The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) provides for a 50 percent retention credit on up to $10,000 of qualified wages paid between March 13 and the end of 2020 for businesses financially affected by COVID-19. This benefit is realized through a reduction or refund of quarterly payroll taxes. However, guidance issued by the IRS in the form of FAQs has imposed greater restrictions on essential businesses than on nonessential businesses. The IRS should be lauded for providing such rapid guidance; however, the distinction between essential and nonessential businesses does not appear to be supported by the legislation, nor is it consistent with the goal of voluntarily keeping employees on the payroll during the crisis.
It's important to note that FAQs are not binding on taxpayers. The IRS's general information FAQs on the retention credit come with the following disclaimer: "This FAQ is not included in the InternalRevenue Bulletin, and therefore may not be relied upon as legal authority." This means that the information cannot be used to support a legal argument in a court case.
The purpose of this article is to evaluate the qualification of essential businesses for the retention credit under the legal authorities issued to date.We're interested in the scope of activity and the scope of qualifying wages constituting a fully or partially suspended business. This article is directed toward larger employers -- those with more than 100 employees -- that did not obtain Paycheck Protection Program loans.
The CARES Act's section 2301 offers a credit to businesses that retain and compensate employees who were affected by government-created closures related to COVID-19. This "employee retention credit for employers subject to closure due to COVID-19" allows qualifying employers to recoup half of their qualifying payroll costs, up to $5,000 per employee per calendar quarter.
According to a report by the Joint Committee on Taxation, the retention credit was modeled after previous legislation that provided credits for businesses that retained employees affected by natural disasters.However, unlike disaster zone relief credits—which are given in the form of income tax credits—the COVID-19-related retention credit provides employers with the cash benefit sooner, in the form of a reduction in quarterly employment taxes.
To qualify for the retention credit, a business must be an"eligible employer" and have "qualifying wages," as discussed in detail below:
Government orders that limit travel, commerce, or group meetings due to COVID-19 are considered "orders from an appropriate governmental authority" if they affect an employer's trade or business.This includes orders that limit hours of operation. If the orders are from a State or local government, they must be from a government that has jurisdiction over the employer's operations.
The first step in determining whether an employer qualifies for the Essential Industry Retention Credit is to evaluate whether any federal, state, or local government orders limiting commerce, travel, or group meetings due to COVID-19 have impacted the employer's business operations.
To date, Treasury has not issued regulations defining what"fully or partially suspended" means. However, according to the JCT report, in order for an employer to qualify for the credit, there must be a government order in effect during the payroll quarter related to COVID-19 that causes a full or partial suspension of the business. This is regardless of whether the business is considered essential or nonessential.
Although it would seem that an essential business would not be eligible for the retention credit since it's exempt from government orders suspending commerce, there are still indirect effects on commercial activity that can result from these orders.
According to FAQ 30, if an essential business is allowed to continue operations under a governmental order, it will not be considered suspended for the purposes of the retention credit. However, there is an exception to this rule outlined in FAQ 31. If an essential business cannot obtain materials for its operations because of government orders affecting its suppliers, it may still be considered as having a partial suspension of operations.
If the facts and circumstances indicate that the essential business’s operations are fully or partially suspended as a result of the inability to obtain critical goods or materials from its suppliers that were required to suspend operations, then the essential business would be considered an Eligible Employer and may be eligible to receive the Employee Retention Credit. Example: Employer A operates an auto parts manufacturing business that is considered an essential trade or business in the jurisdiction where it operates. Employer A’s supplier of raw materials is required to shut down its operations due to a governmental order. Employer A is unable to procure these raw materials from an alternate supplier. As a consequence of the suspension of Employer A’s supplier, Employer A is not able to perform its operations. Under these facts and circumstances, Employer A would be considered an Eligible Employer because its operations have been suspended as a result of the governmental order that suspended operations of its supplier.
This FAQ outlines the circumstances under which an essential business may be unable to operate due to suspended operations of a third party vendor. The key points to remember are:
1. identify which vendors have been affected by COVID-19-related government orders to suspend operations; and
2. determine how those government orders have resulted in the essential business not being able to conduct specific activities within its business operations.
For example, if an essential business has specific types of business activities that are disrupted by a vendor supply chain disruption, this would show that the essential business has been partially suspended. On the other hand, as stated in FAQ 32, if an essential business experiences reduced volume of operations simply because customers are required to stay at home under governmental orders, this would not be considered as partially suspending the essential business.
An employer that operates an essential business that is not required to close its physical locations, or otherwise suspend its operations, is not considered to have a full or partial suspension of its operations for the sole reason that its customers are subject to a governmental order requiring them to stay at home. Example: Employer B, an automobile repair service business, is an essential business and is not required to close its locations or suspend its operations. Due to a governmental order that limits travel and requires members of the community to stay at home except for certain essential travel, such as going to the grocery store, Employer B’s business has declined significantly. Employer B is not considered to have a full or partial suspension of operations due to a governmental order. However, Employer B maybe considered an Eligible Employer if it has a significant decline in gross receipts.
It's important to note that there's a difference between (1)supply chain disruptions that result in a suspension of part of the essential business operations and (2) reduced customer demand, which affects revenue but doesn't cause a partial suspension of operations. However, this distinction between "essential" and "nonessential" businesses isn't in the CARES Act itself. Additionally, the distinction between governmental edicts that result in a partial suspension of the business because of reduced customer demand versus governmental edicts that cause a partial suspension of business operations due to vendors being unable to perform doesn't seem to be well-founded under the statute.
FAQ 32 appears to be inconsistent with the statute, which refers to the operation of a trade or business being “partially suspended . . .due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings . . . due to the coronavirus disease 2019.” In theFAQ 32 example, the operations of the auto repair business have been affected by stay-at-home government orders. The resulting reduction in business will cause a partial suspension of the repair business activity, creating fewer working hours for employees.
It appears that the legislation is seeking to keep repair business employees voluntarily paid by their employer in the same way that it seeks to keep restaurant employees voluntarily paid by their employer. The statute links qualification to the identification of government orders limiting commerce, travel, or group meetings because of COVID-19. The distinction between customers or suppliers causing a suspension of operations appears contradictory to the intent of the law. According to Congress, the purpose of the CARES Act is “providing emergency assistance and health care response for individuals, families, and businesses affected by the 2020 coronavirus pandemic.” This does not draw a distinction between businesses that were affected as the result of governmental orders affecting their suppliers, rather than their customers.
Even if a reduction in demand doesn't meet the criteria fora partial suspension, businesses can still evaluate their qualification by considering direct and indirect effects. For example, if there are any government orders affecting the business, limitations on operating hours, or changes to the availability of parts or delivery services.
There are a few different factors that could make an essential business eligible for government assistance. Firstly, if there is an order from the government related to COVID-19 that limits commercial activity, travel, or group meetings, this could make the business eligible. Secondly, if the business has partially suspended operations due to COVID-19, this could also make it eligible. Lastly, if the business has been significantly impacted byCOVID-19, even if it has not suspended operations, it could still be eligible for government assistance.
Government orders in response to COVID-19 have had a significant impact on businesses. In order to assess the effect of COVID-19 on your business, it may be helpful to focus on government orders and their relation to the illness. By understanding the connection between COVID-19 and government orders, you can determine if your business has experienced a partial suspension of operations.
If any of your facilities remain open, you should check to see if they have been placed on any type of partial restriction by government orders. FAQ 34 provides more information on this:
If a governmental order requires an employer to close its workplace for certain purposes, but the workplace may remain operational for limited purposes, is the employer considered to have a suspension of operations? Yes. If an employer’s workplace is closed by a governmental order for certain purposes, but the employer’s workplace may remain open for other purposes, or the employer is able to continue certain operations remotely, the employer’s operations would be considered to be partially suspended.
Example 1: Employer D, a restaurant business, must close its restaurant locations to in-room dining due to a governmental order closing all restaurants, bars, and similar establishments for sit-down service.Employer D is allowed to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis. Employer D’s business operations are considered to be partially suspended due to the governmental order closing all restaurants, bars, and similar establishments to sit-down service.
Example 2: Employer E, a retail business, is forced to close its retail storefront locations due to a governmental order. The retail business also maintains a website through which it continues to fulfill online orders; the retailer’s online ordering and fulfillment system is unaffected by the governmental order. Employer E’s business operations would be considered to have been partially suspended due to the governmental order requiring it to close its retail store locations.
An essential business may identify a partial suspension of activities by unbundling the business elements that have been impacted by COVID-19-related government orders. The company may still be operational, but with a reduced workload due to these orders.
For example, a trucking company - an essential business -could be indirectly partially suspended because its customers have closed their physical locations in response to COVID-19-related government orders. The trucking company might experience a reduction in servicing an auto factory if the automaker is shut down due to a lack of parts and other materials from its suppliers. Consequently, all logistics and transportation businesses are likely to experience some form of indirect partial suspension because of government orders affecting their customers or customer's suppliers.
You can also get an essential business qualification by identifying locations where operating hours may be restricted. FAQ 35 provides more information on this.
Are an employer’s operations considered to be partially suspended for purposes of the Employee Retention Credit if the employer is required to reduce its operating hours by a governmental order? Yes. An employer that reduces its operating hours due to a governmental order is considered to have partially suspended its operations since the employer’s operations have been limited by a governmental order.
Although the details are still being finalized, it seems that an essential business will be considered partially suspended if it can show that its operations are restricted in some areas due to government orders.Even if the business is classified as essential in other areas and isn't subject to the same restrictions, the limited operations will still be viewed as a suspension. FAQ 36 provides more information:
If an employer operates a trade or business in multiple locations and is only subject to a governmental order requiring full or partial suspension of its operations in some jurisdictions, would it be considered to have a suspension of operations?
Yes, employers who are subject to state and local orders limiting operations in some areas but not others are considered to have a partial suspension of operations. Employers with businesses on a national or regional scale may be ordered to close locations in certain areas, but not everywhere, based on whether the business is considered essential in those areas. Eligible employers are those that have partially or fully suspended their operations as a result of a governmental order related to COVID-19. This could include an order to suspend operations of a trade or business in certain jurisdictions, or merely following CDC or DHS guidelines in those jurisdictions. In all cases, the employer would be considered to have partially suspended operations. Therefore, the employer would be an Eligible Employer with respect to all of its operations in all locations.
Once it is established that an essential business has qualified as an eligible employer, the next step is to identify qualifying wages.
To claim the retention credit, an essential business must identify the compensation paid to employees for hours that are unworked because of governmental orders. It is not entirely clear whether identifying any unworked but compensated hours of an eligible employer will qualify, or whether it is necessary to directly trace unworked hours to the partially suspended elements of the business. Ultimately, it may not be an important distinction if the employee is being compensated for unworked hours related to governmentCOVID-19 orders.
To determine which hours are qualifying wages for the purposes of the employee retention credit, businesses must identify which activities are considered a direct reduction of scheduled work hours, and which are considered reduced workload (compensated COVID-19 downtime). The JCT report and the FAQs are the only source of guidance to date. Based on that guidance, qualifying wages should include two categories of compensated unworked hours:
1. direct reduction of scheduled work hours; and
2. reduced workload (compensated COVID-19 downtime).
Reduction of Work Hours
The JCT report provides an example of a direct reduction of scheduled work:
Qualified wages are wages paid by the eligible employer with respect to which an employee is not providing services due to circumstances that cause the eligible employer to meet either the governmental order test or the reduced gross receipts test.For example, if a restaurant that had an average of 150 full-time employees during 2019 meets the governmental order test, and the restaurant 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. However, if the same restaurant reduces kitchen employees’ working hours from 40 hours per week to 15 hours per week and only pays wages for 15 hours per week, no wages paid to the kitchen employees are qualified wages.
FAQ 54 provides another example of compensation paid to employees whose work schedules have been directly reduced but who continue to be compensated. According to the FAQ, any reasonable method may be used to calculate hours for purposes of the retention credit, other than a calculation based on reduced productivity.
May an Eligible Employer that averaged more than 100full-time employees during 2019 treat the wages paid to hourly and non-exempt salaried employees for hours for which they are not providing services as qualified wages for purposes of the Employee Retention Credit?
Yes. For an Eligible Employer that averaged more than 100 full-time employees in 2019, wages paid to hourly and non-exempt salaried employees for hours that the employees were not providing services would be considered qualified wages for the purposes of the Employee Retention Credit. For an employee who does not have a fixed schedule of work, the hours for which the employee is not providing services may be determined using any reasonable method. The method that the Eligible Employer would use to determine the employee’s entitlement to leave under the Family and Medical Leave Act (FMLA) would be a reasonable method for this purpose. Similarly, the method(s)that the Department of Labor has prescribed to determine the number of hours for which an employee with an irregular schedule is entitled to paid sick leave under the Families First Coronavirus Response Act (FFCRA) would be considered reasonable for this purpose. For more information, see Department of Labor’s Temporary Rule: Paid Leave under the Families First Coronavirus Response Act.
It is not reasonable for the employer to treat an employee’s hours as having been reduced based on an assessment of the employee’s productivity levels during the hours the employee is working.
Wages paid to the employees for hours for which they provided services are not considered qualified wages for purposes of the Employee Retention Credit.
When an employee's work schedule is reduced but they continue to receive compensation for the unworked hours, it's important to review their activities to determine how much of their compensation is due to the reduced work schedule. This will help you make sure that the employee is fairly compensated.
Reduction of Workload
This second category of qualifying wages covers employees who are required to report to work, but have downtime due to COVID-19 governmental orders that have partially suspended business activity. As an example, see FAQ 54:
Employer U, in the business of staging homes that are for sale, averaged more than 100 full time employees in 2019. Employer U’s non-exempt salaried employees cannot perform their usual services of delivering and installing furniture to be used in staging houses because open houses are prohibited in its service area during the second quarter of 2020. However, the employees are required to provide Employer U with periodic status updates about furniture that has been leased out and other administrative matters. Employer U continues to pay wages to employees at their normal rates even though the employees cannot provide their normal services. Employer U has determined that its employees are working 20 percent of the time. Employer U is entitled to treat 80 percent of the wages paid as qualified wages and claim an Employee Retention Credit for 80 percent of the wages paid.
According to FAQ 54 and FAQ 55, all employees who have had their workload reduced due to government-ordered closures or suspensions are entitled to compensation. This includes hourly employees, exempt salaried employees, and nonexempt salaried employees. As stated in FAQ 55:
May an Eligible Employer that averaged more than 100full-time employees during 2019 treat wages paid to exempt salaried employees for time for which they are not providing services as qualified wages for purposes of the Employee Retention Credit? Yes. For an Eligible Employer that averaged more than 100 full-time employees during 2019, the wages paid afterMarch 12, 2020, and before January 1, 2021, to exempt salaried employees for the time that they are not providing services would be considered qualified wages for purposes of the Employee Retention Credit. An Eligible Employer may use any reasonable method to determine the number of hours that a salaried employee is not providing services, but for which the employee receives wages either at the employee’s normal wage rate or at a reduced wage rate. Reasonable methods include the method (or methods) the employer uses to measure exempt employees’ entitlement to leave on an intermittent or reduced leave schedule under the Family and Medical Leave Act, or the method the employer uses to measure exempt employees’ entitlement to and usage of paid leave under the employer’s usual practices. It is not reasonable for the employer to treat an employee’s hours as having been reduced based on an assessment of the employee’s productivity levels during the hours the employee is working.
Example 1: Employer V, a large fitness club business that employed an average of more than 100 full-time employees in 2019, closed all of its locations in City B by order of City B’s mayor. Employer V continues to pay its exempt managerial employees their regular salaries. While the clubs are closed and there is not sufficient administrative work to occupy the managerial employees full-time, they continue to perform some accounting and similar administrative functions. Employer V has determined, based on the time records maintained by employees, that they are providing services for 10percent of their typical work hours. In this case, 90 percent of wages paid to these employees during the period the clubs were closed are qualified wages.
Example 2: Employer W, a large consulting firm that employed an average of more than 100 full-time employees in 2019, closed its offices due to various governmental orders and required all employees to telework. Although Employer W believes that some of its employees may not be as productive while working remotely, employees are working their normal business hours. Because employees’ work hours have not changed, no portion of the wages paid to the employees by Employer W are qualified wages.
These examples show the subtle difference between being less productive and having less work to do. In the second example of FAQ 55, the consultants can still do their work remotely and wouldn't qualify even though they're less productive. However, if the consulting firm could show that there are fewer consulting projects because its clients don't have a budget for them anymore, would the employee's wages qualify? It seems like it would be consistent with the intent of the law to encourage employers to keep salaried employees instead of cutting their hours and pay. Paying nonexempt or exempt salaried employees voluntarily appears to meet the legal criteria if the reduced workload or schedule is due to government orders that have partially shut down the business.
If your business has been affected byCOVID-19-related government orders limiting commercial activity, travel or group activities, you may still be eligible for the Essential BusinessCompensation program. This includes businesses that have received direct government orders affecting their operations, or indirect government orders affecting their customers’ operations.
Hourly employees, nonexempt salaried employees and exempt salaried employees of eligible businesses will be qualified for compensation including:
1. reduction of scheduled work hours; and
2. reduced workload (COVID-19-related downtime).
Employers will need to use reasonable methods to identify the compensation paid to employees who are not working because of COVID-19-related government orders.
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