IRS Clarifies Employee Retention Credit with Issuance of Frequently Asked Questions

As we have previously reported, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”) was enacted on March 27, 2020.  It is a $2 trillion piece of legislation intended to address the devastating impact of the coronavirus (COVID-19) pandemic. 

One of the many tax provisions contained in the Act is an employee retention credit (the “Credit”), designed to encourage employers to keep employees on their payrolls despite the economic hardship related to COVID-19.  The IRS has issued a set of Frequently Asked Questions (“FAQs”) to provide additional clarification and guidance to the statutory language. 

At the outset, given the extraordinary interest in the Paycheck Protection Program loans that are provided for in the Act, please note that employers with such loans will not be eligible for the Credit.

What Is the Employee Retention Credit?

• The Credit is a fully refundable tax credit for employers equal to 50% of “qualified wages” (including allocable qualified health plan expenses) that “eligible employers” pay their employees in a calendar quarter. The credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000; the maximum Credit for an eligible employer for qualified wages paid to any employee is $5,000.
• Eligible employers are those that carry on a trade or business during calendar year 2020, including a tax-exempt organization, that either
  • “Fully or partially suspends operation” during any 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
  • Experiences a “significant decline in gross receipts” during the calendar quarter.
• Governmental employers are not eligible employers. Further, self-employed individuals are not eligible for the Credit for their self-employment services or earnings.
• The operation of a trade or business may be “partially suspended” if an appropriate governmental authority imposes restrictions, as noted above, such that operations can still continue to operate BUT not at its normal capacity.
  Example:  A state governor issues an executive order closing restaurants, bars and similar establishments to reduce the spread of COVID-19, but the order allows those establishments to continue food or business sales to the public on a carry-out, drive-through, or delivery basis.  This results in a partial suspension of the operations of the trade or business due to an order of an appropriate governmental authority with respect to any restaurants, bars and similar facilities that provided full sit-down service, a dining room, or other on-site eating facilities for customers prior to the executive order.
• “A significant decline in gross receipts” begins with the first quarter in which an employer’s gross receipts for a calendar quarter in 2020 are less than 50% of its gross receipts for the same calendar quarter in 2019. The significant decline in gross receipts ends with the first calendar quarter that follows the first calendar quarter for which the employer’s 2020 gross receipts for the quarter are greater than 80% of its gross receipts for the same calendar quarter during 2019.
• The definition of qualified wages depends, in part, on the average number of “full-time” employees employed by an eligible employer during 2019. (A full-time employee means, with respect to any month, an employee who is employed on average at least 30 hours of service per week.)  If the eligible employer averaged more than 100 full-time employee in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services due to either (1) a full or partial suspension of operations by order of a governmental authority due to COVID-19 or (2) a significant decline in gross receipts.  In this case, qualified wages taken into account for an employee may not exceed what the employee would have been paid for working an equivalent amount of time during the 30 days immediately preceding the period of economic hardship.  On the other hand, if the eligible employer averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during any period of economic hardship described in (1) and (2) above.
• The Act does not require employers to pay qualified wages. In addition, eligible employers may elect not to claim the Credit.  Note, however, that federal law does require certain employers to pay sick or family leave wages to employees unable to work or telework as a result of COVID-19.
• Eligible employers may claim the Credit for qualified wages paid as early as March 13, 2020, and before January 1, 2021.

Applying the Credit

• The Credit is allowed against the employer portion of social security taxes (IRC Sec. 3111(a)).
• The Credit is described as “fully refundable” because an eligible employer may get a refund if the amount of the Credit is more than certain federal employment taxes the eligible employer owes. If for any calendar quarter the amount of the Credit the eligible employer is entitled to exceeds the employer portion of the social security tax on all wages paid to all employees, then the excess is treated as an overpayment and refunded to the employer.  The excess will be applied to offset any remaining tax liability on the employment tax return, and the amount of any remaining excess is reflected as an overpayment on the return.  The FAQs point out that, like other overpayments of federal taxes, the overpayment is subject to offset against any liability in respect of any internal revenue tax owed by the person who made the overpayment.

Claiming the Credit

• Eligible employers report their total qualified wages and related credits for each calendar quarter on their federal employment returns (usually IRS Form 941, “Employer’s Quarterly Federal Tax Return”). Form 941 is used to report income and social security and Medicare taxes withheld by the employer from employee wages, as well as the employer’s portion of social security and Medicare tax.

Funding Wages and the Credit

• An eligible employer may fund the qualified wages by accessing federal employment taxes, including those already withheld, that are set aside for deposit with the IRS, for other wage payments made during the same quarter as the qualified wages. In other words, an eligible employer that pays qualified wages to an employee in a calendar quarter before it is required to deposit federal employment taxes with the IRS for that quarter may reduce the amount of federal employment taxes it deposits for that quarter by 50% of the qualified wages paid in that calendar quarter.  The eligible employer must account for the reduction in deposits on Form 941 for the quarter.
• An eligible employer will not be subject to penalty (IRC Sec. 6656) for failing to deposit federal employment taxes relating to qualified wages in a calendar quarter if –
  • The eligible employer paid quarterly wages to its employees in the calendar quarter before the required deposit;
  • The amount of federal employment taxes that the eligible employer does not timely deposit, reduced by any amount of federal employment taxes not deposited in anticipation of paid sick or family leave credits , is less than or equal to the amount of the eligible employer’s anticipated Credit for the qualified wages for the calendar quarter as of the time of the required deposit; and
  • The eligible employer did not seek payment of an advance credit by filing Form 7200 (“Advance Payment of Employer Credits Due to COVID-19,” noted below) with the IRS with respect to any portion of the anticipated Credits it relied upon to reduce its deposits.

Advancing the Credit

• As noted in the FAQs, since quarterly returns are not filed until after qualified wages are paid, some eligible employers may not have sufficient federal employment taxes set aside for deposit to the IRS to fund qualified wages. Following is a procedure established by the IRS for obtaining an advance of the Credits --
  • The eligible employer should first reduce its remaining federal employment tax deposits for wages paid in the same calendar quarter by the maximum allowable amount.
  • If the anticipated Credit for the qualified wages exceeds the remaining federal employment tax deposits for that quarter, the eligible employer can file Form 7200 to claim an advance refund for the full amount of the anticipated credit for which it did not have sufficient federal employment tax deposits.
  • If it files Form 7200, it will need to reconcile this advance Credit and its deposits on Form 941 (or other applicable federal employment tax return), and it may have an underpayment of federal employment taxes for the quarter.
  • The eligible employer should not file Form 7200 if it fully reduces its required deposits of federal employment taxes otherwise due on wages paid in the same calendar quarter to its employees in anticipation of receiving the Credits, and it has not paid qualified wages in excess of that amount.
    Example: Eligible employer paid $20,000 in qualified wages to employees and is therefore entitled to a Credit of $10,000.  It is otherwise required to deposit $8,000 in federal employment taxes, including taxes withheld from all of its employees, on wages paid during the same calendar quarter.  Assume that the eligible employer has no paid sick or family leave credits.  The eligible employer can keep the $8,000 of taxes that the eligible employer was otherwise required to deposit without penalties as a portion of the Credit it is otherwise entitled to claim on Form 941.  The eligible employer may file Form 7200 requesting an advance Credit for the remaining $2,000.

Multiple Credits/Tax Benefits

• An eligible employer can receive both tax credits for qualified sick and family leave wages and the Credit. The amount of qualified wages for which an eligible employer may claim the Credit explicitly does not include the credit for qualified sick and family leave wages.
• As previous noted, an eligible employer may not receive the Credit if it receives a Paycheck Protection Program loan.

EisnerAmper will continue to keep you up to date on relevant new developments regarding the tax implications of the coronavirus pandemic.