May 13th Update:
The IRS had issued previous guidance stating that companies which were not paying wages but were paying health benefits for unpaid, furloughed workers were not entitled to the benefits under the Employee Retention Credit. The tax credit is worth up to $5,000 calculated as 50% of wages and health benefits up to $10,000 per employee.
After substantial pressure from industry groups, as well as lawmakers, on May 7th, the IRS revised the frequently asked questions to include an example that allows employers to claim the credit for benefits, even if wages were not being paid. Many employers are paying benefits to keep employees’ health coverage and to allow a more seamless return to employment for those workers, particularly in the hospitality and restaurant industries.
There have been complaints about Treasury overreaching the intent of the CARES ACT in several areas, including the “credit elsewhere” test. The CARES ACT specifically waives the “credit elsewhere test” (as defined in Section 3(h) of the Small Business Act, and recent IRS guidance indicates that the applicant must take into account the “ability to access other sources of liquidity sufficient to support…ongoing operation in a manner that is not significantly detrimental to the business.” A lawsuit was filed on May 4, 2020, against Mnuchin and Treasury, as well as the SBA and its administrator, Jovita Carranza. The lawsuit, filed by three privately held tech companies, was filed in U.S. District Court, Central District of California. It is seeking an injunction to stop the U.S. Treasury and SBA from making determinations based upon guidance in the FAQs, as well as a declaration of federal court that the FAQs 31 and 37 are unlawful and must be withdrawn.
These two incidents, among others, continue to demonstrate the uncertainty which businesses face in dealing with the new provisions the primary purpose of which was to assist businesses.
The administration also provided additional FAQs related to the PPP program. The latest specifically allows an employer who returns the PPP funds by the May 14 deadline to be treated as though the employer had not received a covered loan under the PPP for purposes of the Employee Retention Credit. Therefore, the employer will be eligible for the credit if the employer is otherwise an eligible employer for purposes of the credit.
Any PPP borrowers should be preparing a projected forgiveness calculation. While many employers do not know who, or how many employees, will be coming back to work, some attempt should be made at a calculation of the tax credit versus PPP forgiveness. If, for example, you know you will have 20 employees earning at least $10,000 by the end of the year, and that your credit will be $100,000, this should be compared to the PPP which will be forgiven. Also, any employer who is concerned with the lack of guidance, as well as the uncertainty of the PPP calculations, should consider if the Employee Retention Credit is a better solution for their business. But do note that you cannot do both, and there is a narrow window to return the PPP money (May 14th) and then utilize the Employee Retention Credit.
What is the Employee Retention Credit?
The credit is a refundable payroll tax credit available in 2020, equal to 50% of the qualified wages for each employee, and capping out at a maximum of $5,000 credit per employee for the year. It designed as a catch-all to provide relief for employers who were not able to get help under other relief provisions. One key difference for the Employee Retention Credit from many other stimulus programs is that it is available to businesses regardless of size.
It has significant interaction with other credit and relief provisions as follows:
- If an employer receives a Small Business Interruption Loan under the Paycheck Protection Program (PPP), authorized under the CARES Act, then the employer is not eligible for the Employee Retention Credit.
- Wages for this credit do not include wages for which the employer received a tax credit for paid sick and family leave under the Families First Coronavirus Response Act.
- Wages counted for this credit can’t be counted for the credit for paid family and medical leave under section 45S of the Internal Revenue Code.
- Employees are not counted for this credit if the employer is allowed a Work Opportunity Tax Credit under section 51 of the Internal Revenue Code for the employee.
Who can take the credit?
The credit is available to two kinds of employers (including nonprofits):
- Those whose operations have been fully or partially suspended as the result of a government order related to COVID-19
- Those whose businesses are experiencing ‘a significant decline in gross receipts’.
- A significant decline in gross receipts begins on the first day of the first calendar quarter of 2020 for which an employer’s gross receipts are less than 50% of its gross receipts for the same calendar quarter in 2019.
- The significant decline in gross receipts ends on the first day of the first calendar quarter following the calendar quarter in which gross receipts are more than of 80% of its gross receipts for the same calendar quarter in 2019.
How is the credit calculated?
The credit is calculated as 50% of the employer’s Qualified Wages. Only wages paid between March 12, 2020 and December 31, 2020 can be qualified wages. The maximum amount of qualified wages taken into account with respect to each employee for all calendar quarters is $10,000, so that the maximum credit for qualified wages paid to any employee is $5,000.
Example 1: Eligible Employer pays $10,000 in qualified wages to Employee A in the second quarter 2020. The Employee Retention Credit available to the Eligible Employer for the qualified wages paid to Employee A is $5,000.
Example 2: Eligible Employer pays Employee B $8,000 in qualified wages in the second quarter 2020 and $8,000 in qualified wages in third quarter 2020. The credit available to the Eligible Employer for the qualified wages paid to Employee B is equal to $4,000 in second quarter and $1,000 in third quarter due to the overall limit of $10,000 on qualified wages per employee for all calendar quarters.
The definition of qualified wages will depend on how many employees an eligible employer has.
- If an employer averaged more than 100 full-time employees during 2019, qualified wages are those wages, including certain health care costs, paid to employees who are not providing services because operations were suspended or due to the decline in gross receipts. These employers can only count wages up to the amount that the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
- If an employer averaged 100 or fewer full-time employees during 2019, qualified wages are those wages, including health care costs, paid to any employee during the period operations were suspended or the period of the decline in gross receipts, regardless of whether or not its employees are providing services.
How do businesses claim the credit?
Eligible Employers will report their total qualified wages and the related credits for each calendar quarter on their federal employment tax returns, usually Form 941, Employer’s Quarterly Federal Tax Return. The Employee Retention Credit will then reduce the payroll taxes due dollar for dollar, with any excess being treated as an overpayment and refunded to the employer. Employers are permitted to access this credit in one of three ways.
- The employer may pay its payroll taxes in full, wait until its 941 is filed, and await a refund from the IRS of the overpaid taxes. This is the slowest method of getting the credit.
- The employer can fund qualified wages by accessing federal employment taxes, including withheld taxes which are required to be deposited with the IRS. In essence, the employer is permitted to reduce its 941 deposits to claim the credit with no penalties.
For Example: An Eligible Employer paid $10,000 in qualified wages (including qualified health plan expenses) and is therefore entitled to a $5,000 credit, and is otherwise required to deposit $8,000 in federal employment taxes, including taxes withheld from all of its employees, for wage payments made during the same quarter as the $10,000 in qualified wages. The Eligible Employer has no paid sick or family leave credits under the FFCRA. The Eligible Employer may keep up to $5,000 of the $8,000 of taxes the Eligible Employer was going to deposit, and it will not owe a penalty for keeping the $5,000. The Eligible Employer is required to deposit only the remaining $3,000 on its required deposit date. The Eligible Employer will later account for the $5,000 it retained when it files Form 941, Employer’s Quarterly Federal Tax Return, for the quarter.
- Finally, if the employer had already made significant payroll tax deposits and the anticipated credit for the qualified wages exceeds the remaining federal employment tax deposits for that quarter, the Eligible Employer can file a Form 7200, Advance Payment of Employer Credits Due to COVID-19, to claim an advance refund for the full amount of the anticipated credit for which it did not have sufficient federal employment tax deposits.
For Example: An Eligible Employer paid $20,000 in qualified wages, and is therefore entitled to a credit of $10,000, and is otherwise required to deposit $8,000 in federal employment taxes, including taxes withheld from all of its employees, on wage payments made during the same calendar quarter. The Eligible Employer has no paid sick or family leave credits under the FFCRA. The Eligible Employer can keep the entire $8,000 of taxes that the Eligible Employer was otherwise required to deposit without penalties as a portion of the credits it is otherwise entitled to claim on the Form 941. The Eligible Employer may file a request for an advance credit for the remaining $2,000 by completing Form 7200.
Contact your Blue & Co. advisor if you would like assistance with the comparative analysis of the Employer Retention Credit.