The Internal Revenue Service (IRS) and the Department of the Treasury on May 7, 2020, decided to revise their frequently asked questions (FAQs) guidance on the Employee Retention Credit to allow employers that don’t pay wages but continue to cover the health plan expenses for laid-off or furloughed employees, to qualify for retention credits. As a result of this change, employers will be encouraged to continue paying health plan expenses for their employees who have been laid off or furloughed due to the COVID-19 pandemic.
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, employers are financially incentivized in the form of tax credits, to keep their employees on the payroll. Specifically, employers are eligible for a tax credit equal to 50% of qualified wages (including healthcare benefits) paid to an employee after March 12, 2020 and before January 1, 2021. The largest tax credit an employer can claim is $5,000 per employee because the number of qualified wages and health plan expenses are taken into account is capped at $10,000 for each employee.
Notably, the qualified wages don’t include wages for which an employer is permitted a tax credit under the Families First Coronavirus Response Act (FFCRA). The Employee Retention Credits are unavailable to employers that receive loans under the Paycheck Protection Program.
To calculate the Employee Retention Credit ‘qualified wages’ is defined under Internal Revenue Code Section 3121(a). Still, the scope of ‘qualified wages’ varies based on the number of full-time employees employed by an employer. Additionally, an employer must satisfy one of the following tests:
- The employer’s business operation is fully or partially suspended by a governmental order because of COVID-19
- The employer’s gross receipts are less than 50% of what they were for the same quarter in 2019.
If either of these tests is satisfied, the employer can immediately decrease the amount of federal payroll taxes deposited.
Initially, the IRS’s position was that employers that provided only health coverage to laid-off or furloughed employees could not claim a retention credit. This interpretation of the Employee Retention Credit created a disincentive for employers to provide health coverage to laid-off and furloughed workers. To avoid this unintended consequence, a group of bipartisan lawmakers wrote to the Treasury Secretary Steve Mnuchin on May 4, 2020, to express their disapproval of the IRS’s determination and urging the Treasury Department and the IRS to reconsider.
In support of their position, the lawmakers stated that maintaining access to healthcare was ‘absolutely critical’ during the COVID-19 pandemic. As per the lawmakers, the tax credit would incentivize employers to maintain employees’ health coverage as well as wage payments.
On May 7, 2020, the Treasury Department’s Office of Legislative Affairs notified Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and other lawmakers that the Treasury Department would be revising its guidance in response to their letter. Following the Treasury Department’s letter, Senator Grassley said in a press release, “This is good news for small businesses and workers across the country. This decision will encourage employers to help employees keep their health insurance while temporarily furloughed due to the shutdown.”
In light of this reversal, employers can now include healthcare expenses paid as qualified wages eligible for the employee retention credit. For eligible employers of all sizes affected by the COVID-19 crisis, the Employee Retention Credit remains viable. The Employee Retention Credit may be an especially effective option for those employers that can’t continue to pay wages, but wish to pay the health plan expenses of furloughed employees and their families.
New Tax Credit Helps Small Businesses Keep Staff During Pandemic
The Federal Government’s Paycheck Protection Program (PPP) has received overwhelming interest from small businesses impacted by the coronavirus pandemic, but it’s not the only option that is available to small businesses. Businesses who have struggled with the complex qualification and application rules of the PPP should consider the employee retention credit (ERC).
The ERC is part of the Coronavirus Aid, Relief and Economic Security Act (CARES). The ERC incentivizes companies to retain employees, despite the tough economic conditions that have resulted from the COVID-19 outbreak. This credit, applied to payroll taxes, may help businesses retain employees instead of resorting to layoffs or furloughs. The ERC is a refundable tax credit against the employer’s portion of Social Security taxes normally paid on the W-2 wages to all workers. It is equal to 50% of qualified wages an eligible employer pays to employees after March 12, 2020 and before January 1, 2021, up to $5,000 per worker.
Qualifying employers may immediately reduce their payroll tax deposits by 50% of eligible wages. The ERC fund comes into play if the employer’s required quarterly payroll tax deposits are less than the credit they would otherwise be eligible to claim. The refundable portion is the amount of the difference in the quarterly payroll report, Form 941.
The tax credit is available to businesses of all sizes, including tax-exempt organizations, although it makes the most sense for employers with 100 or fewer employees. A business is eligible if it’s operations have been fully or partially suspended due to government orders limiting commerce, travel, or group meetings due to COVID-19 or if its gross receipts for the calendar quarter for which the credit is claimed are less than 50% of the gross receipts for the same calendar quarter in the previous year.
Government contractors and self-employed people aren’t eligible for the credit; neither are employers that have received aid from the PPP or an economic injury disaster loan. The ERC can also not be combined with other tax credits. The qualified wages for purposes of the ERC don’t include the amount of qualified sick and family leave wages for which the employer received tax credits under the Families First Coronavirus Response Act. Other rules apply to avoid double-dipping, include restrictions on the eligibility of wages on which the work opportunity tax credit is taken.
For employers with fewer than 100 employees, calculating the credit is going to be easy. Businesses can claim credit for wages paid to anybody, whether they are working or not, as long as they continue to be paid. It’s more problematic for businesses with more than 100 employees. There the credit is available for non-worked wages if you are paying employees who are not working at all or working reduced hours but still being paid. The difficulty is calculating that worktime for salaried employees. We are still waiting for more guidance from the IRS on this.
Is It Worth It or Not?
Employers considering a PPP loan, especially those concerned about their ability to meet the loan’s forgiveness criteria, should crunch the numbers to determine whether the ERC is a better option. It is easier to qualify for the ERC than the PPP. There is also no loan application or forgiveness process, no limited pool of money, and no requirement that a certain amount has to be spent within a certain time frame. It would make sense for businesses, that have already applied for the PPP loan, to calculate what the ERC can do for them.
To date, no guidance has been issued about whether a business that applied for a PPP loan, or even received the loan, but later withdrew its application or returned the proceeds of the loan, can claim the ERC. There is another wrinkle in the law, which states that employers that receive a PPP loan can’t claim the credit. That raises the question, what about the wages paid up until the employer received the loan? The answer to that is still unknown. The CARES Act allows any employer to defer payment of their portion of Social Security taxes through the end of the year without interest or penalty, whether affected by COVID-19 or not. Whatever amount is deferred will be owed in two installments, half by December 31, 2021, and the remainder by December 31, 2022.
Businesses that received a PPP loan can defer Social Security tax payments until the day the loan is forgiven. Congress may still make modifications to the employer retention credit. That could include expansion of eligibility to employers who are not directly affected by a government order but whose suppliers or customers are. It could also include an increase in the maximum amount of credit that is allowed to them.