The IRS has issued frequently asked questions (FAQs) on the payroll tax deferral opportunity provided by the Coronavirus, Aid, Relief, and Economic Security (CARES) Act (Public Law 116-136). Under that provision, employers of all sizes (including tax exempt/non-profit employers) can defer the deposit and payment of the employer’s share of Social Security taxes. Self-employed individuals can also defer payment of some self-employment taxes.
Background
To help employers conserve cash while retaining their workforce, Section 2302 of the CARES Act allows all employers to defer depositing the employer’s share of Social Security taxes for payments due from March 27 (CARES Act enactment date) through December 31, 2020. Generally, employers are required to deposit timely 6.2% of employee wages up to $137,700 (which is the 2020 Social Security wage base), along with 1.45% of Medicare (or “hospital insurance”) taxes (with no wage base cap). But Section 2302 of the CARES act allows employers to defer depositing the 6.2% of wages, interest-free and penalty-free. Payment of half of the amount deferred is due on December 31, 2021, and the remainder is due on December 31, 2022.
Insight
Employers’ 1.45% Medicare tax cannot be deferred under the CARES Act and must be deposited unless it is being used to offset payroll tax credits allowed under the CARES Act or the Family First Coronavirus Response Act.
There is no application form or approval procedure to use the payroll tax deposit deferral. Rather, employers simply do not remit the amount that would otherwise be due. IRS will update the Form 941 for the second quarter of 2020 to track the deferred deposits.
While not addressed by the IRS in the recent FAQs, it appears that an employer who paid their social security tax liabilities due on or after March 27 could take advantage of the full deferral amount allowed by recovering the previously paid, but not required, amounts from other 2020 federal tax deposits. Employers using third party payroll-providers should discuss system capabilities and procedures for taking advantage of the allowed deferral and the possibility of recovering any previously paid amounts that were eligible for deferral.
Coordination With PPP Loan Forgiveness
There was some confusion over whether employers who obtain a Paycheck Protection Program (PPP) Small Business Administration (SBA) loan could use the payroll tax deferral, since Section 2302 of the CARES Act states that employers who obtain forgiveness of a PPP loan may not defer deposit of payroll taxes. The FAQs clarify that employers who obtain PPP loans may defer deposit of payroll taxes until such time that the employer receives a decision from its lender that all or any portion of their PPP loan is forgiven.
Once loan forgiveness has occurred, the employer must resume timely payroll tax deposits. The FAQs confirm that the amount that was deferred through the date that the loan was forgiven will continue to be deferred. Accordingly, half of the deferred amount will be due on December 31, 2021, and the other half will be due on December 31, 2022.
Insight
To maximize the payroll tax deferral opportunity, employers with PPP loans may wish to consider delaying their request for PPP loan forgiveness until December 31, 2020. PPP loans are for two years, at 1% interest and do not require any payments during the first six months. Employers can request PPP loan forgiveness for qualified payroll costs and certain other expenses incurred during an eight-week period beginning on the date they receive the loan proceeds (lenders must disburse proceeds within 10 days after the loan is approved). Lenders generally have up to 60 days to consider the loan forgiveness. There does not appear to be any time limit for when an employer could submit its request for loan forgiveness, and many will wait until after June 30, 2020, to take advantage of provisions that maximize loan forgiveness.
For example, if an employer submits a request for loan forgiveness on July 15, 2020, the lender could forgive the loan anytime through September 15, 2020. Assume the loan is forgiven on August 15, the employer could no longer defer payroll taxes from August 15 through December 31, 2020. But if the employer does not request loan forgiveness until December 15 (and assuming the lender does not forgive the loan until early 2021), the employer could continue deferring payroll taxes through December 31, 2020.
COVID-19 is a new and evolving crisis, which has been labelled a pandemic by many countries and institutions, including the World Health Organization. The full impact of COVID-19 is yet to be determined, and to date has surprised most market observers how in a short period of time, it has wreaked havoc on the global economy as populations are ordered to stay home. As a result, business has ground to a halt in order to stop its spread. This has resulted in governments scrambling to provide stimulus packages hoping to revive their domestic economies.
The result of the above is that many entities across a wide variety of industries are facing extended closures, reduced access to customers, supply chain disruptions, difficulty collecting from customers and other counterparties, or other events that negatively affect operating cash flows and liquidity. The current uncertainty continues to evolve and will make it difficult for organizations to evaluate the impact on their ability to obtain, extend, or renew credit agreements, or they may experience a material adverse event, which could trigger debt to come due or other loan covenant violations. There is also uncertainty about access to other sources of capital and the ability to develop a reasonable forecast. These types of events will need to be considered in an entity’s going concern analysis.
Significant judgement will be required as no two entities fact patterns, even if operating in the same industry, will be the same, but at the end of the day it will come back to one central question, will the company have sufficient cash flows to meet their existing obligations and alleviate any conditions that raise substantial doubt about the ability to continue as a going concern. For both entities that have historically been profitable, have had ready access to liquidity, and no short-term obligations coming due, and those that are accustomed to evaluating going concern on a regular basis, the impacts of COVID-19 could create some significant challenges.
Financial Reporting Framework In accordance with ASC 205-40, in preparing financial statements for each annual and interim reporting period, management must evaluate whether there are conditions and events (e.g. COVID-19 crisis) that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued or available to be issued (when applicable), collectively referred to as “issued” throughout this document.
ASC 205-40 states that substantial doubt about an entity’s ability to continue as a going concern exists when in connection with preparing financial statements for each annual and interim reporting period, an entity’s management shall evaluate whether there are conditions and events, considered in the aggregate, that raise substantial doubt about an entity ’s ability to continue as a going concern within one year after the date that the financial statements are issued . T Therefore, management must evaluate whether it is likely that the entity will be unable to meet its obligations as they become due within the assessment period.
The following diagram illustrates how the two-step assessment is performed:
Step 1: Determine whether conditions and events raise substantial doubt Management’s evaluation of an entity’s ability to continue as a going concern typically is based on conditions and events that are relevant to an entity’s ability to meet its obligations as they become due within one year after the date that the financial statements are issued. The COVID-19 crisis provides new known and unknown factors for management to consider when making this evaluation.
Management’s evaluation is based only on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued, and should be approved by those with proper authority, which for most public companies, would be their Board of Directors, or a special committee of the Board of Directors. The term “reasonably knowable” is intended to emphasize that an entity may not readily know all conditions and events, but management should make a reasonable effort to identify conditions and events that can be identified without undue cost and effort.
When evaluating an entity’s ability to meet its obligations, management should consider information about the following:
The entity’s current financial condition, including its liquidity sources (e.g., available liquid funds, available access to credit) at the date the financial statements are issued
The entity’s conditional and unconditional obligations due or anticipated within one year after the date that the financial statements are issued, regardless of whether they are recognized in the entity’s financial statements
The funds necessary to maintain the entity’s operations considering its current financial condition, obligations and other expected cash flows within one year after the date that the financial statements are issued
Other conditions and events, when considered in conjunction with the items listed above, that may adversely affect the entity’s ability to meet its obligations within one year after the financial statements are issued
Examples of adverse conditions and events that may raise substantial doubt about an entity’s ability to continue as a going concern.
Negative financial trends such as recurring operating losses, working capital deficiencies, negative cash flows from operating activities and adverse key financial ratios
Other indications of possible financial difficulties such as defaults on loans or similar agreements, arrearages in dividends, denials of usual trade credit from suppliers, a need to restructure debt to avoid default, noncompliance with statutory capital requirements and a need to seek new sources or methods of financing or to dispose of substantial assets
Forecasted debt covenant violations during the 12-month period even if no violation has occurred
Internal matters such as work stoppages or other labor difficulties, substantial dependence on the success of a project, uneconomic long-term commitments and a need to significantly revise operations
Internal matters such as work stoppages or other labor difficulties, substantial dependence on the success of a project, uneconomic long-term commitments and a need to significantly revise operations
External matters such as legal proceedings, legislation or similar matters that might jeopardize the entity’s ability to operate; supply chain disruptions; loss of a key franchise, license or patent; no or reduced purchases by a principal customer, none or reduced quantities available for purchase from a supplier; and an uninsured or underinsured catastrophe such as a hurricane, tornado, earthquake or flood
Management must also consider the likelihood, magnitude and timing of the potential effects of any adverse conditions and events. This evaluation is required each reporting period.
Management’s evaluation of whether substantial doubt is raised (step 1) does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date that the financial statements are issued (step 2).
Step 2: Consider management’s plans if substantial doubt is raised If conditions or events indicate that substantial doubt is raised, management is required to evaluate whether its plans that are intended to mitigate those conditions and events will alleviate substantial doubt.
ASC 205-40 specifies that management may consider its plans only when both of the following criteria are met:
It is probable that those plans will be effectively implemented
It is probable that the plans will mitigate the relevant conditions and events within one year after the financial statements are issued
Management plans that do not meet these criteria cannot be considered in the evaluation of whether substantial doubt is alleviated. These criteria prevent management from placing undue reliance on the potential mitigating effect of plans that are not probable of being implemented or succeeding. In other words, if events and conditions make it probable that the entity will be unable to meet its obligations as they become due, plans to mitigate those conditions must be likely to succeed (i.e., management’s plans must be probable of both being implemented and mitigating the events and conditions).
The evaluation of the first criterion (i.e., whether it is probable that management’s plans will be effectively implemented) is based on the feasibility of implementation of management’s plans considering an entity’s facts and circumstances and whether they make sense in light of other publicly available information (i.e. a manufacturing company plan includes mothballing a plant to preserve cash, but they have recently disclosed to investors the plant is key to achieving expected cost synergies which have not been eliminated in management’s plan).
The evaluation of the second criterion (i.e., whether it is probable that management’s plans will mitigate the events and conditions that raised substantial doubt) should consider the expected magnitude and timing of the mitigating effect. For example, if management concludes that substantial doubt is alleviated by its plan to restructure debt, management’s evaluation of the restructuring must consider whether:
The revised debt agreement would be effective within one year of the issuance of the financial statements
The terms of the revised agreement (e.g., debt payment schedule, interest rate) alleviate the relevant conditions and events (e.g., inability to make debt payments) with respect to both the amount and timing of payments due under the revised agreement
That is, management must be able to conclude that it is probable that the debt will be restructured and that the entity will be able to make the payments under the new debt agreement and all other obligations that are due within the year following the date the financial statements are issued
ASC 205-40 states that a plan to meet an entity’s obligations as they become due through liquidation is not considered part of management’s plans to alleviate substantial doubt, even if liquidation is probable.
The following are examples of plans that management may implement to mitigate conditions or events that raise substantial doubt, including the types of information management should consider in evaluating the feasibility of the plans:
Plans to dispose of an asset or business:
Restrictions on disposal of an asset or business, such as covenants that limit those transactions in loan or similar agreements, or encumbrances against the asset or business
Marketability of the asset or business that management plans to sell
Possible direct or indirect effects of disposal of the asset or business
Plans to borrow money or restructure debt:
Availability and terms of new debt financing, or availability and terms of existing debt refinancing, such as term debt, lines of credit or arrangements for factoring receivables or sales and leasebacks of assets
Existing or committed arrangements to restructure or subordinate debt or to guarantee loans to the entity
Possible effects on management’s borrowing plans of existing restrictions on additional borrowing or the sufficiency of available collateral
Plans to reduce or delay expenditures:
Feasibility of plans to reduce overhead or administrative expenditures, to postpone maintenance or research and development projects, or to lease rather than purchase assets
Possible direct or indirect effects on the entity and its cash flows of reduced or delayed expenditures
Plans to increase ownership equity:
Feasibility of plans to increase ownership equity, including existing or committed arrangements to raise additional capital
Existing or committed arrangements to reduce current dividend requirements or to accelerate cash infusions from affiliates or other investors
Historically management may have a track record of successfully planning and executing on similar plans, such as a refinancing, restructuring or asset disposal, which in a normal operating environment would support the feasibility of the plan. In the current evolving economic environment, past history may not be sufficient to support the feasibility of the plan. If part of the plan is dependent on the performance of parties outside of management’s control, such as when COVID-19 will be contained, and business returns to normal, the ability to access financing or capital markets, the ability to close on a potential asset sale, and the proceeds of such actions are subject to negotiation. As a consequence, alleviating substantial doubt may prove challenging for some companies. The preparation of multiple sensitivity analyses based on a variety of assumptions may be required to appropriately assess the probability of results in multiple market conditions. Management should also ensure that these assumptions are kept consistent with other areas of the financial statements, such as those used for estimates and impairments.
Disclosure requirements
The disclosures required by ASC 205-40 may overlap with those required by other areas within US GAAP. The FASB acknowledged this possibility but concluded that providing guidance in US GAAP about management’s responsibility to evaluate and disclose conditions and events that raise substantial doubt would improve financial reporting for all entities. As a general rule, regardless of whether substantial doubt is alleviated or not, the disclosure is very robust to help the reader understand management’s plans and the key components thereof, along with a general statement that there can be no assurance that management’s plans will be achieved.
Substantial doubt is raised and is not alleviated by management’s plans (substantial doubt exists) If substantial doubt is raised and is not alleviated by management’s plans, an entity is required to include a statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern. The entity also is required to disclose information that enables users of the financial statements to understand all the following:
Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
Substantial doubt was raised but was alleviated by management’s plans (substantial doubt was alleviated) If, after management’s plans are considered, substantial doubt about an entity’s ability to continue as a going concern is alleviated, an entity is required to disclose information that enables users of the financial statements to understand all the following:
Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern
Ongoing disclosure requirements An entity must include disclosures related to uncertainty about its ability to continue as a going concern in the notes to the financial statements until the conditions or events giving rise to the uncertainty are resolved. As the conditions or events giving rise to the uncertainty and management’s plans to alleviate them change over time, the disclosures should change to provide users with the most current information, including information about how the uncertainty is resolved.
Internal control over financial reporting
Management needs to evaluate whether it has adequate processes and internal controls in place to comply with the going concern evaluation requirements. Management will likely need to change its current processes and controls or implement new processes and controls to account for the impact, which could vary greatly by industry, as the COVID-19 crisis is a unique and unprecedented event. It may be necessary for management to maintain multiple 12-month rolling cash flow projections reflecting a number of different scenarios.
For example, management will need to evaluate whether it can appropriately identify conditions for its industry (e.g., critical supply shortages, ability to capture critical data remotely, cybersecurity for remote workforce, reduction in demand from significant customers, etc.) and events that raise substantial doubt. The going concern standard requires management to make a reasonable effort to identify these conditions and events. Management will need to determine whether it can do this assessment using its current processes and controls or whether it needs to modify its processes and controls or implement new ones. All significant elements of management’s evaluation of the going concern assessment, including the reviews and approval thereof, should also be subject to the entity’s control environment.
Management’s processes and controls should also address the risk that the going concern assessment could be based on incomplete or inaccurate information about conditions and events that could raise substantial doubt. In the current COVID-19 environment, the going concern evaluation could be a significant undertaking for management and given the rate of change in these factors needs to be updated frequently up to and including the date of issuance if applicable.
Key Takeaways
The ultimate impact of COVID-19 is currently unknown, but it is already having a pervasive impact on the global economy as most market commentators believe we have entered a global recession. This will put more pressure on each entity’s going concern assessment and having a robust process in place to identify and adjust to the evolving COVID-19 landscape will be critical.
How companies should plan to return to work and emerge from COVID-19 stronger and smarter.
As the response to the COVID-19 pandemic progresses, many companies have established operational crisis management teams and adjusted to global restrictions on work and movement. Executives are now beginning to ask the question: How are we going to return to work?
As of April 2020, some countries are starting to ease restrictions, allowing for more freedom of movement and the reopening of specific industries. In the United States, The White House has announced guidelines for re-opening the nation in a three phased approach. These guidelines include thresholds for states to satisfy in the following areas: trajectory of reported symptoms; trajectory of reported cases; and ability for hospitals to care for patients and provide ongoing testing.
Additionally, multiple groups of governors have formed regional coalitions to coordinate reopening their states in a unified way. While it is challenging to predict when each country and U.S. state will begin to return to the workplace, many predictions point toward restrictions being lifted gradually over the next few months, depending on your location.
Regardless of precisely how governments decide to ease their restrictions, companies need to plan for an orderly and thoughtful approach to returning to work. There are three crucial steps to accomplishing this:
Build a return-to-work plan.
Work through the stages of partial and full operations.
Increase resilience through monitoring for possible virus resurgence, completion of after-action reports, and program enhancements.
By doing this carefully and methodically, businesses can begin the process of restoring operations while also ensuring that they do not take one step forward and two steps backward in returning to work.
Build a return-to-work plan
Companies first need to consider the structure in which a return-to-work plan will be created. That structure will need to include identifying stakeholders; outlining authorities and decision trees; defining critical information requirements; identifying assumptions and variables; and, of course, creating detailed execution checklists for individual business units.
It’s essential to examine each part of the return-to-work program in detail:
Identifying stakeholders: Most of the critical stakeholders may already be members of the Crisis Management Team. Members should include representatives from major business units and support functions.
Outlining authorities and decision trees: As your company prepares to make return-to-work decisions, it is important that a decision tree is outlined in advance and that the company agrees on who has the authorities to make those decisions. At a minimum, a company will need to answer three basic questions before returning to work. Those questions are:
Can we do it? Is physical access possible through government easing of restrictions or landlord policies?
Should we do it? Is it safe for staff to commute to and occupy a given work site? Additionally, are there supplemental government restrictions like the required use of personal protective equipment (PPE) that the company must provide for occupants?
How will we do it? Who within the company makes the final decision to open a work site, and what are the steps (checklist items) the business units will need to follow?
Defining indicators: Sometimes referred to as triggers or critical information requirements, these indicators will likely come in the form of the lifting of government orders or easement of agency (e.g., Centers for Disease Control and Prevention, World Health Organization) guidance. This type of information will indicate a country, state, city, or region is ready to begin the process for considering reopening non-essential work sites.
Identifying variables: Any lifting of work and movement restrictions will likely occur in a phased approach. Governments and agencies will closely monitor infection cases and use that information to determine next steps to further ease restrictions or revert to prior levels. Some of the variables companies will need to consider are:
Countries will only begin to ease work and movement restrictions when they see consistent reductions in new infections and are comfortable that they have available medical capabilities and hospital beds to handle any potential resurgence.
In the U.S., individual states will start to return to work in segments (coastal states first with interior states to follow). Additionally, state governors are likely to extend restrictions beyond federal government deadlines due to the differences in when peak infection cases are reached.
Restrictions are likely to remain in the workplace, and it is possible to see government orders that could require a reduction of in-person workforce by half, staggered work schedules, or some other measures to keep occupancy low while the effects of returning to work are measured in any potential new infection cases.
Guidance or government orders may include parameters around which segments of the population can work first (e.g., low-risk and immune persons may be allowed to return first, while higher-risk populations will be required to remain at home).
Some governments are requiring PPE for employees (e.g., China, France, and, in the U.S., New Jersey, New York, and some counties in California and Florida). In these cases, companies will need to prepare for and provide the required equipment before staff are allowed back into the work site. Lead times for this equipment can be very long, so advanced planning is required.
Manufacturing and pharmaceutical equipment may require re-calibration and, in some cases, re-certification by the Food and Drug Administration (or local equivalent). Lead times for these processes could extend many weeks or months.
Finally, companies will need to determine what other government regulations are required of them prior to opening a work site. For example, in Alameda County, California, there is currently a regulation requiring employers to post notifications to the buildings informing staff of the potential dangers that may still exist.
Creating detailed execution checklists: For individual business units, both business unit and support function checklists will need to be created to help ensure proper steps are completed prior to staff returning to a work site. Additionally, critical third parties must be accounted for when preparing to return to work.
Working through the four stages
A return-to-work plan should account for four main stages and allow for a clear roadmap in moving from a (1) current state, to a (2) partial or limited opening, to a (3) full resumption of operations at capacity. The fourth stage accounts for the need to continue to monitor for virus resurgence. This allows for a diagnosis of how the company performed during the crisis and how it will improve going forward.
The situation, objectives, indicators, and actions should be clearly defined for each of the four stages that a company expects to move through during the return-to-work process. Those elements are detailed as follows:
Situation – Parameters are established to help define the given stage. This is especially helpful in determining when a company can begin to move from the partial opening to the full opening stage.
Objectives – A company articulates what is most important in each stage. It could be maintaining cash flow, re-establishing connections with clients and customers, re-evaluating supply chains, or completing a look back at the event with an eye toward future maturity.
Indicators – This information is gathered from both government orders and agency guidance. It informs the company what is or is not allowed from a movement, work, or health and safety perspective.
Actions – Finally, companies should outline how they will act within each stage. This may take the form of specific actions related to People, Process, and Technology.
The final stage of the return-to-work plan is to monitor and prepare. Here it is incumbent on companies to continue to monitor for any resurgence in the virus, identify changes to government restrictions and agency guidance, and better prepare the company to be more resilient toward future disruptions. This is also the stage where companies should do a “look back” to evaluate if any controls were relaxed during the work-from-home period.
There is growing concern among academics that a second wave of virus infection cases may occur later this year. Given that possibility, companies should take full advantage of the expected break over the summer and early fall months to begin to perform after-action reports and outline a plan for improvements. Those in highly regulated industries (e.g., Financial Services, Pharmaceutical) should further prepare for regulatory inquiries on how they are planning to address gaps. Regardless of industry, it is always better to show the Board and regulators (if any) that gaps have been self-identified, remediation programs outlined, and resources allocated.
This will also be the time for companies to build a consolidated operational resiliency function. In this environment, resiliency components are no longer siloed but are integrated and provide end-to-end recoverability regardless of the next business interruption.
Conclusion
As companies continue to navigate these uncharted waters, it is essential to understand that business may fundamentally change when we come out of this. A return to “business as usual” may also be a return to a new normal where we re-evaluate how we work, where we work, how we interact with customers, and where our products are made. Supply chains and concentration risks will be reassessed, and executives will begin to evaluate outsourcing and the use of low-cost locations with more of a risk lens and not merely a cost-cutting lens.
Like every systemic shock to the economy, winners and losers will emerge. One need only look to the long list of defunct internet companies from the late 1990s or the more recent list of white-heeled boutique banks that didn’t make it out of the 2008 financial crisis. In most cases, the firms that emerged had strong risk management programs and decisive leaders who executed on clearly defined recovery plans.
That is why now is the time for companies to begin working on the following three return-to-work steps:
Build a return-to-work plan.
Work through the stages of partial and full operations.
Increase resilience through monitoring for possible virus resurgence, completion of after-action reports, and program enhancements.
