Under the CARES Act, employers get a refundable payroll tax credit for 50% of the first $10,000 in wages paid to employees during the COVID-19 crisis. The credit is allowed against the employer portion of social security taxes on wages paid to all employees. Employers of any size qualify for the credit if their operations are suspended due to COVID-19 or if their gross receipts declined by more than 50% from the same quarter last year.
Because the credit is time-limited to wages paid from March 13 to December 31, 2020 and because employers can offset their payroll tax deposits now to claim the credit, employers need to move fast. To help the process along, the IRS has issued detailed FAQs relating to such issues as aggregate groups of employers, treatment of health plan expenses, and deductions for payroll expenses. IRS FAQs do not have the force of law but indicate the agency’s position on tax issues.
Qualified Wages Clarified
The IRS recently cleared up its conflicting statements about exactly which wages are considered “qualified wages” eligible for the employee retention credit. The confusion involved the eligibility of wages paid to employees of large companies who provide services on a reduced schedule.
Under the CARES Act, the definition of qualified wages differs for companies that average 100 or fewer full-time or FTE (full-time equivalent) employees versus more than 100 full-time or FTE employees, based on 2019 averages. For the smaller companies, all wages paid to employees (up to the $10,000 per employee limit) qualify during any calendar quarter in which business operations are fully or partially suspended due to a governmental order or the business is experiencing a significant decline in gross receipts.
For companies that averaged more than 100 full-time employees, qualified wages are the wages paid to an employee for time that the employee is not providing services due to either suspended operations or a significant decline in gross receipts. If a full-time employee moved to part-time work but was still being paid for full-time work, would the employer be ineligible for the credit because the employee was providing some services? The new IRS guidance answers this question. Large employers are allowed a partial credit for wages paid to employees who continue to work fewer hours. However, the credit is only allowed for the additional wages paid above the employee’s part-time wages.
Example 1: If an employer reduces its administrative staff’s hours by 40% but pays them 100% of the normal wage rate, the employer may treat the 40% of wages paid for the time the employees are not providing services as qualified wages eligible for the credit. The wages paid for the 60% of the time the administrative staff actually worked are not considered qualified wages.
Example 2: If a restaurant that had an average of 150 full-time employees during 2019 continues to pay kitchen employees’ wages as if they were working 40 hours per week but only requires them to work 15 hours per week, the wages paid for the 25 hours per week the kitchen employees are not providing services are qualified wages. However, if the same restaurant reduces kitchen employees’ working hours from 40 hours per week to 15 hours per week and only pays wages for 15 hours per week, no wages paid to the kitchen employees are qualified wages.
Note that for all employers, “qualified wages” include health care expenses, as explained below.
Health Plan Expenses
Wages qualified for the credit include an allocable portion of health plan expenses paid by an employer. “Qualified health plan expenses” are amounts paid or incurred for a group health plan but only to the extent that those amounts are excluded from the employees’ gross income. Contributions to HSAs generally do not qualify for the credit but some contributions to HRAs or FSAs may qualify.
The amount included for credit purposes is the amount that is allocable to the wage hours for employees. The allocation is made on a pro rata basis among covered employees and pro rata on the basis of periods of coverage. For employers with more than one health plan, qualified health plan expenses are determined separately for each plan. If an employee participates in more than one plan, the allocated expenses of each plan are aggregated for that employee.
The IRS reversed its position in two FAQs (64 and 65) after receiving a letter from several members of Congress relating to health plan expenses paid by an employer during the time when an employee is furloughed. The IRS originally said none of those expenses would qualify for the credit but revised its FAQs to allow employers to claim the credit for health care expenses regardless of whether the employee is paid qualified wages. This change will encourage employers to continue paying health plan expenses for furloughed employees.
When determining an employer’s eligibility for and the amount of the credit, all entities that are a controlled group of corporations or affiliated service groups under the Internal Revenue Code are treated as a single employer. For these employers, the amount of the credit must be apportioned among members of the aggregated group on the basis of each member’s proportionate share of the qualified wages giving rise to the credit. The individual entities should separately report their credit on their employment tax returns.
Deductions for Payroll Expenses
The IRS has made clear that any credit claimed reduces the payroll expenses that an employer could otherwise deduct on its federal income tax return. This rule is common in the tax code and applies to other deductions and credits as well.
The IRS has clarified that eligible employers using a third party to report and pay employment taxes are allowed the credit, but special rules apply depending on the type of third-party payer used. If an employer uses a reporting agent to file Form 941, Employer’s Quarterly Federal Tax Return, the reporting agent will need to reflect the credit on Form 941 that it files on the employer’s behalf.
The credit is allowed for wages paid or incurred from March 13, 2020 through December 31, 2020. An eligible employer can elect not to take the credit by not claiming it on the quarterly employment tax return. The employer is allowed to claim it in a subsequent calendar quarter. If an eligible employer did not take the credit in a past quarter, the employer can file a claim for refund and make an interest-free adjustment for a prior quarter to claim the credit. However, qualified wages paid during the first quarter of 2020 should be reported on the employer’s second-quarter Form 941.
Finally, if an employer repays its PPP loan by May 14, 2020, the employer will be eligible for the employee retention credit. The IRS’s original rule was that receiving a PPP loan would disqualify an employer for the employee retention credit.