Businesses Wary of Using Virus Tax Perk Absent More IRS Guidance

Some businesses are hesitant to claim a tax perk meant to encourage them to retain employees during the pandemic because they aren’t sure they qualify and fear potential penalties and reputational damage if they guess wrong.

The employee retention credit enacted by the coronavirus relief law (Public Law 116-136), known as the CARES Act, is a fully refundable tax credit equal to 50% of up to $10,000 in wages an employer pays to each employee—in other words $5,000 per employee. Employers can immediately access this benefit by reducing the payroll taxes they deposit on a monthly or semi-weekly basis by the credit amount. The credit can be claimed for wages paid after March 12 and before Jan. 1, 2021.

The tax break can be a huge help to businesses suffering financially but there are so many unanswered questions that some aren’t taking advantage for fear that the IRS might hit them with large penalties or that they’ll face public backlash for wrongly claiming the benefit, according to tax professionals working with these businesses.

Some of the biggest gaps deal with overall business eligibility and the types of wages that qualify for the credit, said Robert Delgado, a principal in KPMG’s compensation and benefits practice. The Joint Committee on Taxation in its description of the CARES Act offered some insight into the credit provision—for example, affirming that Treasury can allow employers to count certain healthcare expenses toward the credit even if they aren’t paying any other wages. But that guidance isn’t binding in the way IRS guidance would be, Delgado said.

“The uncertainty and lack of guidance is affecting business operations,” said Jeffrey Martin, a partner in Grant Thornton LLP’s Washington, D.C., tax office.

A Treasury spokesperson said the department is actively working on additional guidance that it hopes to have out soon. The IRS didn’t return a request for comment.

Small businesses that are unsure of their eligibility for the credit can instead try to obtain a forgivable loan under the new Paycheck Protection Program. They are restricted from taking advantage of both.

But that program also isn’t so clear-cut, said Sarah Crozier, senior communications manager at the Main Street Alliance, an advocacy group for small businesses. Businesses would like to get more detailed guidance on loan forgiveness and how much needs to be repaid to the government if they meet some—but not all—of the program’s requirements, she said.

Gray Areas

Businesses, including tax-exempt organizations, are eligible under the law to take the employee retention credit if they had to partially or fully suspend their operations in 2020 because of government directives stemming from Covid-19. Otherwise, they would have had to see a significant drop in gross receipts to qualify.

The IRS in website FAQs specifically says bars and restaurants that are ordered to close by state governors but continue to serve customers with carry-out, drive-through, or deliver orders qualify for the tax credit.

But there are a lot of gray areas for businesses that have had to cut back operations but haven’t explicitly been told to do so by government orders. The American Institute of CPAs noted in a recent letter to the IRS that it’s unclear whether wholesalers that supply food to restaurants or trucking companies that deliver the food are eligible for the credit. They may be able to stay open as essential businesses but they’ve still had to reduce their operations because there’s less demand for their services, the group said.

The AICPA asked the IRS to expand its restaurant example to these other connected businesses.

Many members of the International Foodservice Distributors Association should be able to meet the reduced gross receipts test, a spokesperson for the organization said. The test says a business’s gross receipts must have declined by more than 50% when compared to the same quarter in 2019 to qualify for the credit.

Healthcare providers, such as hospitals, that voluntarily suspended elective or non-essential procedures—even if they weren’t directed to do so by a government order—to free up more equipment and resources for Covid-19 work are in another gray area, Martin said. Those businesses want to know if wages paid to employees who have had their work hours eliminated or temporarily reduced qualify for the credit, he said.

There are also questions about businesses with operations in multiple states that are only facing direct government orders to close operations in some, according to Delgado. “There would be supply chain disruptions and other disruptions to that business that may make its operation, even in a location that did not have a direct order, impractical,” he said.

AICPA in total highlighted seven issues it wants the IRS to address in guidance. The CARES Act directs Treasury to issue regulations or other guidance necessary to carry out the purpose of the tax incentive.

Penalty Risk

Businesses that fail to deposit their payroll taxes on time face a penalty of up to 15%. The CARES Act leaves it to Treasury’s discretion to waive the failure-to-deposit penalty in situations where the secretary determines that failure was due to the “reasonable anticipation” of the employee retention credit.

A business’s willingness to risk using the credit before guidance is issued depends largely on how strapped it is for cash, Martin said. Those that are in desperate financial straits are more likely to take the credit now, understanding that they may eventually have to pay that money back or fight to reduce penalties, he said.

Businesses are saying, “if we don’t take the credit, we’re not going to even have a business to care about down the road,” Martin added.

Delgado said the “reasonable anticipation” language is squishy, but he’s optimistic that Treasury will take a sympathetic approach with penalty relief.

Even so, businesses, including tax-exempt organizations that must publicly disclose their activities, have to consider the potential reputational harm and embarrassment of wrongly claiming the credit and then having to give that money back, he said. Burger chain Shake Shack recently returned a PPP loan after facing backlash for taking advantage of relief meant for small businesses.

Businesses that can survive without extra cash from immediate tax savings will likely wait for the IRS’s guidance on the credit before making any moves. If employers aren’t immediately accessing the tax break by reducing payroll tax deposits, they can claim refunds later.

Marna Ricker, EY’s Americas vice chair of tax, said many businesses have already started to model and plan for their anticipated credit.

“Companies are certainly making sure that they’re moving forward and analyzing fact patterns so that they’re ready when guidance comes,” she said.