Almost a year after the employee retention credit was adopted as part of the Coronavirus, Aid, Relief, and Economic Security Act (“CARES Act”), and nearly a month after the final Form 941, Employer’s Quarterly Federal Tax Return, claiming the credit for 2020 was due, the IRS issued Notice 2021-20 (the “Notice”). This is the first of three articles looking at the evolution of IRS guidance on the employee retention credit. This article focuses on Congress’s intention in enacting the employee retention credit and the guidance the IRS provided in the frequently asked questions (“FAQs”) it issued in April 2020. The second article focuses on the first signs of trouble for employers that appeared when the IRS updated the FAQs in June 2020. The final article focuses on how Notice 2021-20 builds on those FAQs to narrow the scope of the credit and limit its availability.
In the April 2020 FAQs, the IRS helpfully, and correctly, recognized the effect of the broad aggregation rule included in section 2301(d) of the CARES Act. Although it operates as a double-edged sword, the aggregation rule permits an employer to become an eligible employer throughout the country on the basis of a partial suspension of its trade or business anywhere in the country.
For small employers (for purposes of claiming the credit in 2020, those with fewer than 100 full-time employees, on average, in 2019; and for purposes of claiming the credit in 2021, those with fewer than 500 full-time employees, on average, in 2019), this resulted in a toggle switch for the credit. A partial suspension in any state, county, city, or town in which the employer operates results in an ability to claim the credit with respect to all wages (within the meaning of section 3121(a) of the Internal Revenue Code) paid during the period of the partial suspension.
For larger employers, the rule has not necessarily had the same effect because the statute permits larger employers to claim the credit only with respect to wages paid “with respect to which an employee is not providing services due to circumstances” described in one of two clauses. The two clauses include a significant decline in gross receipts and a full or partial suspension of the employer’s trade or business. This presents an interpretive conundrum, because determining whether an employee is not providing services due to a significant decline in gross receipts is, at best, an inexact process. A decline in gross receipts does not directly make any particular employee stop performing services. It may put financial pressure on the business and the business may no longer need the employee’s services, but the decline itself did not result in the employee’s ceasing to perform services.
Similar to the difficulty of directly tying an employee’s not performing services to a significant decline in gross receipts, a legitimate question exists as to how closely an employee’s not performing services must be tied to a governmental order for wages paid to the employee to be treated as qualified wages. For example, a restaurant that cannot provide dine-in service could have wait staff polish the flatware. A retail store that cannot provide in-person shopping could have its clerks organize the stockroom and clean the floors. In other words, in both cases, the governmental order would not mandate that the employee be laid off or furloughed. Eventually, an employer might run out of alternate services for employees to perform, but labor law tells us that merely having an employee in the office, store, or restaurant constitutes the performance of services, even if they are merely waiting around for the to-go order to come in or for the phone to ring. So if, after deciding to no longer give the employee these odd jobs, the restaurant or retail store ultimately does ask the employee not to come to work but still pays the employee for the time not worked, at that point is the employee not performing services “due to” the governmental order or due to the employer’s decision? To answer the question with the latter seems to require a rather narrow, and unanticipated, reading of the statute.
Thankfully, the original IRS FAQs generally took a pragmatic and broad approach to the credit’s application. This approach seems to have been grounded in the recognition that the employee retention credit was largely intended to function as an alternative to the unemployment insurance system, at least with respect to larger employers. In the United States, the vast majority of workers are in an at-will relationship with their employers. In other words, if the employer no longer needs an employee’s services or has insufficient work for the employee, the employer need not continue to pay—or even employ—the employee. Congress intended the employee retention credit to encourage employers to do just that—to continue to pay and employ their employees, and to thereby undertake a financial burden (in large part, reimbursed by the government) in the midst of a global pandemic that was unpredictable and indeterminate in length, and that for many employers raised significant questions about the short-term and long-term prospects of their businesses. Many employers responded to the incentive and kept employees on the payroll or paid them for services they did not perform. Many more might have followed that strategy, had the original credit been as generous as the 2021 version enacted in December 2020, as part of the Consolidated Appropriations Act, 2021.
This purpose—of keeping employees on the payroll—and the consequent need to interpret the CARES Act provisions liberally was embodied in many of the initial FAQs that the IRS issued. For example, as mentioned above, in FAQ 36, an employer is an eligible employer on a nationwide basis, even if government orders partially suspending the operation of their trade or business exist only in some locations. Similarly, FAQ 37 extends the same partial suspension concept to all employers required to be aggregated for purposes of the credit. For example, an employer that is required by a governmental order to suspend in-person shopping in some jurisdictions is an eligible employer even in those jurisdictions where it is not subject to the same type of order. What is the effect of these FAQs if the statutory language stating that qualified wages are wages paid to an employee not providing services due to a governmental order is read in an overly strict manner? Doing so would have the effect of making the employer an eligible employer nationwide but treating as qualified wages only wages in those jurisdictions where an order requires the partial suspension of operations. At a minimum, FAQs 36 and 37 strongly suggest that an employer could claim the credit in areas where no governmental order was in effect, thus undercutting the stricter/narrower reading.
Similarly, FAQ 54, at the time of its release, did not apply the due-to-a-government-order requirement when considering why the employee is not performing services. The FAQ states that “For an Eligible Employer that averaged more than 100 full-time employees in 2019, wages paid to hourly and non-exempt salaried employees for hours that the employees were not providing services would be considered qualified wages for the purposes of the Employee Retention Credit.” FAQ 55 uses similar language. Neither FAQ mentions the requirement that the employee is not providing services due to a governmental order or significant decline in gross receipts. Example 1 in FAQ 54 is especially critical as it permits an employer to claim the employee retention credit with respect to staff in its administrative headquarters even though the headquarters itself does not appear to be subject to any governmental order requiring it to partially suspend its operations.
Indeed, many of the original FAQs addressing the definition of qualified wages do not mention the “due to” language with respect to a determination of whether a wage is a qualified wage, but instead treat it only as part of the requirement that an employer must be an eligible employer to claim the credit. For example, in FAQ 52, qualified wages for a large employer are defined as “only wages paid to employees, after March 12, 2020, and before January 1, 2021, for the time they are not providing services during a calendar quarter in which the employer’s business operations are fully or partially suspended due to a governmental order or in which the employer experiences a significant decline in gross receipts may be treated as qualified wages.” In other words, the IRS FAQs treat the “due to” requirement as a requirement for determining the period during which wages may be treated as qualified wages, i.e., the time period in which the employer is an eligible employer, rather than as a requirement of the wages themselves. This approach to interpreting the “due to” requirement is a logical interpretation of the statute and resolves the difficulty of having to determine whether any particular employee is not performing services directly as a result of a decline in gross receipts or a governmental order.
Even where the IRS sought to narrow the scope of qualified wages in the original FAQs, it did not use the “due to” requirements as a means to do so. In FAQ 56, the IRS discusses payments under paid leave, vacation, and sick pay plans. The FAQ indicates that amounts paid under “pre-existing” plans are not qualified wages because they represent benefits accrued during a prior period. If the IRS believed, at the time of the FAQs’ issuance, that the “due to” provision required that the employee not be performing services strictly as a result of a government order, this would have been an ideal place to say so. Instead, FAQ 56 indicates that amounts paid under a pre-existing leave policy are not qualified wages because the wages represent compensation for services performed in an earlier period for which the credit cannot be claimed—the FAQ does not say that the wages are not qualified because they are paid to an employee who is not working due to a vacation as opposed to due to a governmental order.
Even so, the issuance of the original FAQs did reveal some initial hesitancy in determining what constitutes a partial suspension. For example, FAQ 33 indicates that an employer whose entire workplace is closed may not have partial suspension if it can continue on a “comparable basis” by requiring its employees to telework. Left unanswered at the time was the question of what constitutes a “comparable basis” and who gets to make that determination. (The IRS does address this issue in the Notice, as discussed in the final article of this three-part series.) This hesitancy has proven to be a sign of where the IRS’s guidance would head.
Tomorrow, we will look at the June revisions to the FAQs and how they foreshadow the guidance in Notice 2021-20.