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Economic Analysis: Who Would Get Enhanced Employee Retention Credits?

Posted on Aug. 10, 2020

If you aren’t alarmed by the condition of the economy, you should be. Don’t let the stock market highs etherize your sensibility. Even with multimillion rebounds in June and July, there are still 13 million fewer Americans working now than in February. GDP declined by a shocking 9.5 percent from the first to second quarter (39 percent at an annualized rate). Given the slim possibility of a major, behavior-changing medical breakthrough before winter, the economy could deteriorate even further if Congress doesn’t extend expiring stimulus legislation. Figure 1 shows that what we called the Great Recession doesn’t seem so great when compared with the current crisis.

U.S. Real GDP and Employment, 2007-Present

As of this writing, there is a Grand Canyon of difference between the Democratic and Republican positions on the next stimulus legislation. For the tax community, it is notable that tax issues aren’t the major sticking points. For example, there is agreement on a second round of stimulus checks of $1,200 for individuals, $2,400 for couples, and $500 for dependents. There is also general agreement on the employee retention tax credit (ERTC), but here agreement isn’t on keeping things the same but on making the credit far more generous than the stingy $5,000-per-employee annual maximum allowed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) enacted on March 27.

The Health, Economic Assistance, Liability Protection, and Schools (HEALS) Act floated by Senate Republicans on July 27 would increase that annul maximum nearly fourfold, to $19,500. The Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act (H.R. 6800) passed by the Democrat-controlled House on June 15 would increase that annual maximum amount more than sevenfold, to $36,000. Unlike current law, under both proposals, employers that qualified for both the Paycheck Protection Program and the ERTC could use both. Legions of small employers that hadn’t considered the ERTC (except for the self-employed with no employees, who don’t qualify) may have to give the credit serious study. And employers that now are eligible (or are close to eligibility) for the ERTC will want to put renewed effort into maximizing wages that qualify.

Gross Receipts Test

To be eligible for the ERTC, an employer must be carrying on a trade or business and satisfy either a gross receipts test or a suspension of business test. Let’s examine the gross receipts test first. Table 1 shows the gross receipts of 67 large corporations (with sales greater than $20 billion) that filed Forms 10-Q between July 3 and August 3. Second-quarter results are especially timely and interesting because they are the first quarterly results that lie completely in the COVID-19 recession period. We compare 2019 second-quarter, pre-virus, gross receipts with 2020 second-quarter gross results. Besides being interesting in and of itself, the percentage change in receipts in a 2020 quarter relative to the receipts in the corresponding quarter of 2019 triggers eligibility for the ERTC under current law and under the two proposals. Table 1 computes annual maximum credits per qualified employee, assuming the 2020 second-quarter growth relative to 2019 second-quarter growth remains the same.

Table 1. Estimated Maximum Employee Retention Tax Credit Per Employee Assuming
Q2/2020 Growth for the Remainder of 2020 and Using the Gross Receipts Method

Business

 

 

Maximum Annual Per-Employee Credit

SEC Classification

Q2/2020 Change From Q2/2019

Current Law

HEALS Act

HEROES Act

Visa Inc.

Consumer Services

-17.2%

$0

$0

$6,457

Schlumberger Ltd./NV/

Energy & Transport

-35.2%

$0

$19,600

$22,705

Halliburton Co.

Energy & Transport

-46.1%

$0

$19,600

$32,494

Phillips 66

Energy & Transport

-60.8%

$5,000

$19,600

$36,000

PBF Energy Inc.

Energy & Transport

-61.6%

$5,000

$19,600

$36,000

Valero Energy Corp./TX/

Energy & Transport

-64.1%

$5,000

$19,600

$36,000

American Airlines Group Inc.

Energy & Transport

-86.4%

$5,000

$19,600

$36,000

Delta Air Lines Inc.

Energy & Transport

-88.3%

$5,000

$19,600

$36,000

Enbridge Inc.

Energy & Transport

-40%

$0

$19,600

$27,012

Southern Co.

Energy & Transport

-9.4%

$0

$0

$0

Bank of America Corp./DE/

Finance

-3.3%

$0

$0

$0

Federal National Mortgage Association (Fannie Mae)

Finance

-9.9%

$0

$0

$0

American Express Co.

Finance

-18.2%

$0

$0

$7,361

UnitedHealth Group Inc.

Finance

2.5%

$0

$0

$0

Anthem Inc.

Finance

14.9%

$0

$0

$0

Centene Corp.

Finance

51%

$0

$0

$0

Chubb Ltd.

Finance

5.4%

$0

$0

$0

Hartford Financial Services Group Inc.

Finance

-0.5%

$0

$0

$0

Travelers Companies Inc.

Finance

-5.5%

$0

$0

$0

Linde PLC

Life Sciences

-11.5%

$0

$0

$1,332

DuPont De Nemours Inc.

Life Sciences

-11.7%

$0

$0

$1,534

Dow Inc.

Life Sciences

-24.2%

$0

$0

$12,736

Eli Lilly & Co.

Life Sciences

-2.4%

$0

$0

$0

Abbott Laboratories

Life Sciences

-8.2%

$0

$0

$0

Johnson & Johnson

Life Sciences

-10.8%

$0

$0

$743

Amgen Inc.

Life Sciences

24.1%

$0

$0

$0

LyondellBasell Industries N.V.

Life Sciences

-38.7%

$0

$19,600

$25,834

Northrop Grumman Corp./DE/

Life Sciences

5.1%

$0

$0

$0

Thermo Fisher Scientific Inc.

Life Sciences

9.5%

$0

$0

$0

3M Co.

Life Sciences

-12.2%

$0

$0

$1,959

HCA Healthcare Inc.

Life Sciences

-12.2%

$0

$0

$1,955

Mondelez International Inc.

Manufacturing

-2.5%

$0

$0

$0

Tyson Foods Inc.

Manufacturing

-7.9%

$0

$0

$0

Kraft Heinz Co.

Manufacturing

3.8%

$0

$0

$0

Archer-Daniels-Midland Co.

Manufacturing

-0.1%

$0

$0

$0

Bunge Ltd.

Manufacturing

-6.3%

$0

$0

$0

Coca-Cola Co.

Manufacturing

-28.5%

$0

$19,600

$16,631

PepsiCo Inc.

Manufacturing

-3.1%

$0

$0

$0

Philip Morris International Inc.

Manufacturing

-10.8%

$0

$0

$762

International Paper Co. /New/

Manufacturing

-14.1%

$0

$0

$3,721

General Electric Co.

Manufacturing

-24.2%

$0

$0

$12,772

Qualcomm Inc./DE/

Manufacturing

-49.2%

$0

$19,600

$35,295

Intel Corp.

Manufacturing

19.5%

$0

$0

$0

Ford Motor Co.

Manufacturing

-17.2%

$0

$0

$6,457

Tesla Inc.

Manufacturing

-4.9%

$0

$0

$0

Boeing Co.

Manufacturing

-25%

$0

$19,600

$13,536

Raytheon Technologies Corp.

Manufacturing

24.1%

$0

$0

$0

Honeywell International Inc.

Manufacturing

-19.1%

$0

$0

$8,196

General Dynamics Corp.

Manufacturing

-3%

$0

$0

$0

Lockheed Martin Corp.

Manufacturing

12.4%

$0

$0

$0

Lennar Corp. /New/

Real Estate & Construction

-5%

$0

$0

$0

Baker Hughes Co.

Technology

-21%

$0

$0

$9,889

International Business Machines Corp.

Technology

-5.4%

$0

$0

$0

Apple Inc.

Technology

10.9%

$0

$0

$0

Eaton Corp. PLC

Technology

-30.3%

$0

$19,600

$18,278

Verizon Communications Inc.

Technology

-5.1%

$0

$0

$0

Charter Communications Inc./MO/

Technology

3.1%

$0

$0

$0

Comcast Corp.

Technology

-11.7%

$0

$0

$1,532

Facebook Inc.

Technology

10.7%

$0

$0

$0

Arrow Electronics Inc.

Trade & Services

-10%

$0

$0

$44

World Fuel Services Corp.

Trade & Services

-66.6%

$5,000

$19,600

$36,000

Penske Automotive Group Inc.

Trade & Services

-36.6%

$0

$19,600

$23,910

AutoNation Inc.

Trade & Services

-15.2%

$0

$0

$4,655

Starbucks Corp.

Trade & Services

-38.1%

$0

$19,600

$25,308

Amazon.com Inc.

Trade & Services

40.2%

$0

$0

$0

Johnson Controls International PLC

Trade & Services

-17.2%

$0

$0

$6,458

Netflix Inc.

Trade & Services

24.9%

$0

$0

$0

Note that under current law and the HEALS Act, there is a cliff effect. Under current law, gross receipts must decline by 50 percent to qualify for the credit. Under the HEALS Act, gross receipts must decline by 75 percent to get the credit. Under the HEROES Act, there is a credit on a sliding scale, with the maximum credit available for a 50 percent decline, with the credit decreasing linearly until it is zero for a 10 percent decline in credit. Note also that current law and the two proposals deny the credit for companies with more than a specified number of employees, for those employees who are performing services for the company.

Out of 67 businesses, 51 had second-quarter receipts in 2020 below their second-quarter receipts in 2019. In our estimates for current law using the gross receipts method, only six companies were eligible for the ERTC (a decline of more than 50 percent), all in either the air transportation or energy industries. For the HEALS Act, 16 companies were eligible (with a decline of more than 25 percent). And for the HEROES Act, 34 companies were eligible (with a decline of more than 10 percent).

Business Suspension Test

In contrast with the formulaic gross receipts test, the business suspension test depends heavily on facts and circumstances. Section 2301 of the CARES Act is titled “Employee Retention Credit for Employers Subject to Closure Due to COVID-19.” What does “subject to closure” mean? It has little resemblance to what normal people would think it means — that is, that the business is closed. As described above, it can mean that an employer carrying on a trade or business was open but had a significant decline in gross receipts or, as the statute describes the business suspension test, an eligible business “is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to the coronavirus disease 2019 (COVID-19).”

In tax law, piggybacking on nontax rules is usually welcome because familiarity simplifies administration and compliance and reduces uncertainty. But for the ERTC, the reference to government orders probably creates more confusion than it’s worth.

In the United States, we don’t have national orders for business operations during this crisis. We have Centers for Disease Control and Prevention and Department of Homeland Security guidelines that are optional. Merely following those guidelines doesn’t make a business an employer eligible for the credit. What we do have are governors’ orders and guidelines that vary from state to state and over time. On top of that, municipalities may have their own orders and guidelines that may be more or less stringent than state guidelines. Just because a business is following government guidelines or has developed its own practices doesn’t make it an employer eligible for the ERTC.

With that bit of background, let’s look at the FAQs published by the IRS on the ERTC. These detailed FAQs are helpful in many cases, but there is a lot of ground to cover, and much uncertainty remains. And these FAQs, as the IRS must tell us because in the interest of speed it is sidestepping the Administrative Procedure Act, “may not be relied upon as legal authority.” Pity the underfunded IRS as it attempts to rapidly (but always too slowly for practitioners) write crisp rules from the mushy language handed to it by Congress.

An employer whose trade or business operations are fully or partially suspended during a calendar quarter because of a government order is an eligible employer that may be entitled to the credit. Several examples from the FAQs elaborate. Eligibility is attained if more than a nominal portion of an employer’s business operations is suspended by government order. Eligibility is attained if a governmental order requires an employer to close for a portion of normal working hours. Eligibility is attained if essential business materials cannot be obtained from a supplier that itself was required to suspend operations by government order. Eligibility is attained by hospitals and healthcare providers ordered to suspend non-essential procedures.

Eligibility isn’t attained by a government order requiring customers to stay home. Eligibility isn’t attained by a place of business that makes minor virus-prevention modifications unless the government-required modification has more than a nominal effect on operations. In IRS examples, “more than nominal” eligibility is attained by an indoor restaurant that loses capacity because of a table-spacing requirement and by a retailer that is restricted by the government to making online sales and providing curbside service.

One FAQ provides a highly favorable rule for employers operating in multiple jurisdictions. Eligibility can be attained nationwide if an employer complies with a local government and then establishes, to operate in a consistent manner, a companywide policy in compliance with that local-government rule, even in those jurisdictions where the business wasn’t subject to a governmental order. Further, all business members of an aggregated group are eligible if only one member of the group is eligible.

Employers can claim a credit only for wages paid during the period the order is in force, not for the entire quarter when an order is in force. Employers cannot claim the ERTC for wages used to calculate paid and sick leave credits enacted as part of the Families First Coronavirus Response Act (P.L. 116-127) (expanded by the HEROES Act). And employers claiming the work opportunity tax credit (also expanded by the HEROES Act) may not claim the ERTC.

Table 2 reports the financial data of 20 companies that filed Form 10-Q reports with the SEC between July 5 and August 4. These companies were first identified by a search for the phrase “employment tax credit” and similar phrases. From the 62 companies flagged by the word search, the 20 in Table 2 indicated in the text that they had qualified for or expected to receive the ERTC. Others made no specific mention of whether the credit applied to them. And still others reported that the credit had no effect or no significant effect, or that its impact was under consideration.

Table 2. Q2/2020 Percentage Change in Gross Receipts From Q2/2019 for 20 Businesses Reporting Employee Retention Credits in Their Second-Quarter Filings With the SEC

Business

Q2/2002 Growth Over Q2/2019

Las Vegas Sands Corp.

-97%

United Airlines Holdings Inc.

-87%

Spirit Airlines Inc.

-86%

Kura Sushi USA Inc.

-83%

Hyatt Hotels Corp.

-81%

Hilton Grand Vacations Inc.

-73%

Steven Madden Ltd.

-68%

Dine Brands Global Inc.

-52%

Cheesecake Factory Inc.

-51%

Bed Bath & Beyond Inc.

-49%

Bloomin’ Brands Inc.

-43%

Skyline Champion Corp.

-27%

Floor & Decor Holdings Inc.

-11%

Dte Energy Co.

-11%

Spok Holdings Inc.

-10%

Forward Air Corp.

-7%

Microstrategy Inc.

-6%

Chipotle Mexican Grill Inc.

-5%

BMC Stock Holdings Inc.

4%

Leidos Holdings Inc.

7%

After calculating the change in gross receipts for these 20 companies, we found nine had a decline in gross receipts of greater than 50 percent from the second quarter of 2019 to the second quarter of 2020. These results suggest that about half of the companies receiving the ERTC do so by meeting the business suspension test rather than the gross receipts test.

The (Not Too Distant?) Future

If another major stimulus plan becomes law, it is likely to include a greatly enhanced ERTC. Because it will significantly increase the value of the credit, and because small businesses can qualify for Paycheck Protection Program loan forgiveness and the ERTC, interest in the ERTC will increase manifold. Given the complexity and ambiguity of the business suspension test, Congress and the IRS should seriously consider simpler safe harbor rules, particularly for small business.

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