After months of gridlock, the House and Senate, on December 21, both passed another round of COVID relief legislation (H.R. 133).  The 5,593-page bill, which gained momentum following the introduction of bipartisan compromise legislation, provides an enhanced employee retention credit (“ERC”), which is easier for employers to qualify during the first six months of 2021, as compared to the ERC enacted as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act.

The bill also includes extensions to a number of workforce-related tax credits, including the work opportunity tax credit (“WOTC”), the paid family and medical leave tax credit included in the Tax Cuts and Jobs Act as a two-year pilot program, and the paid leave credits enacted as part of the Families First Coronavirus Response Act (“FFCRA”).  The bill would also extend the period during which employers may make student loan payments or reimbursements under an Internal Revenue Code Section 127 educational assistance plan, permit employers to provide additional flexibility under flexible spending accounts, and provide employers with a longer period in which to collect employee Social Security tax which was deferred during 2020 under IRS Notice 2020-65.

The bill would also add an employer income tax credit for qualified wages paid to employees in qualified disaster areas in 2020 for disasters other than COVID-19.  Finally, the bill addresses the deductibility of expenses paid with forgiven PPP loans.

Employee Retention Credit Changes

The ERC, adopted as part of the CARES Act, provides a credit equal to 50% of qualified wages against employer Social Security tax through December 31, 2020.  The bill, would extend the availability of the credit through June 30, 2021.  In addition, the bill makes several improvements to how the credit operates.

First, the credit is increased from 50% of qualified wages to 70% of qualified wages.  Second, the bill increases the per-employee limit on qualified wages from $10,000 total in 2020 to $10,000 per quarter for the first two quarters of 2021. Accordingly, the maximum ERC that an employer could receive with respect to an individual employee in 2021 is $14,000.

Under the CARES Act, employers could qualify for the credit if their business was fully or partially suspended due to an applicable governmental order or if the employer experienced a year-over-year decline in quarterly gross receipts of more than 50%.  Under the legislation, employers would be eligible for the ERC during the first two quarters of 2021 if they experience more than a 20% year-over-year decline in quarterly gross receipts.  In addition, employers can use the prior quarter year-over-year decline to determine eligibility.

The legislation would also confirm existing IRS guidance that group health plan expenses paid for employees who are furloughed and earning no other wages are qualified wages for purposes of the ERC.  Initially, the IRS had said such expenses were not qualified wages, but backtracked after intense bipartisan criticism.

Under the CARES Act, employers with 100 or fewer full-time employees (as determined under Section 4980H) on average in 2019 were permitted to claim the ERC without regard to whether the employee performed services.  Larger employers were permitted to claim the credit only with respect to wages paid for time not worked.  The bill would increase this threshold for the first two quarters of 2021 to 500 full-time employees.  Thus, employers with up to 500 full-time employees on average in 2019 may claim the ERC for qualified wages paid in the first two quarters of 2021 without regard to whether the employees are performing services.

Critically, the legislation would retroactively permit employers to claim the ERC even if they received a Paycheck Protection Program loan.  Under the CARES Act, an employer who received a PPP loan was ineligible for the ERC.  Because the aggregation rule (see earlier coverage) for ERC purposes was broad, many employers who did not receive a PPP loan were also ineligible as a result of PPP loans taken out by affiliates.  Under the legislation, an employer may receive the ERC, even if it has a PPP loan, but may not claim the credit with respect to wages paid using forgiven PPP loan proceeds.  These employers may take the ERC on their current quarter’s Form 941 to reflect qualified wages paid during earlier quarters.  It remains to be seen how the IRS will implement this change, assuming the legislation is enacted.

Section 45S Paid Leave Credit Extension

The paid family and medical leave credit under Section 45S, adopted as a two-year pilot program under the Tax Cut and Jobs Act in 2017 and set to expire at the end of 2020, was extended five years, until December 31, 2025.

FFCRA Paid Leave Credit Extension

Although the bill does not extend the paid leave mandate applicable to small employers of 500 or fewer employees enacted as part of the FFCRA, the bill would extend the availability of the paid leave credits enacted as part of the FFCRA through March 31, 2021.  This will allow employers of 500 or fewer employees to provide the amount of paid leave that would be required if the FFCRA mandate were extended and to receive a payroll tax credit that fully offsets the cost of such leave.

Tax-Free Student Loan Payments

 The CARES Act included a provision allowing employers to exclude student loan repayments of up to $5,250 annually from an employee’s income in 2020.  This provision was adopted as part of Section 127, so all of the nondiscrimination, notice, and other rules applicable to educational assistance plans apply.  The legislation would extend the provision for five years through December 31, 2025.  Employers who already provide a student loan repayment benefit should consider adopting amendments to an existing educational assistance plan or adopting a new plan to provide these benefits tax-free.

Flexible Spending Account Changes

 The bill would also allow employers to permit rollovers of unused health and dependent care FSA funds from 2020 to 2021 and from 2021 to 2022.  Many employees who contributed to dependent care FSAs were unable to use those funds in 2020, so allowing the rollovers will enable employees to make use of the funds they set aside on a pre-tax basis.  Employers may also allow for a grace period that runs 12-months from the end of the plan years ending in 2020 and 2021.  The bill would also permit employers to allow employees to use unused dependent care funds from the last plan year for which the enrollment period ended before February 1, 2020,  for children who aged out (turned 13), until the child turns 14.

The bill would permit employers to allow terminated employees to use funds contributed to their FSAs in 2020 through the end of the grace period for the year in which they terminated employment.  Therefore, an employee who terminated employment in 2020 could still use FSA funds set aside in 2020 through the end of 2021.

Finally, the bill would permit employers to allow mid-year election changes for plan years ending in 2021 without regard to any change in status.  In other words, employees will be permitted to adjust their contributions mid-year depending on the vaccination process and its impact on the pandemic.

These rules are optional, and employers, that would ordinarily receive forfeited funds if participants’ failed to use them before the deadline, may elect not to amend their cafeteria plans to permit these changes.  Employers that elect to make use of the bill’s increased flexibility will likely see fewer forfeitures and incur higher costs for the plans.

Additional Time to Collect Employee Social Security Tax Deferred in 2020

Earlier this year, Notice 2020-65 permitted employers to defer the withholding and deposit of employee Social Security taxes. (See earlier coverage.)  Under the notice, employers must deposit those deferred taxes before April 30, 2021, or interest and penalties will accrue.

The bill would extend the time that employers have to collect the deferred tax from employees until the end of 2021, rather than April 30, 2021.  Although employers, other than the federal government, that took steps to defer employee Social Security taxes may welcome the extension, it also increases the risk that the deferred taxes will not be fully collected.  A longer period in which to collect the deferred taxes also gives employees a longer period in 2021 to leave employment before the tax is collected.  As discussed in our recent article, an employer who pays the employee’s 2020 Social Security tax for the employee in 2021 is required to treat that payment as an additional wage payment to the employee in 2021.

Qualified Disaster Employee Retention Credit

The legislation includes an employee retention credit of 40% of qualified wages against income tax (not against payroll tax, except for certain nonprofits), up to $6,000 of qualified wages per employee for employers who operate a trade or business in a disaster area that became inoperable.  The employee must have a principal place of employment in the disaster area, but the credit is available without regard to whether the employee performs services-for example, the credit is available with respect to qualified wages paid to an employee performing services in a neighboring area that is not inoperable.  The credit is available until the earlier of the date on which significant operations resume at the employee’s principal place of employment or 150 days after the last day of the incident period of the qualified disaster.

Deductibility of Expenses Paid with PPP Loans

In Notice 2020-32, Treasury and the IRS took the position that expenses paid using forgiven PPP loan proceeds were not deductible under Section 265 because forgiveness of a PPP loan did not constitute cancellation of indebtedness income.  Despite bipartisan criticism of the IRS’s position, Treasury and the IRS recently doubled down taking the same position in Rev. Rul. 2020-27. The bill would override this position and make such expenses fully deductible.