On April 6, 2020, we alerted production companies that they could be eligible for employee retention credits (ERC) under the Coronavirus Aid, Relief, and Economic Security, or CARES, Act through Entertainment Partners’ (EP) quarterly federal tax return Form 941 (FICA/employee income tax withholdings). As a refresher of that alert, the ERC serves as a credit against employment tax liability on the quarterly federal tax return Form 941 equal to 50% of qualified wages per employee. Click here to view our prior CARES Act client alert.
On April 29, 2020, the Internal Revenue Service (IRS) issued a series of ninety-four (94) Frequently Asked Questions (FAQs) that provide further guidance. The FAQs are available here, and we have summarized certain (but not all) material FAQs for production companies in this alert. We encourage our production company clients to read the FAQs and consult with their advisors regarding how any particular FAQ guidance may impact their eligibility for the ERC based on their specific facts and circumstances.
Employer’s Suspension of Operations Due to COVID-19 Governmental Order or Significant Decline of Gross Receipts
As a refresher, an employer may be treated as an eligible employer for purposes of the ERC if either of the following qualifying events occurs: (i) an eligible employer’s operations are fully or partially suspended during a 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 COVID-19; or (ii) an eligible employer incurs a “significant decline in gross receipts” for the period beginning with the first calendar quarter in 2020 for which its gross receipts are less than fifty percent (50%) of gross receipts for the same 2019 calendar quarter.
In the FAQs, the IRS provided additional guidance that:
- Mere statements from a governmental official (g., a comment made during a press conference) do not constitute a “governmental order” for purposes of the ERC without an order, proclamation or decree that limits commerce, travel or group meetings due to COVID-19. For a production company operating exclusively in a state that enacted a COVID-19 shelter-at-home order relatively late in March or even in April, the governmental order may not provide ERC relief for wages paid between March 13, 2020 and the date the applicable governmental order was issued, notwithstanding an earlier governor press conference or statement. However, the significant-decline-in-gross-receipts test may nonetheless provide potential ERC eligibility for qualified wages paid commencing March 13, 2020.
- An employer that operates a trade or business in multiple locations (including a production company with multiple entities for purposes of the ERC single-employer-aggregation rules or even a single production company entity with various pre-production, filming and post-production locations) and that is subject to a governmental order limiting operations in at least one jurisdiction may nonetheless be considered to have a partial suspension of operations for purposes of the ERC. Moreover, an employer subject to a governmental order fully or partially suspending its business operations that is subsequently lifted is considered to have business operations that were suspended only for the period during the calendar quarter in which its trade or business operations were actually fully or partially suspended. Regardless of how an employer would be scrutinized under the above scenarios, the employer may nonetheless qualify for the ERC under the significant-decline-in-gross-receipts test.
- To qualify for the ERC based on the significant-decline-in-gross-receipts test, an employer must take into account the gross receipts of all members of its aggregated group within the meaning of the ERC rules, including parent-subsidiary consolidated entities and “brother-sister” entities within the meaning of the “controlled group” rules under the Internal Revenue Code. If the aggregated group does not experience a significant decline in gross receipts, then no member of the group may claim the ERC on that basis. However, as described above, the employer may nonetheless potentially qualify for the ERC based on a full or partial suspension of any of its members’ operations, in solely one geographic location in which a controlling governmental order is in effect.
- For an employer relying on the significant-decline-in-gross-receipts test to qualify for the ERC, the CARES Act does not require that the significant decline in gross receipts be related to COVID-19. However, employers should keep records for the relevant calendar quarters in 2019 and 2020 to document a significant decline in gross receipts, with the records being available for IRS review for at least four (4) years.
Clarifications to Calculation of Qualified ERC Wages
Qualified wages include W-2 wages paid to employees during the qualifying-event period, as well as associated qualified health care expenses (discussed later). For a large employer (an employer averaging over 100 full-time employees in 2019), only those wages paid for the time that an employee is not providing service qualify for the ERC. In contrast, for a small employer (an employer averaging up to 100 full-time employees in 2019), all wages paid during the qualifying event, regardless of whether the employee provides services, qualify for the ERC.
Since qualified wages for large employers are limited to non-service wages, the IRS developed criteria to calculate qualified wages in the event of a reduced work schedule, as opposed to completely inactive periods. For employees of a large employer on a reduced work schedule, only the portion of wages exceeding payment for work will qualify. As examples, a 10% reduction of pay to an employee on a 50%-reduced schedule will mean the difference of 40% will count as qualified wages, while a 50% pay reduction to an employee on a 50% reduced schedule will net zero qualified wages because none of the wages exceed the amount paid for providing service. For employees off work and paid relief wages, the full relief amount will count as qualified wages if all other ERC conditions are otherwise satisfied.
In contrast, all wages paid to a small employer’s employees during the qualifying-event period count as qualified wages (subject to the $5,000 ERC cap per employee across the entire controlled group), regardless of whether the payment involves time in service or on leave or hiatus. Even vacation, sick, or other forms of paid time off wage payments by a small employer count as qualified wages; whereas such time off payments by a large employer would not qualify because the IRS considers them to represent benefits accrued as a result of services performed.
Note that severance pay to a terminated employee or other post-termination payments do not count as qualified wages for any employer because the ERC is predicated on current employment payments.
To the extent that an employee is paid qualified wages by two or more member entities of the employer’s controlled group, the ERC would be apportioned among the member entities in proportion to qualified wages paid. To illustrate, $4,000 of qualified wages paid by employer controlled group member A and $6,000 of qualified wages paid by employer controlled group member B would mean that member A would claim 40% (up to $2,000) of the ERC and member B would claim 60% (up to $3,000) of the ERC.
Qualified Health Care Expenses for Purposes of the ERC
Qualified wages under the ERC include certain qualified health expenses. These costs include the employer cost for health insurance plus the employee pre-tax contribution under Section 125 of the Internal Revenue Code. However, employee after-tax payments are not creditable toward the ERC. Qualified health plan expenses also include employer contributions to health flexible spending accounts and health reimbursement arrangements. If an employer provides for health insurance coverage but pays no qualified wages, the health insurance costs do not qualify because the employer must pay some form of wages to claim the health care expenses as qualified wages. (EP notes that Congress has requested the IRS to reconsider its view on this subject).
Large employers that pay employees on a reduced work schedule may qualify part of the health costs in proportion to the wage payment that does not relate to work. For example, paying an employee 50% of regular wages for working 50% of the time results in net zero relief, which means no health costs qualify. But paying an employee 100% regular wages for 50% of a reduced schedule means 50% of the wages qualify and 50% of the health costs qualify.
For small employers, all wages paid arising out of a qualifying event, as described above, qualify for the ERC and thus all associated health insurance costs paid by the small employer would qualify. However, health care must be allocable to the time during which wages were paid. For example, an employer who pays regular wages to its employees for two weeks during a government-mandated COVID-19 shutdown may qualify health care costs in proportion to the time during which wages were paid. Hence, the employer may allocate two weeks of health care costs as qualified wages in this example.
The FAQs indicate qualified health costs must be allocated to the period for which qualified wages are paid on a pro-rata basis. However, the entertainment industry generally cannot calculate costs that way because it typically is impossible to know any of the data points because of its freelance nature. The better approach for certain segments of the entertainment industry might be to adopt the actual employer health and welfare contribution for union employees under a collective bargaining agreement or the actual employer cost including the employee pre-tax portion for non-union employees under an employer group health plan.
For any questions about this alert, you may contact:
Joseph Scudiero, Senior Vice-President & Chief Labor Counsel
Scott Bishop, Vice-President, Employment Law
James Klima, Senior Contracts & Corporate Law Counsel