Late Wednesday, the IRS released extensive new guidance in the form of frequently asked questions (“FAQs”) on the IRS website addressing various aspects of the employee retention credit. Covington continues to analyze the guidance, but employers who have made use of the employee retention credit—which took effect over a month ago with respect to wages paid as many as six weeks ago—should review the FAQs to determine how the guidance may affect their determination of eligibility for the credit and the calculation of the credit amount. Unfortunately, several of the answers take a narrower approach to interpreting the law than is necessary and seem somewhat divorced from the economic reality that is effecting many employers—particularly large employers—given the COVID-19 pandemic. Employers who have relied on reasonable, good faith determinations of their credit eligibility so that they could afford to keep workers on the payroll may now be put in an even more precarious financial position by FAQs that suggest the credit is not available to them generally or is not available with respect to some workers.
Employers should carefully consider the FAQs, but remain mindful that although they represent the current thinking of the IRS, the FAQs are not binding guidance. This is the first in a series of articles that will address various aspects of the FAQs. This article focuses on the IRS’s interpretation of the aggregation rules under section 2301(d) of the CARES Act and the determination of employer eligibility based on a full or partial suspension of operations due to a government order. Later articles will address employer eligibility based on a significant decline in gross receipts, the determination of qualified wages and allocable qualified health plan expenses, and issues related to the income and deduction treatment of qualified wages for employees and employers. In an earlier article, we addressed how employers can claim the employee retention credit and its interaction with the deferral of employer social security tax deposits.
Aggregation Rules
FAQs 25-27 address the application of rules under section 2301(d) of the CARES Act. Under those rules, all employers that are required to be aggregated under section 52(a) or 52(b) of the Code or if they form an affiliated service group that is required to be aggregated under section 414(m) of the Code, must be aggregated for purposes of the employee retention credit. Section 52 provides aggregation rules for purposes of the Work Opportunity Tax Credit. In general, section 52(a) provides for aggregation of a controlled group of corporations meeting a more than 50% common ownership standard. Section 52(b) provides a similar rule for partnerships, trusts, estates, and sole proprietorships. Under section 414(m) of the Code, an “affiliated service group” is treated as a single employer based on rules related to the performance of services by one entity for another or by one entity in association with another for third parties, even if the entity does not have sufficient ownership or control of the other entity to form a controlled group.
FAQ 26 confirms that the aggregation rules apply for all employee retention credit purposes, including whether a trade or business has been fully or partially suspended, whether the employer has a significant decline in gross receipts, whether the employer has more than 100 full-time employees, and whether the employer is precluded from credit eligibility because it received a loan under the Paycheck Protection Program (“PPP”). Although not unexpected, this is particularly problematic for employers who are ineligible for PPP loans but who are required to be aggregated with employers who were eligible and who received a loan. Because the CARES Act waives the SBA affiliation standard for certain employers, some employers who are ineligible for PPP loans are also ineligible for the employee retention credit as a result of a PPP loan received by another employer with which it must be aggregated, as confirmed in Q&A-81 (formerly Q&A-80).
Moreover, in response to public outcry and media attention, there has been a near-constant shifting of the rules regarding eligibility for the PPP, to include suggestions by the SBA and Secretary Mnuchin that certain companies are ineligible for the PPP despite appearing to satisfy the statutory requirements. This has resulted in a number of companies receiving a PPP loan, but returning the funds almost immediately under guidance issued by the SBA. As a result, it appears that there is an entire group of companies who may be not only ineligible for a PPP loan but also the employee retention credit—no matter how badly affected the business has been by the COVID-19 pandemic. Q&As 79 and 81 fail to address that issue, since they speak only of an employer being ineligible for the employee retention credit if the employer “receives a PPP loan . . . regardless of the date of the loan,” and “regardless of whether and when the loan is forgiven.” Without guidance indicating that a company that repaid a PPP loan within the safe harbor period for doing so under SBA guidance, employers in this situation will be left without any relief and may be forced to lay off large segments of their workforces. (UPDATE: The IRS revised its FAQs to include a new Q&A-80 on May 4, 2020. As reported in our article of May 5, the new FAQ indicates that an employer that repays a PPP loan during the safe harbor period is eligible for the employee retention credit, provided that it is an otherwise eligible employer.)
Employer Eligibility Based on a Governmental Order
Q&A-28 and 29 indicate that an actual governmental order, decree, or proclamation from a state or local government order is necessary for an employer to be eligible based on a governmental order. Press statements encouraging businesses to close or encouraging residents to stay home are not sufficient. Although Q&A-28 makes clear that a governmental order requiring residents to shelter in place or stay home does count as a governmental order, Q&A-30 indicates that an essential business that is permitted to remain open under the order is not considered to have a full or partial suspension, even if the order resulted in the employer having to reduce hours or change its operations in response to a decline in customer demand resulting from the order. Similarly, Q&A-32 concludes that, although a stay at home or shelter-in-place order can result in a full or partial suspension of operations if it prevents an employer’s employees from going to work, it does not result in a full or partial suspension for an essential business that is permitted to remain open. In contrast, a non-essential business that is required by an order to change its operations—by closing, reducing hours, providing only curbside pickup, or offering carryout service—would be eligible for the employee retention credit.
Applying the guidance, it appears that an essential business, such as a grocery store, that reduces its operating hours in order to provide for more in-depth cleaning and restocking or to limit customers during certain hours to vulnerable populations would not be considered to have a partial suspension of its business based on an order closing non-essential businesses even if it experiences a decline in revenue (provided it does not satisfy the 50% decline in gross receipts eligibility standard), since the grocery store is permitted to remain open under the order. Although large grocers are unlikely to be paying employees who are not working right now, small independent grocers, gas stations, and other small business that can claim a credit with respect to all workers during a partial suspension may be left ineligible for the credit because the IRS may not consider their business partially suspended. Similarly, other essential businesses, such as auto repair businesses, bicycle repair shops, pet supply stores, and manufacturers, may be experiencing a significant decline in demand as a result of such orders but be unable to meet the gross receipts tests.
Potentially of some assistance to such businesses, is another question unanswered by the FAQs. Specifically, whether recent governmental orders requiring essential businesses to only serve patrons who wear face coverings or to implement one-way traffic patterns in store aisles would result in a partial suspension of operations. Presumably, a governmental order that reduces store capacity by requiring that stores enforce adequate social distancing standards—by limiting occupancy, requiring floor markings separating customers at registers, or other means—would result in a partial suspension of operations, but that too is left unaddressed.
Troubling for many employers will be Q&A-33, which addresses the ability of employees to telework. Under the guidance, an employer that is required to close its workplace as a result of a governmental order is not considered to have a partial suspension of its operations “if the employer is able to continue operations comparable to its operations prior to the closure by requiring employees to telework.” The IRS’s approach in this FAQ will significantly narrow the scope of employers who are eligible for the employee retention credit. However, there is uncertainty as to what constitutes operations “comparable to” a business’s operations. The example in the FAQ addresses a software company in which employees teleworked one or twice per week and held business meetings at various locations. In the FAQ, the closure of the company’s office resulting in mandatory telework and limiting client meetings to telephone calls and video conferences was not a partial suspension. How that would apply to a company that generally requires its employees to report to the office, encourages employees to regularly meeting in person, and discourages telework because it believes telework diminishes collegiality and collaboration is unclear. Such an employer might reasonably believe that mandatory telework, video conferences, and telephone calls are not “comparable to” its operations before the order closing its office and thus conclude that it is eligible for the credit.
In a bit of good news, Q&A-31 does indicate that if a supplier to an essential business is required to suspend operations as a result of a governmental order and that suspension results in a full or partial suspension of operations by an essential business that is permitted to remain open under local law, the essential business would be eligible for the employee retention credit. Accordingly, a manufacturer that is an essential business but which reduces the number of shifts or otherwise partially suspends its operations because its suppliers are ordered to fully or partially suspend their businesses would be eligible for the employee retention credit. The FAQs do not address whether a downstream suspension can result in a full or partial suspension. In other words, if a manufacturer, which is an essential business and permitted to remain open, partially or fully suspends operations because the stores or wholesalers to which it sells products are required to suspend operations by a governmental order, is the manufacturer considered to have fully or partially suspended operations as a result of a governmental order?
In some other potentially helpful guidance, Q&A-36 suggests that an employer that is required to fully or partially suspend operations in some jurisdictions is eligible to claim the retention credit with respect to employees in jurisdictions where it is not required to suspend operations, either because there is no governmental order or it is considered an essential business. Q&A-37 indicates that this rule applies across all employers required to be aggregated and treated as a single employer for purposes of the credit. Somewhat unclear, however, is whether that, in order to qualify for the credit with respect to employees in jurisdictions in which the employer is permitted to operate, the employer must adopt a uniform policy across the company or whether that policy must comply with CDC recommendations and DHS guidance. In other words, could the employer adopt a policy consistent with CDC guidelines in areas with higher incidence of infection and operate normally in other jurisdictions with lower incidence of infection and still claim the credit with respect to wages paid workers not performing services in jurisdictions where it has followed CDC guidelines but was not subject to a governmental order?
Q&A-38 clarifies that an employer may only take the retention credit with respect to wages paid during the part of a calendar quarter that the employer’s trade or business is partially suspended due to a governmental order (assuming it does not satisfy the significant decline in gross receipts standard).
Closing Thoughts
In conclusion, the FAQs addressing the aggregation rules and employer eligibility based on a full or partial suspension of a trade or business due to a governmental order seem to narrow the scope of companies that might be eligible for the employee retention credit under a more generous reading of the statutory language.