IRS) issued additional guidance to address key questions raised by businesses in evaluating these measures. First, the IRS published updated responses to 95 frequently asked questions (FAQs) regarding qualifying for and claiming the Employee Retention Credit.1 Second, the IRS issued Notice 2020-32 to address the deductibility of payroll and other expenses funded by PPP Loans. While the guidance clarifies certain questions that had arisen during the initial implementation of the CARES Act, many key areas of uncertainty remain, as described below.

Employee Retention Credit FAQs

The Employee Retention Credit is a new refundable tax credit against the 6.2 percent Social Security payroll tax imposed on employers by Section 3111(a)2 to assist employers that retain employees through the COVID-19 crisis. The amount of the credit is 50 percent of "qualifying wages" paid to an employee after March 12, 2020 and before January 1, 2021, and is capped at $10,000 of qualifying wages per employee (giving a maximum credit of $5,000 per employee). The Employee Retention Credit is generally available to employers engaged in a trade or business that experience: i) a full or partial suspension of operations (Suspension) due to a governmental order regarding COVID-19 (the Suspension Test) or ii) a "significant decline" in gross receipts (the Gross Receipts Test). Businesses that receive PPP Loans are not eligible for the Employee Retention Credit.

A business's ability to claim the Employee Retention Credit is affected by the number of its employees. Small employers (with 100 or fewer employees, as further explained below) are generally eligible for the Employee Retention Credit for any qualified wages paid. In contrast, larger employers (with more than 100 employees) are generally eligible for the Employee Retention Credit only for qualified wages paid with respect to employees who are not providing services.

Businesses have recently raised many questions about qualifying for the Suspension Test, determining the number of employees, and determining what amounts are eligible for the Employee Retention Credit. This alert discusses insight the FAQs provide into these key questions. The FAQs are lengthy and not all details that may be relevant to a business are addressed. The FAQs provide the IRS's current interpretation of the Employee Retention Credit provisions, but may not be relied upon as legal authority and may be revised or updated.

Qualification Under the Suspension Test

Qualifying governmental orders and voluntary suspensions (Questions 28 and 29) – Under the CARES Act, an employer must experience a Suspension "due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings" to claim the Employee Retention Credit under the Suspension Test. An employer who voluntarily suspends operations has not undergone a Suspension. The IRS clarifies that orders, proclamations, or decrees from the federal government, or any state or local government, are qualifying orders for this purpose 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, including orders that limit hours of operation. If the relevant order is from a state or local government, it must be from a state or local government that has jurisdiction over the employer's operations. A government order does not include: a statement from a governmental official, including comments made during press conferences or in interviews with the media; a declaration of a state of emergency that does not limit commerce, travel, or group meetings in any manner; or a declaration that limits commerce, travel, or group meetings, but does so in a manner that does not affect the employer's operation of its trade or business.

The IRS provides the following examples of qualifying governmental orders: i) an order from a city's mayor stating that all non-essential businesses must close for a specified period, ii) 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, and iii) an order from a local official imposing a curfew on residents that impacts the operating hours of a trade or business for a specified period.

Businesses that continue to operate via telework (Question 33) – Many businesses have transitioned operations, at least to some extent, with employees working remotely and have wondered about their ability to qualify under the Suspension Test. In the FAQs, the IRS takes the position that if an employer's workplace is closed by a governmental order, but the employer is able to continue operations "comparable to its operations prior to the closure by requiring its employees to telework," the employer's operations have not undergone a Suspension. The IRS provides a single example of a software development company that maintains an office in a city where the mayor has ordered that only essential businesses may operate. The company's business is not essential under the mayor's order and must close its office. Prior to the order, all employees at the company teleworked once or twice per week, and business meetings were held at various locations. Following the order, the company ordered mandatory telework for all employees and limited client meetings to telephone or video conferences.

In the FAQs, the IRS takes the position that the company's business operations have not undergone a Suspension due to the governmental order because its employees may continue to conduct its business operations by teleworking. However, it is not clear how the IRS would evaluate a business with some employees who are unable to telework (such as laboratory or security personnel). Of note, in an explanation of the CARES Act released on April 22, 2020, the Joint Committee on Taxation (JCT) described an accounting firm that is subject to a directive from public health authorities to cease activities other than minimum basic operations and that closes its offices. The JCT observed that if the accounting firm does not require employees who cannot work from home (e.g., custodial and mail room employees) to work, the accounting firm would meet the Suspension Test. Whether the IRS agrees with the JCT is not addressed in the FAQs. Further, other than providing this example, the IRS does not address how it will determine whether operations are "comparable" to those conducted prior to COVID-19-related closures.

Businesses with locations in multiple jurisdictions (Question 36) – Some employers that operate a trade or business in multiple jurisdictions may be subject to state and local governmental orders limiting operations in some, but not all, jurisdictions. This variance may be because the business is an essential business in some jurisdictions, but not others. The IRS confirms that a multi-jurisdictional business in such circumstances is considered to be subject to a Suspension. The IRS notes that such a business may establish a policy that complies with the local governmental orders, as well as Centers for Disease Control and Prevention (CDC) recommendations and the U.S. Department of Homeland Security (DHS) guidance to operate in a consistent manner in all jurisdictions. Helpfully, the IRS confirms that even though the business may merely be following CDC or DHS guidelines in some jurisdictions, it will still be considered to be subject to a Suspension, and thus eligible to claim the Employee Retention Credit for its operations in all jurisdictions.

Resumption of business operations (Question 38) – The IRS also addresses how the Suspension Test applies to a business that is subject to a qualifying governmental order that is subsequently lifted. In this case, the business is considered to have been subject to a Suspension only for periods during which operations were fully or partially suspended. This means that the business may only claim the Employee Retention Credit under the Suspension Test for periods during which the order is actually in force.

Other effects of governmental orders (Questions 30-32) – The IRS also addresses questions that have arisen about the collateral effects of governmental orders. According to the IRS, an essential business that is allowed to remain open under a governmental order does not experience a Suspension even if the order causes the business's customers to stay home (presumably preventing the business from selling goods or services to them). However, the IRS also takes the position that an essential business may undergo a Suspension if its suppliers are unable to deliver critical goods or materials due to a governmental order that causes the suppliers to suspend their operations. In such a case, the IRS indicates that it will evaluate the relevant facts and circumstances to determine whether the essential business has undergone a Suspension.

Businesses that do not qualify for the Employer Retention Credit as a result of a Suspension may nevertheless qualify under the Gross Receipts Test.

Additional qualification considerations

Determining the number of employees (Question 49) – The CARES Act requires an employer to base its employee count on the number of "full-time employees" employed in 2019. A "full-time employee" means an 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, as determined in accordance with Section 4980H. The IRS does not indicate that an employer should aggregate the hours of part-time employees to include them in the count, but this remains an area of uncertainty.

An employer that operated its business for the entire 2019 calendar year determines the number of its full-time employees by taking the sum of the number of full-time employees in each calendar month in 2019 and dividing that number by 12. 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 follows a consistent approach, taking into account the full calendar months in 2020 in which it operated its business.

Continuing employee health care coverage (Questions 64-65) – Qualifying wages for the Employee Retention Credit generally include an allocable portion of certain qualified health plan expenses paid or incurred by the employer. Some employers have continued their employees' healthcare coverage even if they furlough or lay off employees due to the COVID-19 crisis. The IRS states that if a small employer lays off or furloughs its employees without paying any wages, but continues the employees' healthcare coverage, the employer may not treat any portion of the health plan expenses as qualifying wages because no portion of the health plan expenses are considered to be allocable to wages paid to those employees. If a small employer instead reduces employees' hours and wages, but continues to provide full healthcare coverage, health plan expenses allocable to the wages paid may be treated as qualifying wages.

Similarly, if a larger employer reduces employees' hours and wages commensurately, but continues to provide full healthcare coverage, the IRS states that it may not treat any portion of the health plan expenses as qualified wages because wages are not being paid for the time for which the employees are not providing services.

On May 4, 2020, a bipartisan group consisting of leading members of the Senate Finance Committee and the House Ways and Means Committee questioned this interpretation and urged the IRS to reconsider its position. Business groups have similarly expressed their concerns.

Reduction in hours (Questions 54-55) – The FAQs provide that larger employers are eligible for the Employee Retention Credit with respect to wages paid to employees for hours (for hourly or non-exempt salaried workers) or time (for exempt workers) for which they are not providing services. The FAQs state that the hours for which an employee is not providing services may be determined using any reasonable method. Examples of reasonable methods include the method used to determine entitlement to leave under the Family Medical and Leave Act or sick leave under the Families First Coronavirus Response Act. However, an assessment of the employee's productivity levels during hours worked is not a reasonable method.

Deduction of Expenses Funded with PPP Loans

Under Section 1106(b) of the CARES Act, a PPP Loan recipient is generally eligible for forgiveness of its PPP Loan to the extent of its payments for certain qualifying expenses, including payroll, rent, and utilities during the eight-week period beginning with the origination of the PPP Loan (eligible Section 1106 expenses). For U.S. federal income tax purposes, Section 1106(i) of the CARES Act provides an exclusion from a PPP Loan recipient's gross income for income that would otherwise arise from forgiveness of the PPP Loan. This includes income that would otherwise be characterized as income from the discharge of indebtedness under Section 61(a)(11).

Although payroll, rent, and utilities are generally deductible as ordinary and necessary business expenses under Section 162, the IRS stated in Notice 2020-32 that payments of eligible Section 1106 expenses that result in loan forgiveness under Section 1106(b) of the CARES Act are not deductible. According to the IRS, this conclusion is consistent with other provisions of the Internal Revenue Code and existing case law that generally prevent taxpayers from receiving a double tax benefit. Leading members of the House Ways and Means Committee and Senate Finance Committee have expressed their disappointment with this interpretation, however, and it is currently uncertain whether the IRS will amend its position or if Congress will consider legislation to specifically address this treatment.


[1] The FAQs are available on the IRS website, at  https://www.irs.gov/newsroom/faqs-employee-retention-credit-under-the-cares-act

[2] Sections references are to the Internal Revenue Code of 1986, as amended, unless otherwise specified.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Wilson Sonsini Goodrich & Rosati | Attorney Advertising

Written by:

Wilson Sonsini Goodrich & Rosati
Contact
more
less

Wilson Sonsini Goodrich & Rosati on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide