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June 04, 2021

New IRS Guidance on the Employee Retention Credit

This Briefing is brought to you by AHLA’s Tax and Finance Practice Group.
  • June 04, 2021
  • Nicholas Kump , King & Spalding LLP

When the Department of Health and Human Services first declared a Public Health Emergency in January 2020 due to COVID-19, many employers, including the country’s health care providers, adapted and identified ways to provide critical services to customers and patients. Some employers even continued to pay their employees despite the government shutdown of their businesses. Congress and the Trump administration responded by passing the Coronavirus Aid, Relief, and Economic Security Act (CARES Act),[1] which included the Employee Retention Credit to encourage all businesses to keep employees on their payroll during the COVID-19 public health emergency (PHE).

Since its passage last spring, Congress has amended the CARES Act and the Employee Retention Credit multiple times, and the Internal Revenue Service (IRS) has issued multiple notices offering employers guidance on this valuable tax credit. This article offers a framework for health care providers and other employers to evaluate whether they are eligible to take advantage of the Employee Retention Credit under recent changes effective January 2021 and looks forward to the next expected guidance from the IRS.

Background

Section 2301 of the CARES Act codifies the Employee Retention Credit, which allows a credit against applicable employment taxes for eligible employers, including tax-exempt organizations, that pay qualified wages to their employees. In other words, employers get a tax credit for keeping their employees on the payroll during the COVID-19 PHE.

Sections 206 and 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020[2] (Relief Act) adopted certain changes to the Employee Retention Credit. Specifically, Section 206 adopts amendments and technical changes to the Employee Retention Credit for qualified wages primarily relating to who may claim the credit. Section 207 extends the Employee Retention Credit to July 1, 2021 and modifies the calculation of the credit amount for qualified wages paid after December 31, 2020.

On March 1, 2021, the IRS announced the issuance of Notice 2021-20 for employers claiming the Employee Retention Credit.[3] Notice 2021-20 provides guidance on Section 206 of the Relief Act including clarification of retroactive changes applicable to 2020. Notably, the IRS provided Notice 2021-20 in a frequently asked questions (FAQs)-style format, with similar information to the FAQs posted on the IRS’ website. The publication in an official notice, rather than informally on the website, allows taxpayers to rely on the IRS’ statements and positions for penalty protections.

On March 11, 2021, Congress and the new Biden administration passed the American Rescue Plan Act,[4] which among other things, extended the Employee Retention Credit to wages paid during the third and fourth quarters of 2021. Most recently, on April 2, 2021, the IRS announced the issuance of Notice 2021-23 explaining changes to the Employee Retention Credit for the first two calendar quarters of 2021 under the Relief Act.[5] The Department of the Treasury and the IRS will provide further guidance on the Employee Retention Credit under the American Rescue Plan Act later this year.

Amount of the Credit

Effective January 1, 2021, the credit amount is 70% of qualified wages paid to each employee in a calendar quarter. The maximum wage for each employee is $10,000 per quarter, so the maximum credit per quarter is $7,000 per employee.

Employer Eligibility

Eligible “Trade or Business”

The Employee Retention Credit offers a credit for employers carrying on a “trade or business” and paying wages when the employer is partially or fully shutdown due to COVID-19, or the employer experienced a significant decline in gross receipts during the quarter. “Trade or business” generally has the same meaning as used in Section 162 of the Internal Revenue Code (IRC), which means the primary purpose is to make a profit and it is carried on with regularity and continuity.

Many hospitals and health systems operate as nonprofit organizations and for purposes of the Employee Retention Credit, a tax-exempt organization under Section 501(c) of the IRC that is exempt from tax under Section 501(a) is considered a “trade or business” with respect to all operations of the organization. Additionally, under the CARES Act, a “trade or business” initially did not include any governmental entities such as a hospital associated with a state university. However, the Relief Act created an exception and beginning January 1, 2021, an eligible “trade or business” includes colleges or universities or other government entities with a principal purpose or function of providing medical or hospital care.

Significant Decline in Gross Receipts

Assuming the employer is engaged in an eligible trade or business, the employer must pay wages when shutdown due to COVID-19 or during a significant decrease in gross receipts. With industry-wide government shutdowns becoming less widespread, the significant decline in gross receipts requirement for the Employee Retention Credit becomes more meaningful moving forward. Effective January 1, 2021, the decline is “significant” if the employer’s gross receipts are less than 80% of its gross receipts compared to the same quarter in 2019. There is also an alternative election that allows the employer to use the prior quarter’s gross receipts compared to the same quarter in 2019. For example, for the first quarter of 2021, employers can compare gross receipts for the fourth quarter of 2020 against the fourth quarter of 2019 instead of comparing its first quarter of 2021 against first quarter of 2019.

As is often the case in today’s world of frequent health care mergers and acquisitions, complications may arise when an employer acquires another employer midyear. FAQ 28 in Notice 2021-20 provides that if an employer acquired another business in 2020, the employer must include the gross receipts of the acquired business in its gross receipts calculation. In determining whether there is a decline in gross receipts, the employer should use the acquired business’ gross receipts from 2019 before the acquisition to the extent they are available. Thus, hospital systems that acquired new facilities significantly impacted by the COVID-19 PHE may be able to leverage the acquired facilities’ gross receipts for the benefit of the entire hospital system.

Gross Receipts for Tax-Exempt Organizations

Nonprofit hospitals and other tax-exempt organizations refer to Section 6033 of the IRC to determine the scope of gross receipts. FAQ No. 25 in Notice 2021-20 explains for tax-exempt organizations, gross receipts include, but are not limited to:

  • the gross amount received as contributions, gifts, grants, and similar amounts without reduction for the expenses of raising and collecting such amounts;
  • the gross amount received as dues or assessments from members or affiliated organizations without reduction for expenses attributable to the receipt of such amounts;
  • gross sales or receipts from business activities (including business activities unrelated to the purpose for which the organization qualifies for exemption),
  • the gross amount received from the sale of assets without reduction for cost or other basis and expenses of sale; and
  • the gross amount received as investment income, such as interest, dividends, rents, and royalties.

Prior to the Relief Act, tax-exempt organizations looked to Section 448(c) of the IRC to determine their gross receipts, just like all other employers claiming the Employee Retention Credit.[6] However, the IRS states in Notice 2021-20 that it does not anticipate the change in the definition of gross receipts will significantly impact which employers are eligible for the credit.

Paycheck Protection Program (PPP) Loans

The CARES Act originally precluded organizations that received PPP Loans from taking advantage of the Employee Retention Credit. The Relief Act repealed this prohibition, but the credit is not allowed for wages paid with the proceeds of a PPP Loan. If an eligible employer obtains forgiveness of only a portion of the PPP loan amount or pays wages in excess of reported payroll costs on the PPP Loan application, those amounts are eligible for the Employee Retention Credit.

Hospitals and health care providers must be intentional with the amounts they include in their PPP Loan application or risk leaving Employee Retention Credits available and unused. The third example to FAQ 49 on Notice 2021-20 provides that expenses eligible for PPP forgiveness that were not included in the loan forgiveness application cannot be factored in after the fact. Consequently, employers should ensure the PPP Loan application includes all eligible non-payroll costs such as personal protective equipment for frontline workers, utilities, rent, and other operational expenses to maximize the qualified wages available for the Employee Retention Credit.

Qualified Wages

The Employee Retention Credit only applies to “qualified wages,” which include wages and compensation including amounts paid by an eligible employer to provide and maintain a group health plan. The scope of qualified wages depends on whether the employer is a small or large employer. Effective January 1, 2021, a large employer is an employer with over 500 employees. Small employers have 500 or fewer employees. Entities are treated as a single employer and all employees are aggregated if the entities are under common control.[7]

For large employers, qualified wages only include wages paid to an employee for time that the employee is not providing services to the employer. In other words, even if the employer experienced a significant decline in gross receipts, the credit only applies to large employers that continue to pay wages to employees who are not working such as furloughed workers. This substantially limits the qualified wages for large health systems that often employ well over 1,000 people across all facilities and continued to provide essential services through the COVID-19 PHE.

For small employers such as an independent medical facility, they may claim the Employee Retention Credit for wages paid regardless of whether the employee actually provided services to the employer as long as they meet the other eligibility requirements.

Claiming the Credit

All eligible employers claim the Employee Retention Credit for qualified wages by reporting their qualified wages and the amount of the credit to which they are entitled on the designated lines of their federal employment tax return. Most employers, including most health care providers, use Form 941 to report income and Social Security and Medicare taxes.

In anticipation of receiving the Employee Retention Credit, eligible employers can reduce their deposits of federal employment taxes, including withheld taxes, that would otherwise be required up to the amount of the anticipated credit. Small employers may also request an advance of the amount of the anticipated credit in an amount not to exceed 70% of the average quarterly wages paid in calendar year 2019. Notice 2021-20 provides specific guidelines on which Form 941 lines employers should use to calculate average quarterly wages.

What’s Next?

Employers can expect the Employee Retention Credit to be around at least until the end of 2021 under the American Rescue Plan Act. However, new guidance from the IRS is expected regarding how it will interpret the Employee Retention Credit during the second half of 2021. The IRS is expected is make changes to Form 941 consistent to changes in the American Rescue Plan Act including changes to reflect that after June 30, 2021, the tax the credit is taken against Medicare taxes rather than Social Security.

Health care providers should make sure to consult their tax advisers who have an in-depth understanding of the Employee Retention Credit before making major operational decisions, particularly decisions related to payroll. Providers should only make decisions when they understand the impact on the Employee Retention Credit because hospitals with hundreds of employees may inadvertently lose access to hundreds of thousands of dollars in tax credits.

A sincere thank you to Travis Jackson for his expert insight and assistance with this article.

 

[1] Pub. L. No. 116-136, 134 Stat. 281 (Mar. 27, 2020).

[2] Congress enacted the Relief Act as Division EE of the Consolidated Appropriations Act, 2021, Pub. L. No. 116-260, 134 Stat. 1182 (Dec. 27, 2020).

[3] IR-2021-48, IRS Provides Guidance for Employers Claiming the Employee Retention Credit for 2020, Including Eligibility Rules for PPP Borrowers (Mar. 1, 2021), https://www.irs.gov/newsroom/irs-provides-guidance-for-employers-claiming-the-employee-retention-credit-for-2020-including-eligibility-rules-for-ppp-borrowers.  

[4] Pub.L. 117-2 (Mar. 11, 2021).

[5] IR-2021-74, IRS Provides Guidance for Employers Claiming the Employee Retention Credit for First Two Quarters of 2021 (Apr. 2, 2021), https://www.irs.gov/newsroom/irs-provides-guidance-for-employers-claiming-the-employee-retention-credit-for-first-two-quarters-of-2021.   

[6] See FAQ 25 in Notice 21-20 for explanation of “gross receipts” under IRC Section 448(c).

[7] FAQ 7 to Notice 20220 further explains when related entities must aggregate their employees as a single employer and provides: “All entities that are members of a controlled group of corporations or trades or businesses under common control under sections 52(a) or (b) of the Code, members of an affiliated service group under section 414(m) of the Code, or otherwise aggregated under section 414(o) of the Code are treated as a single employer for purposes of applying the employee retention credit.”