On Friday, June 19, the IRS updated several FAQs on its website related to the Employee Retention Credit adopted as part of the Coronavirus Relief, Aid, and Economic Security (“CARES”) Act. The updated FAQs provide additional insight into the IRS’s current thinking regarding employer eligibility for and determination of the credit. Unfortunately, the updated FAQs still leave significant uncertainty regarding the eligibility of some employers, many of whom will be making a determination of their eligibility before filing their Forms 941, Employer’s Quarterly Federal Tax Return, for the second quarter in July.
The following Q&As were updated:
- Q&A-28, What “orders from an appropriate governmental authority” may be taken into account for purposes of the Employee Retention Credit?
- Q&A-30, If a governmental order requires non-essential businesses to suspend operations but allows essential businesses to continue operations, is the essential business considered to have a full or partial suspension of operations?
- Q&A-33, If a governmental order requires an employer to close its workplace, but the employer is able to continue operations comparable to its operations prior to the closure by requiring employees to telework, is the employer considered to have a suspension of operations?
- Q&A-34, If a governmental order requires an employer to close its workplace for certain purposes, but the workplace may remain operational for limited purposes, is the employer considered to have a suspension of operations?
- Q&A-35, Are an employer’s operations considered to be partially suspended for purposes of the Employee Retention Credit if the employer is required to reduce its operating hours by a governmental order?
- Q&A-46, What are “gross receipts” for a tax-exempt employer?
- Q&A-58, If an amount an Eligible Employer pays to an employee is exempt from social security and Medicare taxes, can the Eligible Employer still claim the Employee Retention Credit on the amount paid to that employee?
- Q&A-88, May a payroll reporting agent sign and submit Form 7200 on behalf of a client?
- Q&A-90, May third party payers rely on client employer information regarding the Employee Retention Credit?
The most substantive updates for many employers will be those in Q&As 30, 33, 34, and 35 that relate to an employer’s eligibility for the credit on the basis of a full or partial suspension of operations due to a governmental order.
Q&A-30 clarifies that an employer who maintains both essential and non-essential operations is considered to have a partial suspension if its non-essential operations are suspended as a result of a governmental order, provided that the non-essential operations are more than a nominal portion of the business. Q&A-35 clarifies that a business that is required to reduce its operating hours to comply with a governmental order is an eligible employer.
For many employers, Q&A-33, which provides two additional examples regarding the effect that the employees’ ability to telework may have on an employer’s eligibility for the credit, will be of interest. In the first new example (Example 2), the employer is eligible for the credit because access to its workplace and the equipment in it are essential to its operations and the employer is unable to serve all of its clients remotely. Under these facts, the employer is unable to continue operations in a comparable manner due to a governmental order requiring it to close its workplace. In the second new example (Example 3), the employer is also eligible for the credit when a significant part of its operations cannot be conducted by telework and a governmental order required it to close its workplace, even though another significant part of its business can continue its operations by telework. Unfortunately, the available guidance remains vague regarding what constitutes a “comparable manner,” and the two new examples would seem to clearly result in an employer being eligible for the credit. Employers with more complex facts will likely continue to struggle with the determination of whether their employees’ ability to telework precludes them from claiming the credit.
Similarly, several new examples in Q&A-34 fail to provide clear guidance regarding which governmental orders permit the employer to claim a credit and may, in some cases, suggest that many orders may be insufficient even if they result in reduced operating capacity for the employer. The examples suggest an exacting examination of the facts and circumstances of each employer’s operations may be necessary in order to determine eligibility, which will likely result in arbitrary distinctions of credit eligibility among employers. For example, the FAQs suggest that an employer whose occupancy limits are reduced by governmental order may be ineligible for the credit (unless it suffers a 50% decline in gross receipts) if the order does not result in more than a “nominal effect” on its business operations. What constitutes a “nominal effect” is unclear and undefined. The example seems to assume that customers will wait in line outside of a business to enter if the location is capacity constrained. How an employer would demonstrate that customers refused to wait or merely drove by without stopping when they saw the line is unaddressed. In contrast, if a governmental order required a business to reduce its operating hours, Q&A-35 seems to presume it is eligible for the credit even if it served the same number of customers in the reduced operating hours that it served pre-pandemic. The fact-specific nature of the inquiries suggested by the examples would indicate that an employer claiming the credit should carefully document the specifics of how governmental orders affected its business operations, the basis on which it determined that its business operations were partially suspended, and how it determined that the effect on its business operations was more than nominal. That way, if the IRS were to challenge the employer’s basis for taking the credit, the employer will be prepared to explain the reasons why it was an eligible employer for purposes of the credit.
The other updated Q&A likely to be of most interest to employers is Q&A-58, although the result is not particularly surprising. The Q&A indicates that amounts paid to an individual must constitute wages for purposes of Medicare taxes in order to be included in the credit determination. Specifically, the example indicates that amounts paid for services that do not constitute employment and that are exempt from FICA wages cannot be used as the basis for the credit. Similarly, payments excluded from the definition of wages under section 3121(a), including employer contributions to qualified employee retirement plans, employer contributions and any pre-tax employee salary reductions for qualified transportation fringe benefits or dependent care benefits also cannot be used to claim the credit. In contrast, employee elective deferrals under a section 401(k) plan can be used to claim the credit because such amounts are included in the definition of FICA wages. Pre-tax contributions for qualified health plans also are included in calculating the amount of the credit, as well as employee salary reductions under a cafeteria plan that are used to pay for qualified health plan benefits.
Employers that have claimed or intend to claim the employee retention credit should consider how the updated FAQs may affect their eligibility for and determination of the credit.