The government has provided guidance to employers on various aspects of the new employee retention credit program to aid struggling companies facing economic emergencies, including dipping into employment tax funds.
The FAQ released by the IRS on March 31 explains in detail the employee retention credit created under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), signed into law March 27. In the guidance, the IRS explains how the credit is applied generally and addresses its application to other coronavirus provisions.
The CARES Act also added the Paycheck Protection Program, which will provide loans to small businesses that want to keep paying employees during the downturn.
The loans will be forgiven as long as the proceeds cover payroll costs and some interest, rent, and utility payments during the eight-week period after the loan is made, and granted employee and compensation levels are maintained. Under the loan program, payroll costs are capped at $100,000 annually for each employee, and it’s likely that no more than 25 percent of the forgiven loan may be for non-payroll costs, according to a Treasury Department post.
If an employer uses the loan program, it can’t take advantage of the employee retention credit program.
Under an earlier coronavirus bill, the Families First Coronavirus Response Act (FFCRA) (P.L. 116-27), some employers are required to pay sick or family leave wages to employees who can’t work because of circumstances stemming from the coronavirus. Those employers can receive a refundable credit for portions of the required leave pay up to specific limits, and the wages for that credit can’t be counted for the employee retention credit.
Employers must determine whether the payroll loan program or the employee retention credit program is more beneficial. If an employer chooses the retention credit program, it must make sure it isn't counting the FFCRA sick or family leave wages for the retention credit.
Anthony J. Nitti of RubinBrown LLP said on a March 31 webcast that he thinks most employers will opt for the loan program over the employee retention credit program.
Louis Vlahos of Farrell Fritz PC agreed. “You’ve got a choice between the two, and folks really are clamoring for the loan,” he said.
Step-by-Step Approach
Obtaining the employee retention credit requires taxpayers and practitioners to go through the statute and IRS guidance methodically to see if employers qualify.
The credit is equal to 50 percent of qualified wages paid by eligible employers to employees from March 12, 2020, to January 1, 2021. The credit is fully refundable, and the maximum amount of wages applicable for each employee for all calendar quarters is $10,000. That means the maximum employer credit is $5,000 per employee.
An eligible employer for the credit must carry on a trade or business during calendar year 2020 and either completely or partially suspend operations in any calendar quarter of 2020 because of government orders limiting commerce, travel, or group meetings, or the employer must have a significant decline in gross receipts during the calendar quarter.
A “significant decline in gross receipts” starts in the first quarter in which an employer’s gross receipts are less than 50 percent of the company’s gross receipts for the same quarter in 2019. The decline ends with the first quarter in which the employer’s gross receipts are greater than 80 percent of its gross receipts for the same quarter in 2019.
Practitioners also must determine what constitutes qualified wages for the credit. If an employer has more than 100 full-time employees, qualified wages are those paid to employees for the time they aren’t providing services because of a full or partial suspension of operations by governmental authority or when there is a significant decline in receipts. For employers that averaged 100 or fewer employees in 2019, qualified wages are those paid to any employee in the economic hardship described above, but regardless of whether the employees are providing services.
The credit is against payroll taxes, so it applies to the employer’s share of the 6.2 percent Social Security tax, Nitti said.
Nitti laid out an example to show how the credit works in practice.
Company X was in business for all of 2020, and in the second quarter it had to close operations and send its six employees home. Each employee was paid $6,000 for that quarter, totaling $36,000 in wages.
In the third quarter of 2020, the business reopened its doors, but its gross receipts were only 30 percent of what they were in the third quarter of 2019 — a significant decline under the rules. However, in the third quarter, the six employees were paid only $5,000 each, or $30,000 total. In the fourth quarter, the gross receipts increased to over 80 percent of the previous year’s fourth-quarter receipts, so there was no significant decline.
Here’s the result: Because the company had fewer than 100 employees, it can count wages paid to its six employees in both the second and third quarters of 2020 of up to $10,000 per employee. The total wages paid in the second quarter were $36,000, so the credit is 50 percent of that amount, or $18,000. The employer’s portion of Social Security taxes was $2,232 ($36,000 wages paid multiplied by 6.2 percent). After subtracting the Social Security liability amount from the credit ($18,000 minus $2,232), Company X gets a refund of $15,768.
However, for the third quarter, the outcome is a little different, Nitti explained. The six employees each received wages of $6,000 for the second quarter, but because wages are capped at $10,000 per employee, there is only $4,000 left per employee for the third quarter. The employer would multiply $4,000 by its number of employees, which equals $24,000. The credit would be $12,000, and the Social Security tax for that quarter would be $1,860, so Company X would get a refund of $10,140, Nitti said.
Getting It Upfront
The IRS FAQ made it clear that an eligible employer can fund the qualified wages by accessing employment taxes, even those the employer has already withheld and are set aside for deposit with the agency.
“That is, an Eligible Employer that pays qualified wages to its employees 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 half of the amount of the qualified wages paid in that calendar quarter,” the IRS explained. “The Eligible Employer must account for the reduction in deposits on the Form 941, Employer's Quarterly Federal Tax Return, for the quarter.”
The IRS also said employers can get an advance of the credits if they don’t have sufficient federal employment taxes set aside to cover those payments.
“Because 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 their qualified wages,” according to the FAQ. “Accordingly, the IRS has established a procedure for obtaining an advance of the refundable credits.”