As we noted in an earlier post, on July 27, Senate Republicans introduced new legislation in response to the continued COVID-19 pandemic. One of the introduced bills, titled the American Workers, Families, and Employers Assistance Act (the “Bill”), would enhance the existing employee retention credit.
The Existing Credit
The employee retention credit is a refundable employment tax credit, and was originally enacted as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. In its current form, the credit equals 50 percent of qualified wages, with qualified wages limited to $10,000 per employee for all calendar quarters. This results in a maximum credit of $5,000 for each employee.
To qualify for the credit, the employer must be one carrying on a trade or business during calendar year 2020, the operation of which is fully or partially suspended under orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19. An employer may also claim the employee retention credit if the employer experiences a significant decline in gross receipts in any calendar quarter beginning after December 31, 2019, meaning gross receipts are less than 50 percent of gross receipts in the same calendar quarter in the prior year. This period ends with the calendar quarter following the first calendar quarter in which gross receipts exceed 80 percent of the same calendar quarter in the prior year.
In calculating qualified wages, employers with more than 100 full-time employees (“Large Employers”) should take into account wages paid by the employer with respect to which an employee is not providing services. For employers that are not Large Employers (i.e., employers with 100 or fewer full-time employees), qualified wages include all wages paid, even if the employee provides services during this period. Any employer that receives a paycheck protection program (“PPP”) loan is not eligible for the employee retention credit.
The Enhanced Credit
The Bill would make a number of enhancements to the credit, intended to increase the maximum benefit and loosen certain restrictions.
- Maximum Credit. The credit percentage would be increased from 50 percent to 65 percent, and qualified wages would be increased from $10,000 to $30,000 for all calendar quarters ($10,000 in each calendar quarter). This would result in a maximum credit of $19,500 per employee. Although this will likely make the credit more attractive, it is significantly uncertain whether a 65 percent credit will be sufficient to induce Large Employers to retain or rehire workers and pay them for time not worked. Accordingly, the retention may not achieve its stated goal of reducing reliance on the unemployment system. Other legislative proposals generally provided a more generous credit of 80 percent to 100 percent that would likely have a greater effect on unemployment.
- Gross Receipts Test. The test for determining eligibility due to a significant decline in gross receipts would be loosened: employers would be eligible if gross receipts are less than 75% of gross receipts in the same calendar quarter in the prior year. Further, for employers that were not eligible for the credit as of June 30, 2020, the employer could instead calculate eligibility on the basis of a significant decline in gross receipts using the prior calendar quarter and the corresponding quarter in the prior year. Although this represents a significant improvement from the original requirement, a 25% year-over-year decline in gross receipts would be catastrophic decline in other circumstances and the credit may remain unavailable to many employers who are forced to lay off employees in the face of decreased revenue. Other legislative proposals included lower thresholds for eligibility that would make the credit more broadly available.
- Large Employer Treatment. Under the Bill the definition of Large Employer would be amended from an entity with more than 100 employees to an entity with more than 500 employees. Accordingly, more employers could take advantage of the preferential treatment provided to non-Large Employers, permitting them to calculate qualified wages using all wages paid, even if an employee provides services for such wages. In other words, an employer of 500 or fewer employees that is eligible for the credit would receive a credit equal to 65% of the first $10,000 in qualified wages paid each quarter to each of its employees. The increased threshold will likely enable smaller employers to better weather the pandemic by significantly reducing their payroll costs attributable to workers who are fully engaged.
- Improved PPP Coordination. Although the legislative language is unclear, it appears that the Bill would permit employers that receive a PPP loan to take advantage of both programs for the third and fourth quarters of calendar year 2020. However, qualified wages for which an employer claims the credit do not result in forgiveness of a PPP loan during this period. The Bill includes a conforming amendment to section 2301(j) of the CARES Act, however, that suggests an employer who received a PPP loan could not take the retention credit in the third or fourth quarter of 2020, but could take the credit in the second quarter. The two provisions seem to conflict, and we assume there is a drafting error in the Bill.
This approach differs from that of the House-backed Health and Economic Recovery Omnibus Emergency Solutions Act (“HEROES Act”). The HEROES Act would allow employers who received a PPP loan to claim the employee retention credit during the second quarter except that wages paid with PPP loan proceeds would generally be excluded from the credit. The Bill’s approach would leave open questions about the eligibility of a company that claimed the retention credit in the second quarter of 2020 and later acquired a company that took a PPP loan before being acquired.
In addition to these substantive changes, the Bill would also make certain technical amendments to the credit. For example, the Bill would clarify that for purposes of tax-exempt organizations, a decline in gross receipts would be calculated using the Code section 6033 definition of gross receipts, as opposed to the Code section 448(c) definition applicable under the CARES Act. In addition, the Bill would also clarify that qualified wages include health plan expenses paid or incurred by an employer to provide health benefits even if no other wages are paid to an employee. As discussed in an earlier blog post, the IRS now takes the position that such expenses are eligible for the credit, although the IRS reached this position only after first taking the position that such expenses were ineligible, and following bipartisan criticism.
As currently drafted, these enhancements to the employee retention credit would be effective for calendar quarters beginning after June 30, 2020, although the clarifications with respect to tax-exempt organizations and health plan expenses would be retroactive to the original effective date.