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.  This is the second in a series of articles that will address various aspects of the FAQs.  This article addresses employer eligibility for the credit based on a significant decline in gross receipts.  In our first article, we discussed 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.  Subsequent articles will address the determination of qualified wages and allocable qualified health plan expenses, issues related to the income and deduction treatment of qualified wages for employees and employers, and issues related to the use of third-party payers.  Before the release of the IRS FAQs, we addressed how employers can claim the employee retention credit and its interaction with the deferral of employer social security tax deposits (see earlier article).

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.

In addition to employers whose trade or business has been fully or partially suspended by a governmental order, employers that experience a “significant decline in gross receipts” are eligible to claim the employee retention credit under section 2301 of the CARES Act. Q&A-41 clarifies that the decline in gross receipts does not have to be related to COVID-19.  As explained in Q&A-39, an employer experiences a significant decline in gross receipts when its gross receipts for a calendar quarter in 2020 are less than 50% of its gross receipts for the same quarter in 2019.  Once an employer is eligible for the employee retention credit as a result of a significant decline in quarterly gross receipts, it will remain eligible until the calendar quarter following the quarter in which quarterly gross receipts are greater than 80% of its gross receipts for the same quarter in 2019 (or the end of 2020).

Accordingly, an employer that is eligible for the credit on the basis of a significant decline in gross receipts will always be eligible for at least two full calendar quarters: the quarter in which gross receipts falls below 50% of gross receipts for the same quarter in 2019 and the quarter in which gross receipts exceed 80% of gross receipts for the same quarter in 2020.  This contrasts with employers whose eligibility is based on a full or partial suspension of operations due to a governmental order and applies only for the period in which a governmental order requires operations to be fully or partially suspended.

Q&A-40 defines gross receipts for an employer other than a tax-exempt organization to mean total sales (net of returns and allowances) and all amounts received for services.  In addition, income from investments and from incidental or outside sources, such as interest (including original issue discount and tax-exempt interest), dividends, rents, royalties, and annuities regardless of whether derived in the ordinary course are included.  Gross receipts are not reduced by the costs of goods sold but are reduced by the taxpayer’s adjusted basis in capital assets sold.  Sales taxes legally imposed on the purchaser of the goods or services that a business collects from the purchaser and remits to the taxing authority on behalf of the purchaser are not included in gross receipts.

Q&A-43 clarifies that the aggregation rules (discussed in the first article in our series) apply, and accordingly an employer must consider the gross receipts of all employers with which it is required to be aggregated to determine whether it has experienced a significant decline in gross receipts.  Employers should be aware, because the aggregation rules apply a 50% common ownership standard and apply to partnerships, trust, and estates, the gross receipts of entities outside of its consolidated group may have to be considered to determine whether the standard is met.  Conversely, if an employer has not experienced a significant decline in gross receipts but other employers with which it must be aggregated have, it may be eligible for the employee retention credit to the extent that the gross receipts of all aggregated employers have significantly declined.  The aggregation rules may have a significant impact on the eligibility of private equity-backed companies that may have to be aggregated with other portfolio companies to determine eligibility.

The IRS FAQs also provide guidance to new employers that commenced business in 2019.  In such a case, Q&A-44 says that the employer should use the gross receipts from the 2019 quarter in which it commenced operations to determine whether it is eligible for each quarter in 2020 until it reaches the calendar quarter in 2020 that matches the 2019 commencement quarter.  In other words, a company that commenced operations in the third quarter 2019, would use its gross receipts from that quarter to determine eligibility for the first, second, and third quarters of 2020.  For the fourth quarter of 2020, it would use gross receipts from the fourth quarter of 2019 to determine eligibility.  If the employer commenced business in the middle of a quarter in 2019, the employer should estimate what its gross receipts would have been for the full quarter had it been in operation for the full quarter.  Although the FAQ is silent on this point, presumably an employer that is aggregated with other employers would use the actual gross receipts for all aggregated employers to determine whether the aggregated employers satisfy the gross receipts test without regard for the fact that it was not in operations during some quarters in 2019.

Conversely, Q&A-45 provides guidance on how an employer that acquires (in any form of acquisition) a trade or business during 2020 determines if it experienced a significant decline in gross receipts.  In general, the employer must include the gross receipts of the acquired business in its gross receipts for each calendar quarter that it owns and operates the acquired business.  The FAQ provides a safe harbor under which an employer that acquired another employer may include the gross receipts of the acquired business in its gross receipts for the 2019 calendar quarter to determine if the employer has experienced a significant decline in gross receipts without regard to the fact that the employer did not own or operate the acquired business during that calendar quarter in 2019.  Under the safe harbor, an employer that acquires a trade or business in the middle of a calendar quarter in 2020 must estimate the gross receipts it would have had from that acquired business for the entire quarter based on the gross receipts for the portion of the quarter that it owned and operated the acquired business. However, if an employer chooses not to use the safe harbor, it is only required to include the gross receipts from the acquired business for the portion of the quarter that it owned and operated the acquired business.

Unanswered by the FAQs is how an employer that acquired a business during late 2019 determines whether it had a significant decline in gross receipts for earlier quarters in 2020 during which the gross receipts of the acquired business presumably must be included as part of its aggregated gross receipts.  Applying the safe harbor approach seems reasonable, but by its terms it applies only to an acquisition that occurred during 2020.

Because quarterly gross receipts cannot be known with certainty until after the end of a quarter, an employer may not know in real time if it is eligible for the credit.  Helpfully, the IRS clarifies in Q&A-42 that an employer may use the Form 941-X process to amend its prior-filed Forms 941 to claim credits that it was eligible for but did not claim.  Unfortunately, the FAQs do not explicitly address whether the IRS will seek to impose late deposit penalties if an employer reasonably anticipates it is eligible for the credit, reduces its deposits in anticipation of those credits, and later determines that it is ineligible for the credit because its gross receipts were higher than anticipated.

Photo of S. Michael Chittenden S. Michael Chittenden

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden…

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden advises companies on their obligations under FATCA and assists in the development of comprehensive FATCA and Chapter 3 (nonresident alien reporting and withholding) compliance programs.

Mr. Chittenden advises large employers on their employment tax obligations, including the special FICA and FUTA rules for nonqualified deferred compensation, the successor employer rules, the voluntary correction of employment tax mistakes, and the abatement of late deposit and information reporting penalties. In addition, he has also advised large insurance companies and employers on the Affordable Care Act reporting requirements in Sections 6055 and 6056, and advised clients on the application of section 6050W (Form 1099-K reporting), including its application to third-party payment networks.

Mr. Chittenden counsels clients on mobile workforce issues including state income tax withholding for mobile employees and expatriate and inpatriate taxation and reporting.

Mr. Chittenden is a frequent commentator on information withholding, payroll taxes, and fringe benefits and regularly gives presentations on the compliance burdens for companies.

Photo of Marianna G. Dyson Marianna G. Dyson

Marianna Dyson practices in the areas of payroll tax, fringe benefits, and information reporting, with a specific focus on perquisites provided to employees and directors, worker classification, tip reporting, cross-border compensation, backup withholding, information reporting, and penalty abatement.

Ms. Dyson advises large employers…

Marianna Dyson practices in the areas of payroll tax, fringe benefits, and information reporting, with a specific focus on perquisites provided to employees and directors, worker classification, tip reporting, cross-border compensation, backup withholding, information reporting, and penalty abatement.

Ms. Dyson advises large employers on the application of employment taxes, the special FICA tax timing rules for nonqualified deferred compensation, the voluntary correction of employment tax errors, and the abatement of late deposit and information reporting penalties for reasonable cause. On behalf of the restaurant industry, her practice provides extensive experience with tip reporting, service charges, tip agreements, and Section 45B tax credits.

She is a frequent speaker at Tax Executives Institute (TEI), the Southern Federal Tax Institute, and the National Restaurant Association.