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Employee Retention Credit FAQs Released

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On March 1, the IRS issued guidance for employers claiming the employee retention credit (ERC) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), as modified in December 2020 by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act). The ERC is designed to help eligible businesses keep employees on their payroll by offering a credit against employment taxes when qualified wages and healthcare expenses are paid during the COVID-19 pandemic. The guidance under Notice 2021-20 clarifies and describes retroactive changes to the ERC under the new law for employers seeking to claim the credit for 2020 in the form of frequently asked questions. The IRS has stated that it will address calendar quarters in 2021 in later guidance.

Under the 2020 ERC rules, 50% of qualified wages and healthcare expenses (up to $10,000 of wages per employee in 2020) are fully refundable if paid by businesses that experienced a full or partial suspension of their operations or a significant decline in gross receipts. Prior to the Relief Act, employers that had received Paycheck Protection Program (PPP) loans were not eligible to claim the ERC. Now, employers with PPP loans can retroactively claim the ERC, however, the same wages cannot be used for both benefits. Q&A 49 of the notice outlines the IRS’ position on the interaction of the ERC with PPP loans for 2020.

UPCO Insight

Unfortunately, borrowers who have already received PPP loan forgiveness do not have the same planning opportunities that are available to borrowers who have not yet filed the SBA application, Form 3508 series, for forgiveness.

An eligible employer can elect which wages are used to calculate the ERC and which wages are used for PPP loan forgiveness. Generally, the election is made by not claiming the ERC on the federal employment tax return for the quarter. If the IRS adhered to this general rule, it would nullify the retroactive effective date of the credit. Therefore, in lieu of the general rule on how an employer would elect the wages used for ERC (i.e., by not claiming the ERC on the federal employment tax return for the quarter), the notice provides for a deemed election for any qualified wages that are included in the amount reported as payroll costs on the PPP Loan Forgiveness Application, unless the included payroll costs exceed the amount needed for full forgiveness when considering only the entries on the application.  

For example, a business that borrows $100,000 of PPP loans and has both payroll and nonpayroll costs that far exceed the borrowed amount but reported payroll costs of $100,000 on their application to simplify the forgiveness process, cannot use any of the $100,000 of payroll cost to claim the ERC. This is notwithstanding the fact that 100% forgiveness may have been achieved by reporting only $60,000 of payroll costs and the remaining $40,000 from nonpayroll costs.   

While the text of Q&A 49 appears to treat the minimum amount of payroll costs required for PPP loan forgiveness (i.e., 60%) as being the deemed election, the examples make it clear that the entire $100,000 in payroll costs reported on the PPP application cannot be included in ERC calculations. The IRS’ examples do not address the documented nonpayroll expenses that were excluded from the PPP application but were retained in the borrower’s files in accordance with the SBA’s instructions. 

The notice also formalizes and expands on prior IRS responses to frequently asked questions and addresses changes made since the enactment of the Relief Act. It contains 71 frequently asked questions regarding the following topics:

  • Eligible employers
  • Aggregation rules
  • Governmental orders
  • Full or partial suspension of trade or business operations
  • Significant decline in gross receipts
  • Maximum amount of employer’s ERC
  • Qualified wages
  • Allocable qualified health plan expenses
  • Interaction with PPP loans
  • Claiming the ERC
  • Special issues for employees regarding income and deduction
  • Special issues for employers regarding income and deduction
  • Special issues for employers that use third-party payers
  • Substantiation requirements

An Outlook On The Real Estate Industry

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If the real estate industry has learned anything from the economic cycles of the past three decades and from crises like the savings and loan collapse, it’s patience.

On the surface, the global pandemic seems to have had a uniform impact on the global economy—the tendency is to look at the big picture impact on national economies, job losses and stock markets. While there is no arguing that the effects of this singular event in modern history will be felt—and studied—for years to come, the devil is in the details.

Those who own real estate assets across sectors and around the country see varying realities: Some industries, like restaurants, are harder hit than others. Yet within the restaurants industry itself there is variation: Many quick-serve and fast-food concepts are thriving, while others, like fine dining, are struggling.

For the real estate industry, lessons learned from past cycles and crises are translating into wait-and-see mode. Sellers are not willing to meet buyers’ expectations. On the commercial side, 61% of buyers expected a discount from pre-pandemic prices while only 9% of sellers were willing to offer them, according to CBRE’s Q3 2020 cap rate report. While some institutional investors may expect to see more distressed deals, unlike the Great Recession of 2008, there is significantly more capital sitting on the sidelines, enabling would-be sellers to wait out the current disruption.

With the vaccine rollout underway, the questions for those with real estate holdings are: When will the return to normal occur, will we be dealing with a new normal, what can be done in the meantime, and how can we position ourselves for the upside?
 

While lending has tightened, banks are still willing to be flexible

Since the Great Recession, when banks ended up owning and taking losses on real estate assets that borrowers could no longer make payments on, banks have been hesitant to foreclose on properties in default. Today, they are looking closely at de-risking their loan portfolios, and in some cases are selling debt to private credit funds to reduce losses. The private credit funds look at this as a way to become owners of real property at a lower price point.

Many banks and real estate owners are waiting for a recovery, as they know from history that the economy eventually comes around. In the meantime, banks have also allowed late or delayed payments or let borrowers tap into loan reserves to meet payment deadlines.
 

Office + retail real estate

More than any other sector in the industry, offices will look very different post-pandemic. The new reality that employees can—and want to—work remotely, at least part of the time, has forced conversations about contingency plans for how office space and layouts should look going forward, what the new demand for square footage may be, the extent to which companies will move to a hub-and-spoke or hybrid model, and the comeback of coworking. Office landlords will need to sell more of an experience as opposed to just a space. That experience could center around additional concierge type services to suit evolving office tenant needs.

Cap rates for offices vary based on location and occupancy. For a fully occupied prime office location, particularly in central business districts like New York City, Los Angeles and Chicago, deals have closed at around 6%, down to 4% for trophy assets. Underscoring the theme of variation within segments, cap rates for niche office segments like life sciences remain lower than non-life sciences properties, as demand for these types of defensive properties rises. In terms of new office leases in 2020, the tech sector accounted for 18% of the top 100 leases, according to CBRE. National cap rates for the office sector in the third quarter of 2020 were 7.12%, closely in line with the five-year rolling average of 7.16%, according to CBRE.

If they aren’t already, office buildings with vacant ground floor retail or restaurant space should be considering leasing to life sciences or medical businesses, which are and will continue to be in high demand. Meanwhile, the conversion of second- and higher-floor office space, as well as shuttered hotels, for residential use is expected to continue to increase.

Retail and restaurants/hospitality have seen the greatest disruption; retail brick-and-mortar closures are expected to range from 20,000 to 25,000 in 2021, on top of the more than 10,000 stores closures that have already occurred in 2020.

Retail cap rates have increased for freestanding net lease real estate, while for retailers seen as defensive, such as Dollar General, cap rates have declined 50 basis points at most. On the flip side, for typically well-occupied properties seeing vacancies, cap rates have increased 50 to 75 basis points. Cap rates for assets of troubled retailers are, of course, much higher.

Mom-and-pop or “quirky” retail tenants, such as shoemakers or instrument repair shops, who were priced out of central business districts or high-rent downtown areas may see an opportunity to return to cities. Landlords who heretofore were willing to go for years advertising vacant retail space may be more willing to consider working with such prospects on affordable lease terms.

Lease terms should be top of mind, of course. Tenants with less than a year left on their leases are likely surveying the market for alternatives, depending on their evolving workplace needs. Landlords should be willing to work with them to accommodate these needs and to renegotiate leases.
 

Industrial real estate

Industrial real estate has been the most resilient sector of real estate throughout the pandemic, in large part due to the increase in demand for e-commerce as the U.S. population largely sheltered in place. As such, the largest distribution tenants—Amazon and Walmart, for example—have been fueling the sector’s success. The average cap rate is 6.2% for industrial sales, falling by 119 basis points over the course of 2020, according to CoStar data. However, for Class A properties, cap rates are lower—4.3%, which represents a decline of 171 basis points from the fourth quarter of 2019, according to CoStar.

Industrial tenants’ new needs (e.g., on-demand warehousing) have altered business as usual for landlords. E-commerce sales are estimated to hit $1.5T by 2025, creating demand for 1 billion square feet of industrial space, according to JLL.
 

Suburban migration’s impact

The great migration to the suburbs is driving single-family home values up; multifamily home values remain steady and cap rates have compressed. In central business districts, the story is a little different. Multifamily class B and C properties are seeing vacancies rise and the cap rate increase about 50 basis points. 

Suburban landlords and developers should be aware that urban migrants will take with them their desire for urban amenities. Ultimately, urban tastes may help support suburban businesses like restaurants, which will also see support from a surge in demand for in-person dining as more of the U.S. population gets vaccinated.

Many industries, as we approach a return to normalcy, may be quite altered from how they looked pre-pandemic. Brick-and-mortar retailers will continue to give way to e-commerce, offices will need to be overhauled and locations across sectors will migrate from cities to more suburban locations. At the same time, those who previously could not afford urban real estate may seek to move to central business districts if the lease terms are right.

Real estate owners are not panicking. As the vaccine rollout continues and the light at the end of the pandemic tunnel eventually appears, deal making will pick up. With $300 billion of global available capital for real estate investment—much of which is aimed at North America, according to CBRE—willingness to sell at discounted prices will remain elusive.

CARES Act Loans and Distributions: Long-Term Impact On Retirement Savings

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The Coronavirus Aid, Relief and Economic Security (CARES) Act allowed plan sponsors to relax loan and distribution rules in 2020, giving participants greater access to funds during the pandemic. These provisions were implemented to provide relief as many employees do not have adequate short-term savings. Employee Benefit Research Institute (EBRI) has found that only one in five families has at least three months of liquid savings. Layoffs, furloughs and other circumstances caused by the pandemic have left many workers struggling financially, so naturally, many looked to their retirement accounts for relief. While this access has been a useful tool for many financially strained Americans, such loans and withdrawals could inflict long-term damage on their progress toward a successful retirement.
 
Employers have an important role to play in helping to ensure that the flexibility offered by the CARES Act is used to alleviate workers’ short-term financial strains while minimizing the impact on their overall retirement strategy. Employers can do their part by carefully communicating how these withdrawals affect the amount that will be available to use in retirement and providing resources to assist in developing strategies to recuperate those funds.
 

CARES Act Allows for Loans and Coronavirus-Related Distributions

Under the CARES Act, plan sponsors had the option to allow participants to take advantage of increased loans with delayed repayments or coronavirus-related distributions (CRDs) without an early withdrawal penalty. Participants are allowed – but not required – to pay back the distributions within three years. During 2020, employers determined whether they would allow those provisions to be adopted within their plans, and if so, the amounts in which employees could take.
 
Research from the Plan Sponsor Council of America (PSCA) found in the 4th quarter of 2020, 54% of plan sponsors adopted the provision to allow CRDs while 31% permitted an increase to the plan loan limit. When offered both the option of loans and CRDs under the CARES provisions, 54% of participants selected a CRD which would not require a repayment.
 
According to Vanguard, as of the end of 2020, only 5.7% of the participants offered the option to withdraw assets initiated a CRD. While the percentage of participants who selected this option is relatively low and is less than initially projected, the average distribution represented 55% of the participant’s total balance with one in four distributions accounting for nearly 100% of their account balance. These participants may now face hardship in beginning their retirement savings accounts back at square one.
 

Communicate Long-Term Impact in Real Terms

Plan sponsors who did adopt these provisions should help participants understand that loans and distributions from defined contribution plans can negatively affect retirement savings and help them build a strategy around getting back to where they were. Participants have a lot on their minds today; in addition to navigating the pandemic and work and childcare routines, many are also wrestling with financial issues like healthcare bills or mortgage payments. Providing educational resources can help show participants how they can rebuild savings and get back on track for retirement – including tangible examples of repayment schedules.
 
The Employee Benefit Research Institute (EBRI) created projections to show the impact of taking CRDs on employees’ retirement balances for various age groups. These projections assume that employees take the full $100,000 distribution (or their full vested amount if it is less than $100,000). The projections show how much an employee’s retirement account balance at age 65 is projected to decrease as a multiple of the employee’s projected annual compensation at age 65.
 
In one scenario projected by the EBRI, employees take the full CRD and pay it back over three years. EBRI found that doing so caused account balances upon reaching age 65 to decrease a median of 2.3 percent across all age groups. But the negative impact was more than twice as significant (5.8 percent) for employees who took the distribution between the ages 60 and 64.
 
In another scenario, employees take the full CRD but do not pay it back. EBRI found that doing so caused account balances upon reaching age 65 to decrease a median of 20 percent for all age groups. But the negative impact was a staggering 45 percent for employees between the ages of 60 and 64.
 

Insight: Help Participants See the Impact

Based on the PSCA research, as of November 2020, only 38% of organizations had communicated the impact of these loans and distributions to plan participants. Plan sponsors can help their employees by providing straightforward information about how accessing the funds now can affect their financial futures. This information should include reminding participants that the repayment of these CRDs within the three-year time period will allow participants to avoid paying income taxes on the related distributions.
 
Although participants may not have the resources to currently increase their deferral rate to help make up the funds distributed as the pandemic is ongoing, plan sponsors should continue to encourage those who took CRDs to set a plan to increase their contributions in the future. Once financially stable, these participants can benefit from putting a plan in action to increase their contributions to make up for the funds and related investment earnings lost during this time period.