Many companies and their advisors have spent the past weeks carefully analyzing the CARES Act and determining the best courses of action in response to the new legislation. One benefit for companies to consider is the Employee Retention Credit for Employers Subject to Closure Due to COVID-19 (ERC).  What makes the ERC both unique and powerful is how it is monetized – an “Eligible Employer” (defined below) can apply these credits against federal payroll taxes as opposed to income taxes. The ERC is not available to companies who participate in the SBA Payroll Protection Program (PPP). (For a more detailed description of PPP, see our past TAW.) However, unlike the PPP, the ERC does not inhibit a company’s ability to adjust employee headcount and compensation (although such an adjustment could impact the amount of the ERC). Additionally, eligibility for the ERC is not limited to “small business concerns” (i.e., companies of all sizes can generally benefit), so the ERC could provide a benefit for companies that maintain some level of payroll, even if they choose to implement wage reductions, layoffs, or furloughs.  However, late last night, the IRS released revised Frequently Asked Questions (FAQs), which although they are not binding authority, address many of the areas of uncertainty. Unfortunately, for the most part, the FAQs generally limit the scope of the extent a taxpayer can benefit from the ERC.

What is the ERC?

The ERC is a fully refundable payroll tax credit for an “Eligible Employer” equal to 50% of “Qualified Wages,” limited to $10,000 per employee per year.  As a result, the ERC is effectively capped at $5,000 per employee and is only available for wages paid while the employer meets the Eligible Employer definition. 

Who Is an Eligible Employer?

An “Eligible Employer” is an employer (including tax-exempt organizations) which was carrying on trade or business during the calendar year 2020 and incurred either (1) a full or partial suspension of operations with respect to a trade or business (FPSO) or (2) a significant decline in gross receipts.

FPSO

An employer incurs a FPSO in any calendar quarter for which the operations are “fully or partially suspended … due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings” due to COVID-19.  The FAQs clarify how to determine whether an employer satisfies this requirement.  With respect to whether an employer has a FPSO, the FAQs clarifies that “governmental order” is an “[o]rder, proclamation, or degree from the Federal government or local government … if they limit commerce, travel or group meetings due to COVID-19.”  The FAQs then exclude “[s]tatements from a governmental official, including comments made during press conferences or in interviews with the media ….”

Additionally, the FAQs clarify that an employer has a FPSO:

• If the governmental order allows the trade or business to operate, but it prevents a supplier from making deliveries of critical goods or materials to the employer.
• If the governmental order closes an employer’s workplace for certain purposes but allows it to stay open for other purposes (e.g., a restaurant that is closed for sit-down service but can operate carryout, drive-through, or delivery basis).
• If the operating hours are reduced due to a governmental order.
• If an employer: (1) operates a trade or business in multiple locations, which is subject to a governmental order requiring FPSO in some jurisdictions but not all of its locations; (2) adopts a policy that complies with local governmental orders, as well as the Center for Disease Control and Prevention recommendations, and the Department of Homeland Security guidance (collectively, Other Policies); and (3) the Other Policies require FPSO in the other jurisdictions.

On the other hand, the FAQs also clarify that an employer does not have a FPSO:

• If the governmental order allows the employer to remain open, but the governmental order reduces the number of customers the employer has or demand for its services. 
  
  Example: Employer operates a dry cleaning business which is an essential business and is not required to close its locations or suspend its operations. Due to a governmental order that limits travel due to COVID-19, Employer’s business has declined significantly. Employer does not have a FPSO, but it may qualify as having a significant decline in gross receipts (described below).
   
•  If the employer experiences a decrease in employee’s productivity levels during the hours the employee is working.
  
  Example: Employer provides online support to various websites but had to close its offices due to a governmental order that limited travel. Employer required all employees to telework.  On average, employees were able to address 15 help tickets a day when they were working in the office, but now that they are working from home, they are generally able to address 8 help tickets a day. Employer does not have a FPSO, but it may qualify as having a significant decline in gross receipts (described below).

Significant Decline in Gross Receipts

An employer incurs a significant decline in gross receipts with respect to any calendar quarter which is within the period beginning with the first calendar quarter beginning after December 31, 2019, for which gross receipts are less than 50% of the same calendar quarter in the prior year and ending with the calendar quarter following the first calendar quarter for which gross receipts are greater than 80% of the prior year’s calendar quarter. The FAQs provide the following helpful clarifications:

• Employers do not need to prove that the significant decline in gross receipts is related to COIVD-19 in order to qualify.
• If an employer started a trade or business in 2019, then it can use the gross receipts for the quarter in which it started its business as the gross receipts for the prior quarters for purposes of comparing its 2020 gross receipts to its 2019 receipts.  For example, if an employer started a business in the third quarter of 2019, then it can use that quarter’s gross receipts for purposes of comparing to the employer’s gross receipts from the first, second, and third quarter of 2020.
• If an employer acquires (e.g., due to an asset purchase or a stock purchase) a trade or business in 2020, it is required to include its post-acquisition gross receipts in the computation of whether it has a significant decline in gross receipts.  However, for purposes of the ERC, the employer is also allowed to include, to the extent information is available, the gross receipts of the acquired business in its gross receipts for 2019 calendar quarter even though the employer did not own the acquired business.
• The employer is only eligible for the ERC for the calendar quarter in which its gross receipts are less than 50% of the same calendar quarter in 2019 through the calendar quarter in which its gross receipts are more than 80% of the same calendar quarter in 2019 (as opposed to the following quarter).  For example, if the employer’s first, second, and third quarter gross receipts for 2020 were approximately 40%, 85%, and 90% of its 2019 first, second, and third quarter receipts, respectively, then it would be an Eligible Employer that had a significant decline in gross receipt for the first and second calendar quarters only.

What Are Qualified Wages?

For purposes of the ERC, the term “wages” means wages (section 3121(a)) and compensation (section 3231(e)) that are paid by an Eligible Employer to some or all of its employees are March 12, 2020, and before January 1, 2021, so long as they are not paid to a person related to the employer.  However, what wages constitutes Qualified Wages depends on the average number of full-time employees the employer had in 2019.

Eligible Employers Who Averaged More Than 100 Full-time Employees in 2019

For Eligible Employers who averaged over 100 full-time employees in the calendar year 2019, Qualified Wages are limited to wages paid to employees not providing services due to the fact that the employer is an Eligible Employer (FPSO or a significant decline in gross receipts). The FAQs clarify that:

• Both hourly and salaried employees can be paid wages while not providing services.<
  • For hourly and non-exempt salaried (i.e., entitled to overtime pay) employees, it is merely a matter of determining the extent they are paid for hours that they did not work.  For exempt salaried employees (i.e., not entitled to overtime pay), employers are allowed to use any reasonable method for purposes of determining the number of hours the employee is not providing services.
• The amount of wages that constitute Qualified Wages cannot exceed the amount the employer would have paid for an equivalent duration during the 30 days immediately preceding the commencement of the FPSO or the first day of the calendar quarter in which the employer experienced a significant decline in gross receipts.
  • This is interesting because if an employee received a raise (even if it was pursuant to their contract) after the FPSO or the first day of the calendar quarter in which the employer experienced a significant decline in gross receipts, such amounts are not included as Qualified Wages.
• A decrease in employee’s productivity levels does not constitute wages paid to an employee who is not providing services.
• Amounts paid to an employee who is not providing services as paid time off, vacation pay, holiday pay, sick pay, and other paid days off does not constitute qualified wages.

Additionally, it is important to remember that the determination of whether an employer experiences a FPSO is made on a trade or business level and that an employer who suffers a partial shutdown may have to bifurcate its employees to determine whether wages constitute Qualified Wages.  For example, if an employer operates both a retail business, which is forced to close due to a governmental order, and a website, through which it continues to fulfill online orders, then the employer’s online ordering and fulfillment system is unaffected by the governmental order.  Therefore, wages that are paid to employees that work on the website business are eligible Qualified Wages only if the employer has a significant decline in gross receipts (i.e., the FPSO with respect to the retail business does not apply with respect to these employees).

Eligible Employers Who Averaged 100 or Less Full-time Employees in 2019

For Eligible Employers who averaged 100 or fewer full-time employees in calendar year 2019, Qualified Wages includes all wages paid (even if the employee is providing services) during a FPSO or while the employer is experiencing a significant decline in gross receipts.

Qualified Health Plan Expenses

In addition to wages, Qualified Wages also includes amounts paid or incurred to provide and maintain a group health plan, so long as the employee is not taxed with respect to such expenses and the amounts are properly allocable to wages (Qualified Health Plan Expenses).

While the ERC may provide some liquidity, the ERC does not provide the cash savings an employer may receive by laying off or furloughing some of its employees.  As a result, many employers that are in need for liquidity have pursued layoffs and furloughs but continued to provide and maintain a group health plan for such employees.  The FAQs clarify that in order for costs to be included in Qualified Wages, the costs have to be allocable to Qualified Wages (without regard to qualified health plan expenses).  Therefore, if the employer is not paying wages to an employee that is furloughed, then no amount of the employer’s health plan expenses relating to such employee constitute Qualified Wages.

Aggregation Rules

As noted previously, the ERC is a credit that applies against federal payroll taxes.  Therefore, the ERC rules focus on “employers” as opposed to “taxpayers.”  In determining who is an employer, the ERC rules contain aggregation rules that apply to treat multiple taxpayers as a single employer for purposes of the ERC.  Specifically, if taxpayers satisfy the “single employer test” of section 52(a) or (b) or 414(m) or (o), then the FAQs provide that they are treated as a single employer for purposes of determining:

• Whether it received a PPP.
  • If a taxpayer receives a PPP, then all other taxpayers that are treated as the same single employer are prohibited from claiming the ERC.
• Whether it operated a trade or business that incurred a FPSO.
  • If one taxpayer incurs an FPSO with respect to a trade or business, then all taxpayers that are treated as the same employer and operate the same trade or business are treated as incurring an FPSO for ERC purposes.
  • At first blush, this may seem contrary to the discussion above regarding the employer that operates both a retail business and a website.  However, it is important to remember that for purposes of these rules, if taxpayers satisfy the single employer test they are treated as a single employer for ERC purposes.  As a result, under this FAQ, all of the taxpayers would have incurred a FPSO.  However, that does not mean they have Qualified Wages.  In the case of an employer that has more than 100 full-time employees, the taxpayer would still need to pay wages to an employee who is not providing services due to the FPSO.  If that particular taxpayer is not closed, from an economic standpoint it is unclear why they would unnecessarily pay an unrelated employee to not work and how such payment is as a result of the FPSO.  
• Whether it incurred a significant decline in gross receipts.
  • For this purpose, the aggregate gross receipts for all taxpayers that are treated as a single employer are aggregated for purposes of the calculation.
• Whether they have more than 100 full-time employees.

How Can the ERC Generate Liquidity?

In order to appreciate how the ERC generates liquidity it is important to understand the mechanics of claiming the credit.  The ERC is a fully refundable credit.  For any calendar quarter, the excess, if any, of the Eligible Employer’s ERC over the employer’s portion of the social security taxes on all wages paid to all employees is treated as an overpayment.  This overpayment is used to offset any remaining employment tax liabilities, with any excess being refunded.  The FAQs clarifies that in determining the amount of the overpayment and any excess, the employer’s portion of social security taxes that is eligible for deferral is disregarded.  The FAQs also clarify that an employer is not entitled to a deduction to the extent of Qualified Wages are included in the computation of a claimed ERC.

Due to the calculation of the fully refundable credit, companies can monetize the ERC benefit in three ways:

1. Request an Advance of the ERC
   • Under this approach, an Eligible Employer takes advantage of the CARES Act provisions as soon as possible (including the deferral of the employer’s portion of social security taxes) and requests an advance of the ERC prior to the end of the calendar quarter by filing a Form 7200 to request the refund. At the end of the quarter, the Eligible Employer has to reconcile the amount of ERCs that it claimed throughout the quarter to the amount of ERCs it is actually entitled to claim on its Form 941. If there is any excess, then it can claim a refund at that point. This option provides companies with the fastest infusion of liquidity but requires the taxpayer to reasonably determine the amount of the ERC for the quarter, otherwise they could be subject to penalties and interest. 

   • Example: Eligible Employer pays $8,000 in Qualified Wages during the calendar quarter.  Eligible Employer has a federal tax deposit obligation of $5,000 (of which $1,250 relates to the employer’s share of social security tax) prior to any deferral.  Eligible Employer reasonably anticipates a $4,000 ERC for the quarter.

     The Eligible Employer first defers the employer’s share of social security tax, thereby reducing its federal tax deposit obligation to $3,750.  Due to the anticipated ERC, Eligible Employer reduces its federal employment tax deposit for the payroll period to $0 and files a Form 7200 to request a refund of $250.

2. Apply the ERC throughout the Quarter But Request a Refund at the End of the Quarter
   • Under this approach, an Eligible Employer takes advantage of the CARES Act provisions as soon as possible (including the deferral of the employer’s portion of social security taxes) but does not request a refund until the end of the quarter on its Form 941.  This option provides companies with some infusion of liquidity due to the deferral and offset of payroll tax liabilities, but still requires the taxpayer to reasonably determine the amount of the ERC for the quarter, otherwise they could be subject to penalties and interest.  Therefore, this approach should be taken to the extent taxpayers do not need the fastest infusion of liquidity and want to minimize the amount of payroll tax forms they need to file.

   • Example: Eligible Employer pays $8,000 in Qualified Wages during the calendar quarter.  Eligible Employer has a federal tax deposit obligation of $5,000 (of which $1,250 relates to the employer’s share of social security tax) prior to any deferral.  Eligible Employer reasonably anticipates a $4,000 ERC for the quarter. (The same facts as above.)

     The Eligible Employer first defers the employer’s share of social security tax, thereby reducing its federal tax deposit obligation to $3,750.  Due to the anticipated ERC, Eligible Employer reduces its federal employment tax deposit for the payroll period to $0.  However, instead of filing a Form 7200, the Eligible Employer claims the ERC on its Form 941 at the end of the quarter.

3. Continue to Make Payroll Tax Deposits and Request a Refund at Quarter-End
   • Under this approach, an Eligible Employer defers its portion of social security taxes under the CARES Act but does not apply the ERC during the quarter.  As a result, the Eligible Employer deposits employment taxes that can be offset by the ERC and claims the full amount of the ERC at the end of the quarter.  This option provides companies with least amount of infusion of liquidity but does not require the taxpayer to reasonably determine the amount of the ERC for the quarter, because no amount is claimed during the quarter.

   • Example: Eligible Employer pays $8,000 in Qualified Wages during the calendar quarter.  Eligible Employer has a federal tax deposit obligation of $5,000 (of which $1,250 relates to the employer’s share of social security tax) prior to any deferral.  Eligible Employer reasonably anticipates a $4,000 ERC for the quarter. (The same facts as above.)

     The Eligible Employer first defers the employer’s share of social security tax, thereby reducing its federal tax deposit obligation to $3,750.  The Eligible Employer deposits the $3,750.  At the end of the quarter, the Eligible Employer claims the ERC on its Form 941 and requests a refund of $4,000 

A&M Taxand Says

Although the ERC may not eliminate the economic need for wage reductions, layoffs, or furloughs, the ERC has the potential to cover a broad range of companies.  As a result, any company of any size that does not receive a PPP should consider whether they qualify for the ERC.  As highlighted in this alert, there are qualitative and quantitative complexities associated with assessing eligibility for the ERC.  With the potential for IRS penalties if erroneous credits are claimed and/or mistakenly applied, it is important that interested companies work with their advisors to determine both eligibility and the extent to which they qualify for the ERC.  Establishing that a taxpayer is an Eligible Employer that is paying Qualified Wages may require formulating a sustainable methodology supported by contemporaneous evidence to demonstrate the “how” and “why.”  Alvarez & Marsal would be happy to discuss your particular situation and help address your questions.