New guidance on the CARES Act’s Employee Retention Credit: Aggregation rules, qualified wages, and other clarifications

The Coronavirus Aid, Relief, and Economic Security (CARES) Act  provides for a fully refundable federal payroll tax credit (Employee Retention Credit (ERC)) equal to 50% of the first $10,000 of “qualified wages” paid by an “eligible employer” during the period March 13 – Dec. 31, 2020, under certain circumstances related to the COVID-19 pandemic. See our prior article on employment-related provisions of the CARES Act for details. 

The IRS recently issued detailed guidance (“the Guidance”) on the ERC in a Q&A format. Read on for a summary of the most important aspects.

PPP loan precludes ERC – An employer that receives a loan under the Paycheck Protection Program (PPP) is not eligible for an ERC. The Guidance clarifies that for ERC purposes, all employers that are members of an Internal Revenue Code (IRC) Section 52 “controlled group” (generally based on greater than 50% common ownership) or an IRC Section 414(m) “affiliated service group” are required to be aggregated and treated as a single employer, and thus where any employer receives a PPP loan, all employers that are members of that employer’s controlled group or affiliated service group are ineligible for an ERC.

Note: Employers that applied for a PPP loan by April 24, 2020, received payment, and then repay the loan by May 14, 2020, will be eligible  for the credit, provided they are otherwise eligible for purposes of the ERC. (Read more about this “safe harbor” in our updates on PPP eligibility and guidance.)

“More than 100 full-time employees” test – Different rules apply as to the wages that constitute “qualified wages” eligible for the ERC depending on whether for 2019 the eligible employer had on average 100 or fewer full-time employees, or more than 100. (If 100 or fewer, all wages paid are “qualified wages,” but if more than 100, only wages paid for time when the employee is not working are “qualified wages.”) For this purpose, the term “full-time employee” is defined by cross-reference to a definition used for purposes of the “Applicable Large Employer” standard under the Affordable Care Act. The Guidance clarifies that “full-time employee” means an employee who with respect to any calendar month in 2019 had an average of at least 30 hours of service per week or 130 hours of service in the month. An employer that operated its business for the entire 2019 calendar year determines the average number of its full-time employees for 2019 by adding the number of its full-time employees for all months and dividing the result by 12 (or, divide by the number of months the business was operated in 2019 if fewer than 12). There is no mention of the applicability of a “full-time employee equivalent” concept (i.e., the need to take part-time employees into consideration) as is applicable under the “Applicable Large Employer” test under the Affordable Care Act. The Guidance further clarifies that all full-time employees of all employers within the same “controlled group” or “affiliated service group” must be aggregated for purposes of this test.

“Underutilization pay” – If an “eligible employer” that averaged more than 100 full-time employees in 2019 continues to pay an employee’s regular wages while the employee is working a reduced schedule (e.g., working 80%), the pay for the time when the employee is not providing services (20%) will count as “qualified wages” for purposes of the ERC.

Health care coverage and “qualified wages” – In addition to the amount of wages paid, “qualified wages” eligible for the ERC may be increased by the “qualified health plan expenses” (generally, the employer’s cost of providing medical, dental, and vision benefits, plus the employee’s contributions made on a pre-tax basis) allocable (on a pro rata basis) to the wages paid. The Guidance had clarified that if an employer of any size continued an employee’s health care coverage when the employee was not providing services and did not pay wages to the employee for that time (e.g., where the employee had been laid off or furloughed), the health care costs would not be “qualified wages” eligible for the ERC, because no portion of the health plan expenses would be allocable to wages paid to the employee. However, the IRS revised that guidance on May 7, with the result that such coverage when no services are being performed will count as “qualified wages” for employers of all sizes. Note, though, that eligible employers that averaged more than 100 full-time employees in 2019 may not treat health plan expenses allocable to the time for which employees are receiving wages for providing services as “qualified wage”; for those eligible employers, only the portion of health plan expenses allocable to the time that the employees are not providing services are treated as “qualified wages.” Both groups remain subject to the ERC’s maximum of $10,000 of “qualified wages” per employee for all calendar quarters.

No changes have been made to the provisions of the Guidance that employer contributions to HSAs (health savings accounts) and QSEHRAs (qualified small employer health reimbursement arrangements) do not count as “qualified health plan expenses,” but employer contributions to HRAs (health reimbursement arrangements) and to FSAs (flexible spending accounts) do count.

The “significant decline in gross receipts” test – One of the two tests for “eligible employer” status is a 50% or greater reduction of gross receipts when comparing any 2020 quarter to the same quarter in 2019. The Guidance clarifies that for this purpose, the gross receipts of all members of a “controlled group” or “affiliated service group” must be aggregated. The Guidance also advises that the IRS plans to issue future guidance as to how this test is to be performed for a tax-exempt organization.

Wages paid under a pre-existing vacation, holiday pay, sick pay, or other personal leave policy or as severance pay – The Guidance clarifies that wages paid by an “eligible employer” that averaged more than 100 full-time employees in 2019 pursuant to an existing vacation, holiday pay, sick pay or other leave policy are not “qualified wages,” and for employers of all sizes, severance pay is not “qualified wages.”

Wages paid to “related individuals” – The Guidance clarifies that wages paid by an “eligible employer” to IRC Section 51(i)(1) “related individuals” are not “qualified wages.” For an “eligible employer” that is an individual, a “related individual” is the eligible employer’s:

• Child or descendant of a child;
• Brother, sister, stepbrother, or stepsister;
• Father or mother or an ancestor of either;
• Stepfather or stepmother;
• Niece or nephew;
• Aunt or uncle;
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

For an eligible employer that is a corporation, a “related individual” is any person that has any of the above relationships to an individual who directly or indirectly owns more than 50% in value of the corporation’s outstanding stock. For an entity other than a corporation, the test is based on such a relationship with an individual who is an owner of more than 50% of the capital and profits interests in the entity. For an estate or trust, the test is based on such a relationship with an individual who is a grantor, beneficiary, or fiduciary of the estate or trust.

ERC reduces employer’s otherwise deductible compensation expenses – The CARES Act provides that rules similar to those under IRC Section 280C(a) apply to the ERC. The Guidance clarifies that an employer’s otherwise compensation deduction amount is therefore reduced by the amount of the ERC taken with respect to that compensation.

Claiming an ERC for a past quarter – Where an “eligible employer” is entitled to an ERC for a quarter but does not claim the ERC, it can later claim the ERC for that quarter by filing a Form 941-X.

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}