The IRS has issued extensive FAQs addressing application of the employee retention tax credit (ERTC), including employer eligibility and determination of qualified wages. Enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to incentivize employers to maintain their payrolls, the ERTC allows eligible employers to claim a credit equal to 50% of qualified wages paid between March 13, 2020, and Dec. 31, 2020, up to a maximum credit of $5,000 per employee. Qualified wages are paid by businesses during a shutdown order or during a period of significantly declined gross receipts.
Shutdown Orders. Employers experiencing a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings are eligible employers. The FAQs offer insights into how the shutdown order must impact operations, which will be of particular importance as these orders are lifted and employers begin to reopen.
- Essential businesses. An employer permitted to continue operations because it is an “essential business” generally will not be considered to have a full or partial suspension of operations, even if a government order keeps customers at home. However, an essential business may be considered suspended if a governmental order causes its critical suppliers to suspend their operations.
- Telework. If an employer is subject to a governmental order but nonetheless continues to operate comparable to its operations prior to closure by requiring its employees to telework, its operations have not been suspended for purposes of the ERTC.
- All for one and one for all. A partial suspension of an employer’s operations in one location or for one entity will extend to all operations in all locations. If one member of an aggregated group treated as a single employer, or one location of an employer that operates in multiple jurisdictions, is subject to a governmental order, the employer is considered to have a partial suspension of operations in all locations. For a discussion of the single-employer aggregation rules, which also apply to determine whether an employer has experienced a decline in gross receipts and whether a Paycheck Protection Program loan will prohibit an employer from claiming the ERTC, see our alert, The Employee Retention Tax Credit: Aggregation Aggravation
Employees Not Providing Services. For employers with more than 100 full-time employees, the ERTC is available only for wages paid to employees who are not providing services due to a shutdown order or decline in gross receipts. This determination can become complicated when the employee’s services are reduced but not completely eliminated.
- Any reasonable method. For purposes of determining the hours for which employees are not providing services, an employer can use any reasonable method, regardless of whether the employees are hourly, nonexempt salaried or exempt salaried. For example, an employer may base its determination on employee time records, on employee status updates, or on the method typically used to measure employees’ entitlement to paid leave.
- Reduction in productivity is not enough. However, it is not reasonable for an employer to treat an employee’s hours as reduced based on an assessment of productivity levels. If employees are remotely working during their normal business hours, no portion of their wages is qualified, even though the employer may believe that remote work has decreased productivity.
- Pre-existing PTO doesn’t qualify. Time off for vacation, holidays, sick days, and other time accrued due to services provided in a prior period and paid pursuant to existing leave policies is not qualified wages because it is not considered to be paid for time in which the employees are not providing services.
- Severance payments don’t qualify. Qualified wages must be paid to a continuing employee. Payments made to a former employee following termination of employment are not considered qualified wages
Qualified Wages Include Qualified Health Plan Expenses. Qualified wages include an allocable portion of amounts paid or incurred by the employer to provide and maintain a group health plan but excluded from the employees’ gross wages.
- Furloughed employees. The current guidance permits eligible employers to treat health plan expenses as qualified wages even if the employees are not working and do not receive any wages. As originally issued, the FAQs provided that, if an employer laid off or furloughed employees and continued their healthcare coverage but did not pay the employees any wages for the time they were not working, the employer could not treat any of the health plan expenses as qualified wages. However, at lawmakers’ urging, the IRS has reversed course and modified the FAQs to include these expenses in qualified wages.
- Allocation of health plan expenses. An employer with more than 100 full-time employees that pays wages to employees not providing services may treat the allocable portion of health plan expenses as qualified wages. For example, if the employees are not providing any services but the employer continues to pay 40% of wages, the employer may also treat 40% of the health plan expenses as qualified wages for purposes of the ERTC.
Other Clarifications. The FAQs clear up a number of other statutory ambiguities, including:
- Qualified wages are determined without regard to the $137,700 Social Security contribution and benefit base, and therefore may include amounts paid to employees who have received wages in excess of this amount.
- Because qualified disaster relief payments do not include wages paid by an employer, qualified wages are not excluded from the employee’s gross income as “qualified disaster relief payments.” (See our alert, FAQs: Section 139, for a complete discussion of qualified disaster relief payments.)
- Although the ERTC is not includible in the employer’s gross income for federal income tax purposes, the employer must reduce its otherwise deductible expenses by the amount of the credit.
The IRS has indicated additional FAQs are in the works, in particular to address application of the decline in gross receipts test to tax-exempt employers. Further, while the FAQs provide insight into how the IRS plans to apply the ERTC, they are not binding precedent for either the IRS or taxpayers. As demonstrated by the IRS decision to reverse its position on health plan expenses of furloughed employees, the FAQs also may be influenced by congressional criticism. Because application of the ERTC may be complex and fact-specific, we encourage employers to carefully consider all aspects of the guidance in evaluating the availability of the credit.