Overview
For additional guidance, please refer to Steptoe's COVID-19 Resource Center.
Since the Families First Coronavirus Response Act (the FFCRA) was enacted on March 18, 2020 and the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was enacted on March 27, 2020, the Internal Revenue Service (IRS) has been busy trying to provide guidance. Most of the guidance has been in the form of frequently asked questions (FAQs), press releases, or other website content. This type of guidance has the benefit of being quick to issue and update.[1] We expect to continue to see updates to these resources as the IRS responds to open questions, and will update this summary accordingly.
The following guidance is discussed below:
- FAQs on Tax Credits for Paid Leave
- FAQs on the Employee Retention Credit
- FAQs on Deferral of Employment Taxes
- FAQs on Payroll Support for Air Carriers and Contractors
FAQs on Tax Credits for Paid Leave
The IRS has issued FAQs providing guidance on tax credits for the cost of providing paid sick and family leave that are available to businesses with fewer than 500 employees under the FFCRA. The credit is equal to 100% of qualified sick leave wages or qualified family leave wages.[2] The credit is also applicable to the self-employed.[3] The guidance clarifies that employers may claim the tax credits for the qualified leave wages paid to employees on leave for reasons related to COVID-19 beginning on April 1, 2020, and ending on December 31, 2020.
Qualified Sick Leave Wages. Qualified sick leave wages include allocable qualified health plan expenses and the employer's share of Medicare taxes. The term does not include any contributions to a retirement plan or any other welfare plan. The guidance provides definitions of the terms "qualified sick leave wages," "qualified family leave wages," "qualified health plan expenses," and the employer's share of Medicare tax for which the credits may be claimed.
Qualified health plan expenses are allocated to the qualified sick or family leave wages through a pro rata allocation among covered employees and relative to the time periods of leave to which such wages relate. The amount of qualified health plan expenses taken into account in determining the credits generally includes both the portion of the cost paid by the employer and the portion of the cost paid by the employee with pre-tax salary reduction contributions. However, the qualified health plan expenses do not include amounts that the employee paid for with after-tax contributions. The amount also includes both group health care costs and the employee’s flexible spending account under a cafeteria plan. The amount of qualified health plan expenses does not include employer contributions to HSAs, QSEHRAs or Archer MSAs. The employer may use any reasonable method to determine and allocate the plan expenses, including (1) the COBRA applicable premium for the employee typically available from the insurer, (2) one average premium rate for all employees, or (3) a substantially similar method that takes into account the average premium rate determined separately for employees with self-only and other than self-only coverage.
Claiming the Credits. In anticipation of receiving the credits, an employer may access federal employment taxes related to wages paid between April 1, 2020, and December 31, 2020. Note that taxes not yet paid for March wages cannot be accessed. Notice 2020-22 and the FAQs provide that employers can retain the federal employment taxes that they otherwise would have deposited, including federal income tax withheld from employees, the employees’ share of social security and Medicare taxes, and the employer's share of social security and Medicare taxes with respect to all employees. An employer may fund the qualified leave wages (and allocable qualified health plan expenses and the employer's share of Medicare tax on the qualified leave wages) by accessing federal employment taxes, including those that the employer already withheld, that are set aside for deposit with the IRS, for other wage payments made during the same quarter as the qualified leave wages. In other words, these payments can be "prefunded" from upcoming tax amounts in the same quarter. The employer must account for the reduction in deposits on Form 941, Employer's Quarterly Federal Tax Return. Draft versions of Form 941 and accompanying instructions have been released to reflect these changes. The nonrefundable portion of the credit is limited to the employer share of social security tax reported on Form 941, lines 5a and 5b, after that share is first reduced by any credits claimed for the Qualified Small Business Payroll Tax Credit for Increasing Research Activities or the Work Opportunity Credit. Any credit in excess of the remaining amount of the employer share of social security tax is refundable and reported on Form 941, line 13c. An employer will generally not be subject to a penalty under section 6656 for failing to deposit federal employment taxes relating to qualified leave wages.
The credits are fully refundable if the amount of the credits is more than certain federal employment taxes the employer owes. Thus, if for any calendar quarter the amount of the credits the employer is entitled to exceeds the employer portion of the social security tax on all wages (or the employer portion of the social security tax and Medicare tax on all compensation for employers subject to RRTA) paid to all employees, then the excess is treated as an overpayment and refunded under sections 6402(a) or 6413(a). If there are insufficient federal employment taxes to cover the amount of the credits, an employer may request advance payment of the credits by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19. Form 7200 is submitted to the IRS via fax. There is no estimate given for when employers might receive their credits if filed for in this fashion.
Documentation Requirements. Employers claiming the credits for qualified leave wages (and allocable qualified health plan expenses and share of Medicare taxes) must retain records and documentation related to and supporting each employee’s leave to substantiate the claim for the credits for at least four years. The FAQs provide that an employer can substantiate eligibility for the sick leave or family leave credits if the employer receives a written request for such leave from the employee in which the employee provides their name, the date or dates for which leave is requested, a statement of the COVID-19 related reason the employee is requesting leave and written support for such reason; and a statement that the employee is unable to work, including by means of telework, for such reason.
Tax Treatment of Sick Leave Wages. The qualified sick leave wages are not subject to the employer portion of social security tax. However, employees must include the wages in income. While section 139 excludes from a taxpayer’s gross income certain payments to individuals to reimburse or pay for expenses related to a qualified disaster (qualified disaster relief payments), qualified leave wages are not excludible qualified disaster relief payments, because qualified leave wages are intended to replace wages or compensation that an individual would otherwise earn, rather than to serve as payments to offset any particular expenses that an individual would incur due to COVID-19. In addition, all tax credit amounts are includible in the employer’s income but the wages paid are generally deductible as a business expense.
Finally, the FAQs clarify that an employer may receive both the tax credits for qualified leave under the FFCRA and the Employee Retention Credit under the CARES Act (discussed below), but not for the same wage payments. Also, an employer may receive both the tax credits for leave paid under the FFCRA and a Paycheck Protection Program (PPP) loan, but if an employer receives tax credits for qualified leave wages, those wages are not eligible as "payroll costs" for purposes of receiving loan forgiveness under section 1106 of the CARES Act. Similarly, there is no double payment of credits for amounts under section 45S for wages with respect to which the FFCRA paid leave credits are claimed.
FAQs on the Employee Retention Credit
The IRS has issued FAQs to provide guidance on the Employee Retention Credit, which was enacted as part of the CARES Act. The Employee Retention Credit is a fully refundable tax credit for employers equal to 50% of qualified wages that eligible employers pay their employees. The maximum amount of qualified wages for any single employee is $10,000, so that the maximum credit is $5,000 per employee. The Employee Retention Credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021.
Eligible Employers. Eligible employers are those that carry on a trade or business in 2020 and:
- Fully or partially suspend operation during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19; or
- Experience a significant decline in gross receipts during the calendar quarter.
The credit is available to all employers regardless of size, including tax-exempt organizations. However, the credit does not apply to state and local governments and their instrumentalities or to small businesses who receive a loan under the PPP that is authorized under the CARES Act. The FAQs clarify that the Employee Retention Credit also does not apply to self-employed individuals with respect to their self-employment services or earnings.
Partial Suspension. The FAQs clarify that the operation of a trade or business may be partially suspended if an appropriate governmental authority imposes restrictions upon business operations by limiting commerce, travel, or group meetings due to COVID-19 such that the operation can still continue to operate but not at its normal capacity. For example, a state governor issues an executive order closing all restaurants in the state in order to reduce the spread of COVID-19, but the order allows restaurants to continue carry-out, drive-through, or delivery food service. This results in a partial suspension of the operations of any restaurants in the state that provided on-site eating facilities for customers prior to the executive order. In addition, if a trade or business operates in multiple jurisdictions, in which some of the jurisdictions suspend the operations of the business but others do not, the business has a suspension of operations for all of its operations in all locations.
In general, an essential business that is able to continue to stay open under a governmental order does not have a partial suspension of business, though it may have a partial suspension if, pursuant to a governmental order, the business's hours of operations must be reduced or a supplier is unable to deliver critical goods. However, an employer's decision to partially close its business or reduce its hours due to a reduction in demand is not a partial suspension, even if the reduced demand is due to customers’ abiding by stay-at-home orders. These circumstances may, nonetheless, qualify under the gross receipts test if it meets the requirements of that test.
Similarly, a business does not have a partial suspension of business if it is required to close its workplace, but its employees are able to continue comparable operations through telework. It is unclear what the FAQs mean by "comparable operations" through telework. For example, it is not clear whether the IRS would consider the example provided in the Report of the Joint Committee on Taxation, JCX-12R-20 (Joint Committee Report), to be a partial suspension. In the example, an accounting firm in a county where accounting firms are among businesses subject to a directive to cease all activities other than minimum basic operations closes its offices and does not require employees who cannot work from home (e.g., custodial employees, mail room employees) to work. The Joint Committee Report concluded that the accounting firm met the partial suspension test.
Significant Decline in Gross Receipts. The FAQs clarify that a significant decline in gross receipts begins with the first quarter in which an employer's gross receipts for a calendar quarter in 2020 are less than 50% of its gross receipts for the same calendar quarter in 2019. Once the employer’s gross receipts go above 80% of a comparable quarter in 2019, they no longer qualify after the end of that quarter. For example, if an employer’s gross receipts in the first three calendar quarters of 2020 were approximately 48%, 83%, and 92% of its 2019 first, second, and third quarter gross receipts, respectively, the employer had a significant decline in gross receipts commencing on the first day of the first calendar quarter of 2020 and ending on the first day of the third calendar quarter of 2020. Thus, the employer is entitled to an Employee Retention Credit with respect to the first and second calendar quarters in 2020.
Note, however, that because this is a quarterly computation, if the employer does not meet the significant decline for the first quarter of 2020, it will not be able to determine that it qualifies for the employer retention credit until the end of the second quarter. This will place further pressure on whether the employer has experienced a partial suspension under the first test.
Qualified Wages. Qualified wages are defined as wages[4] and compensation[5] and include the employer's qualified health plan expenses that are properly allocable to the wages. Qualified health plan expenses include both the portion of the cost paid by the employer and the portion of the cost paid by the employee. The IRS had originally stated in FAQs that the payment of health plan expenses by the employer without any accompanying wages paid to the employee do not constitute qualified wages. The IRS subsequently reversed that position and is allowing the payment of health plan expenses without attributable wages paid by the employer to count as qualified wages. For example, if the employee has been laid off or furloughed, but the employer continues to provide health insurance to the employee, the cost of the health insurance constitutes qualified wages. The Joint Committee Report confirms this policy interpretation, stating that the statute provides broad authority to permit the IRS to treat qualified health plan expenses are as qualified wages in a situation where no other qualified wages are paid by the eligible employer or to the particular employee to which such expenses are allocable.
The amount of wages that count towards qualified wages depend on whether the employer has more than 100 full-time employees. Only full-time employees are counted for this purpose. The FAQs define a full-time employee as an employee who had an average of at least 30 hours of service per week or 130 hours of service in the month determined in accordance with section 4980H. This is different from, and more taxpayer-favorable than, the definition suggested in the Joint Committee Report, which would apply the definition of full-tine equivalents in section 4980H(c)(2)(E).
If the eligible employer averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during any period of economic hardship described in (1) and (2) above.
If the eligible employer averaged more than 100 full-time employees in 2019, the qualified wages are the wages paid to an employee for time that the employee is not providing services due to the economic hardship described in (1) or (2) above, but may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
If the employee works reduced hours, any amount paid in excess of those hours are qualified wages. The Joint Committee Report provides an example of a restaurant that 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 to the kitchen employees for the 25 hours per week with respect to which the kitchen employees are not providing services are qualified wages.
Similarly, if the employee has a reduction in duties, the amount paid in excess of those duties are qualified wages. In this case, the employer can make a reasonable estimation of the percentage of work being done. The FAQs include an example of a fitness club that is required to close all of its locations but continues to pay managerial employees their full salaries. There is not enough work to keep them busy full-time, but they continue to perform some accounting and administrative functions. The employer has determined, based on time records, that the managers are performing services for 10% of their normal work hours. Thus, 90% of the wages are qualified wages.
However, the FAQs clarify that if an employer that requires its employees to telework believes that its employees are less productive while working remotely, as long as the employees continue to work their normal business hours, no portion of their wages are qualified wages attributable to not providing services.
The FAQs clarify that an employer may receive both the Employee Retention Credit and the tax credits for qualified leave under the FFCRA, but not for the same wage payments. The qualified wages for the Employee Retention Credit do not include the amount of qualified sick and family leave wages for which the employer received tax credits under the FFCRA.
Aggregation Rules. Aggregation rules apply to treat multiple entities as a single employer for purposes of the gross receipts test, determining whether an employer has more than 100 employees, the prohibition on receiving a PPP loan and the Employee Retention Credit, and the full or partial suspension of business test. If one member of the aggregated group experiences a full or partial suspension of business, the other members of the group in the same trade or business also have a suspension of business. The aggregation rules are determined in accordance with section 52(a) or (b) and section 414(m) or (o) and treat entities as a single employer if they are under common control or part of an affiliated service group.
Claiming the Credit. The Employee Retention Credit is a credit against payroll tax (Social Security[6] and Railroad Retirement[7]) liability. The credit is fully refundable because the eligible employer may get a refund if the amount of the credit is more than the amount of payroll tax liability. If for any calendar quarter the amount of the credit the employer is entitled to exceeds the employer portion of the social security tax on all wages paid to all employees, then the excess is treated as an overpayment and refunded to the employer under sections 6402(a) and 6413(a).
Employers claim the Employee Retention Credit on Form 941, Employer's Quarterly Federal Tax Return. In anticipation of receiving the credits, Notice 2020-22 and the FAQs provide that eligible employers can fund qualified wages by accessing federal employment taxes, including withheld taxes, that are required to be deposited with the IRS, for other wage payments made during the same quarter as the qualified wages, without incurring a penalty for failure to deposit federal employment taxes under section 6656. If the anticipated credit for the qualified wages exceeds the remaining federal employment tax deposits for that quarter, an employer may request advance payment of the credits by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19. For example, an eligible employer paid $20,000 in qualified wages during the quarter, and is therefore entitled to a credit of $10,000. The employer is otherwise required to deposit $8,000 in federal employment taxes during the same calendar quarter. The employer can keep the entire $8,000 of taxes that it was otherwise required to deposit without penalties as a portion of the credits it is otherwise entitled to claim on the Form 941. The employer may file a request for an advance credit for the remaining $2,000 by completing Form 7200.
FAQs on Deferral of Employment Taxes
The IRS has issued FAQs on the deferral of employment taxes. The CARES Act postpones the due date for depositing the employer’s share of payroll taxes and 50% of self-employment taxes related to Social Security and Railroad Retirement and attributable to wages paid between March 27, 2020 and the end of 2020.[8] The deferred amounts would be payable over the next two years – half due December 31, 2021, and half due December 31, 2022.
The deferral applies to all employers, including tax-exempt and governmental employers. However, it does not apply to those employers who have had a PPP loan forgiven. The FAQs provide that employers may continue to defer deposit and payment of employment taxes, even if they have received a PPP loan. However, once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer deposit and payment of employment taxes. The employment taxes deferred until that date continue to be deferred.
The FAQs provide that an employer is entitled to defer deposit and payment of employment taxes prior to determining whether the employer is entitled to the paid leave credits or the Employee Retention Credit, and prior to determining the amount of employment tax deposits that the employer may retain in anticipation of these credits, the amount of any advance payments of these credits, or the amount of any refunds with respect to these credits.
The IRS has released a draft version of Form 941, Employer's Quarterly Federal Tax Return, and instructions on the process for deferring deposits. On Form 941, line 13b, employers should enter the amount of the employer share of social security tax that is being deferred for the quarter. This amount is not reduced for the nonrefundable portion of credits for qualified sick and family leave wages or the Employee Retention Credit. The maximum amount that can be deferred each quarter is the employer share of social security tax, minus any excess of total deposits (line 13a) over the difference between total taxes after adjustments (line 10) and the employer share of social security tax (50% of column 2 of line 5a and line 5b).
FAQs on Payroll Support for Air Carriers and Contractors
The IRS issued FAQs on the tax treatment of payments authorized under the CARES Act from the Treasury Department to passenger air carriers, cargo air carriers, and certain contractors that must be used exclusively for the payment of employee wages, salaries, and benefits (Payroll Support).[9] Payroll Support is intended to preserve aviation jobs and compensate air carrier industry workers. The CARES Act also includes a separate program to make loans to eligible businesses, including air carriers, to provide them liquidity (Economic Stabilization).[10]
Section 4117 of the CARES Act provides that the Treasury Department (Treasury) may receive warrants, options, preferred stock, debt securities, notes, or other financial instruments issued by a company receiving Payroll Support (Recipient) to provide appropriate compensation to the federal government for the provision of the financial assistance (Taxpayer Protection Instruments). The Treasury Department has determined that passenger air carriers receiving payroll support of more than $100 million, cargo air carriers receiving more than $50 million, and eligible contractors receiving more than $37.5 million are required to provide Taxpayer Protection Instruments to the US Government in the form of a 10-year senior unsecured promissory note and warrants for shares of common stock. The Payroll Support Program Agreement provides that Taxpayer Protection Instruments will be treated for federal tax purposes in accordance with the form in which it was issued (e.g., debt or equity).
This is distinguished from the detailed framework provided for financial protection of the federal government for companies receiving Economic Stabilization. Section 4003 provides that Treasury may not issue a loan or loan guarantee to an eligible company unless it receives a warrant or equity interest in the case of a public company or a warrant or senior debt instrument in the case of a non-public company; however, Treasury may not exercise voting power.[11] The statute also provides that the instrument is treated as debt for tax purposes[12] and grants Treasury authority to issue guidance, including guidance providing that the acquisition of warrants, stock options, or stock does not result in an ownership change for purposes of section 382.[13]
The FAQs only address the Payroll Support program; they do not provide guidance on the Economic Stabilization program. The FAQs clarify that if a Recipient does not issue Taxpayer Protection Instruments to the Treasury Department in exchange for receiving Payroll Support, the Payroll Support payment is taxable income to the Recipient. If a Recipient does issue Taxpayer Protection Instruments to Treasury, the Payroll Support payment is not taxable income to the Recipient to the extent of the fair market value of the warrants, options, or preferred stock, plus the issue price of any debt securities or notes issued as Taxpayer Protection Instruments. If the Payroll Support payment exceeds the fair market value of the Taxpayer Protection Instruments, that excess amount is taxable income to the Recipient.
The FAQs provide that regardless of whether the Recipient issues Taxpayer Protection Instruments, the payment of wages, salaries, and benefits to employees using the Payroll Support payment is a deductible expense to the employer Recipient. The FAQs reason that the Code generally permits the payment of wages, salaries, and benefits to employees to be deducted as ordinary and necessary business expenses. This seems somewhat inconsistent with the IRS’s conclusion in Notice 2020-32 that expenses paid with PPP loans that have been forgiven are not deductible.
[1] However, this type of informal guidance does not constitute substantial authority for purposes of avoiding accuracy related penalties without disclosure. See Treas. Reg. § 1.6662-4(d). Reliance on this type of guidance may, however, be used to establish a reasonable cause and good faith exception to accuracy related penalties (unless the item relates to a tax shelter). See Treas. Reg. § 1.6664-4(f)(2).
Unless otherwise specified, all section references are to the Internal Revenue Code of 1986, as amended, and references to "Treas. Reg. §" are to the Treasury regulations thereunder.
[2] Because the rules relating to the credit for sick leave and family medical leave are the generally the same, this summary only refers to sick leave.
[3] The amount of credit allowable to self-employed individuals is equal to the number of days that the individual is unable to perform services as a result of being sick, multiplied by the lesser of (1) $200 (for illness of a child or other family member) and $511 (for illness of the individual himself or herself), and (2) the average daily self-employment income. Average daily self-employment income is an amount equal to the net earnings from self-employment for the taxable year divided by 260. A taxpayer's net earnings from self-employment are based on the gross income that he or she derives from the taxpayer’s trade or business minus ordinary and necessary trade or business expenses.
[4] As defined in section 3121(a) (Social Security taxes).
[5] As defined in section 3231(e) (Railroad Retirement taxes).
[6] As defined in section 3111(a).
[7] As defined in section 3221(a).
[8] Section 2302 of the CARES Act.
[9] These payments are authorized by section 4112 (in Division A, Title IV, Subtitle B—Air Carrier Worker Support) of the CARES Act.
[10] This program is authorized by section 4003 (in Division A, Title IV, Subtitle A—Coronavirus Economic Stabilization Act of 2020) of the CARES Act.
[11] Section 4003(d) of the CARES Act.
[12] In contrast, the statute does not provide any rule regarding the characterization of warrants or other instruments issued as part of the Payroll Support program, though Treasury provided for debt characterization in the application.
[13] Section 4003(h) of the CARES Act.
