CARES Act Employee Retention Credit: A Detailed Analysis
The Coronavirus Aid, Relief, and Economic Security Act (Act) contains several business relief provisions, including a provision providing for an employee retention credit. While a brief overview of this provision is included in our CARES Act Reference Guide (see p. 9), the following is our detailed analysis of its key aspects. Detailed analysis of the employer payroll tax deferral is provided in a separate alert.
As a general rule, the employee retention credit (Credit) is a refundable credit that is equal to 50 percent of the “qualified wages” of each employee of an “eligible employer.” The Credit is calculated on a calendar quarter basis and is applied against “applicable employment taxes” of the eligible employer, although in application, only the employer portion of the Social Security tax (6.2 percent of wages) is eligible for the Credit. As such, the Credit does not apply to employee income tax withholding, the employee or employer portion of Medicare tax, or the employee portion of the Social Security tax.
The mechanics of the Credit are complicated and work as follows:
- The Credit is limited to wages paid after March 12, 2020 and through December 31, 2020. While the Credit calculation starts with qualified wages, these wages are capped at $10,000 per employee for all quarters. Given this wage cap and the 50 percent of qualified wages limit, the maximum Credit is $5,000 per employee.
- An employer is an “eligible employer” if the employer was carrying on a trade or business during the 2020 calendar year and the operation of the trade or business with respect to any calendar quarter was fully or partially suspended due to orders from an appropriate governmental authority limiting business activity (commerce, travel or group meetings for commercial, social, religious or other purposes) due to the coronavirus (COVID-19). In the case of a tax-exempt organization described in Code Section 501(a), the COVID-19 test is applied to all operations for such organization.
- An employer will also be an “eligible employer” if the employer was carrying on a trade or business during the 2020 calendar year, even if the trade or business was not fully or partially suspended due to orders related to COVID-19, as long as there is a significant decline in gross receipts during a calendar quarter in 2020. Specifically, if the gross receipts for a calendar quarter are less than 50 percent of gross receipts for the same calendar quarter in the prior year, there will be a significant decline in gross receipts until the calendar quarter in which gross receipts are greater than 80 percent of the same calendar quarter in the prior year. This alternate test allows the Credit to be available for the gross receipt declines even if the decline is not COVID-19-related.
- An eligible employer can elect out of the Credit for any calendar quarter.
- The Credit does not apply if an employer takes a Small Business Interruption Loan under Section 1102 of the Act, which is referred to as the Paycheck Protection Program. As noted below, the Internal Revenue Service (IRS) has authority to issue regulations and guidance regarding the Credit and one specific grant of authority relates to the ability of the IRS to recapture the Credit when a Paycheck Protection Program loan is obtained in a subsequent quarter. For more information on the Paycheck Protection Program, see p. 2 of our CARES Act Reference Guide and our alert on the program for non-profits.
- The calculation of “qualified wages” depends on the average number of full-time employees of the eligible employer.
- If the average number of full-time employees during 2019 was greater than 100, wages are counted only to the extent that they are paid to an employee who is not providing services due to a COVID-19 order or due to a significant decline in gross receipts. Wages for these employees cannot exceed the amount that such employees would have been paid for working an equivalent duration during the 30 days immediately preceding such period.
- If the average number of full-time employees of the eligible employer during 2019 was 100 or less, wages are counted to the extent they are paid to all employees due to the a COVID-19 order or due to a significant decline in gross receipts.
- The key distinction between the two categories is that the 100 or less full-time employee category allows wages to be counted for all employees, even if the employees have not been prevented from providing services, and the greater than 100 full-time employees category allows wages to be counted only for those employees who cannot provide services due to the COVID-19 order or due to a significant decline in gross receipts.
- There are several special rules that are considered for purposes of calculating wages.
- First, wages are not counted if taken into account under Section 7001 or Section 7003 of the Families First Coronavirus Response Act, which provide for refundable tax credits for most employers with fewer than 500 employees that pay qualified sick leave wages or qualified family leave wages to their employees.
- Second, wages include the eligible employer’s qualified health plan expenses that are allocated to the wages. These expenses are those related to employer-provided group health plan coverage where the cost of the coverage is excluded from the employee’s income.
- Finally, the Credit rules use the same definition of wages as used under Section 3121(a) of the Internal Revenue Code of 1986, as amended (Code), for Social Security tax purposes.
- After the wages are calculated, there are additional rules regarding the use of the Credit. The general rule is that the amount of the Credit for any calendar quarter cannot exceed the applicable employment taxes on wages paid with respect to the employment of all employees for the calendar quarter. In calculating the applicable employment taxes, any credits under Code Section 3111(e) (credit for employment of qualified veterans), Code Section 3111(f) (credit for research expenditures of qualified small businesses), and the refundable tax credits under Section 7001 or Section 7003 of the Families First Coronavirus Response Act are applied first. In addition, if the Credit exceeds the employment tax limitation in any quarter, then the excess amount is treated as an overpayment and refunded to the employer, which is the primary benefit for businesses who continue to retain their employees.
- The IRS recently issued guidance on the mechanics for claiming the Credit. First, the Credit is used to reduce the required deposits of payroll taxes for each quarter that have been withheld from an employee’s wages. Under this approach, the employer keeps the withheld payroll taxes (instead of depositing the taxes with the IRS) in an amount up to that of the Credit. This frees up cash flow by eliminating the deposit requirement. Second, starting with the second quarter of 2020, Credit amounts in excess of the required employment tax deposits can be refunded by filing Form 7200 to receive an advance refund of the Credit. The IRS is expected to comment on the timing of when the refund of the Credit will be sent to employers.
- In addition to these calculation rules, there are a series of special operating rules.
- If an employer is treated as a single employer under the controlled group/common control rules of Code Section 52(a) and (b) or the affiliated service group rules of Code Section 414(m) and (o), all such employers are aggregated as one employer for purposes of the Credit rules, including determining the number of employees.
- Wages of certain parties related to the employer (using the principles of Code Section 51(i)(1)) as well as certain wages already subject to credits (using the principles of Code Section 280C(a)) are excluded.
- Federal, state and local governmental employers cannot take advantage of the Credit.
- If an employer is allowed a credit under Code Section 51 (work opportunity credit), the employer cannot also claim the Credit. Wages taken into account for the credit under Code Section 45S (employer credit for paid family and medical leave) cannot also be counted as wages for purposes of the Credit.
- The IRS is required to waive any penalty for the failure to make a timely deposit of employment tax it determines that the failure was due to the reasonable anticipation of the Credit being allowed.
- The IRS is authorized to issue regulations and guidance regarding certain aspects of the Credit rules.
While these rules are complicated and require an analysis of the use of other credits under the Code and Section 7001 or Section 7003 of the Families First Coronavirus Response Act, there is significant benefit to eligible employers who continue to pay employees during the balance of 2020, particularly when the Credit is refunded and can then be used to fund other tax obligations or business expenses.
The availability of the Credit is an important aspect of the Act and employers should evaluate whether they can benefit from this provision. To discuss how the Credit provision affects your business, please contact John Eagan (firstname.lastname@example.org; 212.868.4835) or Stephen Bowers (email@example.com; 215.864.6247).
As we continue to monitor the novel coronavirus (COVID-19), White and Williams lawyers are working collaboratively to stay current on developments and counsel clients through the various legal and business issues that may arise across a variety of sectors. Read all of the updates here.