IRS Updates FAQs to Expand Eligibility for Employee Retention Credits Under the CARES Act
On May 7, 2020, the Internal Revenue Service (IRS) and the Department of the Treasury revised their frequently asked questions (FAQs) guidance on the Employee Retention Credit to allow employers that do not pay wages, but continue to cover the health plan expenses for laid-off or furloughed employees, to qualify for retention credits. As a result of this change (see updated FAQs 64 and 65), employers will be encouraged to continue to pay health plan expenses for employees who have been laid off or furloughed due to the COVID-19 pandemic.
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, employers are financially incentivized—in the form of tax credits—to keep their employees on payroll. Specifically, employers are eligible for a tax credit equal to 50 percent of qualified wages (including healthcare benefits) paid to an employee after March 12, 2020, and before January 1, 2021. The largest tax credit an employer can claim is $5,000 per employee, because the amount of qualified wages and health plan expenses taken into account is capped at $10,000 for each employee. Notably, qualified wages do not include wages for which an employer is permitted a tax credit under the Families First Coronavirus Response Act (FFCRA). The Employee Retention Credits are unavailable to employers that receive loans under the Paycheck Protection Program.
For purposes of calculating the Employee Retention Credit, “qualified wages” is defined under Internal Revenue Code Section 3121(a), but the scope of “qualified wages” will vary based on the number of full-time employees employed by an employer. Additionally, an employer must satisfy one of the following tests: (1) the employer’s business operation is fully or partially suspended by a governmental order because of COVID-19 or (2) the employer’s gross receipts are less than 50 percent of what they were for the same quarter in 2019. If either of these tests is satisfied, the employer can immediately decrease the amount of federal payroll taxes deposited.
Initially, the IRS’s position was that employers that provided only health coverage to laid-off or furloughed employees could not claim a retention credit. This interpretation of the Employee Retention Credit created a disincentive for employers to provide health coverage to laid-off and furloughed workers. To avoid this unintended consequence, a group of bipartisan lawmakers wrote to Treasury Secretary Steven Mnuchin on May 4, 2020, expressing their disapproval of the IRS’s determination and urging the Treasury Department and the IRS to reconsider.
In support of their position, the lawmakers stated that maintaining access to healthcare was “absolutely critical” during the COVID-19 pandemic and that the tax credit would incentivize employers to maintain employees’ health coverage, as well as wage payments. On May 7, 2020, the Treasury Department’s Office of Legislative Affairs notified Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and other lawmakers that the Treasury Department would be revising its guidance in response to their letter. Following the Treasury Department’s letter, Senator Grassley said in a press release, “This is good news for small businesses and workers across the country. This decision will encourage employers to help employees keep their health insurance while temporarily furloughed due to the shutdown.”
In light of this reversal, employers can now treat healthcare expenses paid while an employee is furloughed or laid off as qualified wages, which will make them eligible for a retention credit. For eligible employers of all sizes affected by the COVID-19 crisis, the Employee Retention Credit remains a viable option. The Employee Retention Credit may be an especially effective option for those employers that cannot continue to pay wages but wish to pay the health plan expenses of furloughed employees and their families.