IRS expands allocable healthcare expenses eligible for employee retention credit

In a May 7, 2020, update to its list of “frequently asked questions” (FAQ) on the employee retention credit (ERC), the IRS revised the manner in which employers determine the amount of their qualified healthcare expenses for which the credit can be claimed. In a significant taxpayer-favorable development, eligible employers that continue to provide their employees with healthcare coverage can now claim the ERC for these costs regardless of whether the employees continue to receive a salary.

This development marks a reversal of the IRS’ previous stance that only healthcare expenses allocable to employee wages could produce the credit. Lawmakers were quick to rebuke this position, saying it did not conform to congressional intentions behind the ERC, which include incentivizing employers to continue to provide its workers with healthcare coverage during the pandemic.

To illustrate the effect of this change, consider an employer whose operations have been shut down due to a government order. In response, the employer furloughs all of its workers, stops paying their salaries but continues to provide them with healthcare benefits. Based on the IRS’ prior guidance, none of the employers’ costs would have factored into its ERC calculation because there were no qualifying wages related to the associated healthcare expenses. Now, all of the healthcare costs can be considered in determining the credit, as they were provided while the employer’s operations were suspended pursuant to the government order. Note that in the case of an employer with more than 100 employees, the costs must also be attributable to a period during which its workers are not providing services. In this example, that test would be met as the employees were furloughed outright.

For more background and details on the ERC, please see our previous tax alert, which has been revised to reflect this change. The complete FAQ is posted on a dedicated IRS webpage.

Please reach out to your Baker Tilly tax advisor to discuss how these changes may impact your tax situation.