Employee Retention Credit: IRS & Treasury Guidance on the CARES Act (Coronavirus and the Law)

In response to the COVID-19 pandemic, the federal government enacted laws designed to relieve the payroll tax burden on employers. Eligible employers may be entitled to refundable tax credits under both the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).

We previously provided extensive coverage of the eligibility under the FFCRA for the refundable tax credits against payroll tax attributable to paid sick leave.

This article discusses the refundable tax credit against general payroll taxes available under the CARES Act, known as the Employee Retention Credit (the “Credit”). The IRS and the Treasury Department issued their guidance on March 31, 2020.

[clear]How to Determine Eligibility

An important note: If an employer is applying for one of the SBA loans under the Paycheck Protection Program (PPP), it will not be eligible for the Credit. We previously provided details on the SBA PPP loans. An employer should weigh the benefits and limitations of the Credit against that of the PPP small business loan.

Other requirements:

1. The Credit is not available for state and local governments or their instrumentalities. Tax-exempt employers are otherwise eligible.
2. It is available to employers of any size, whether above or below 500 employees. As explained below, however, an employer with fewer than 100 employees is able to take greater advantage of the Credit.
3. The employer must meet one of the following two tests:
   1. The employer’s business is fully or partially suspended by a government order due to COVID-19 during the calendar quarter for which the credit is claimed. The IRS states that a partial suspension means an organization can continue to operate but not at its normal capacity including for commercial, social, religious, or other purposes,
      or
   2. The employer’s gross receipts are below 50% of the comparable quarter in 2019. An employer qualifying under this test will remain eligible for the Credit until gross receipts exceed 80% of a comparable quarter in 2019 in which case the employer will no longer qualify after the end of that quarter.

How to Determine the Amount of the Credit

The Credit is equal to 50% of qualified wages paid to employees after March 12, 2020, and before January 1, 2021. Qualified wages are “wages” under §3121(a) of the Internal Revenue Code (IRC) and “compensation” under §3231(e) of the IRC. There are three key limitations on the Credit.

1. The employer is limited to a maximum of $10,000 in qualified wages for each employee for the total of all calendar quarters. Therefore, assuming full eligibility otherwise, an employer potentially could receive up to $5,000 in Credits for each employee over the span of the program.
2. For employers with more than 100 employees, qualified wages are limited to wages paid to those employees who did not work during the calendar quarter due to a government order or economic hardship related to COVID-19.
3. Finally, the amount of qualified wages for which an employer may claim the Credit does not include the amount of qualified sick and family leave wages for which the employer received tax credits under the FFCRA.

Examples Provided by the IRS:

1. Eligible Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to Eligible Employer for Employee A is $5,000.
2. Eligible Employer pays Employee B $8,000 in qualified wages in Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to Eligible Employer for Employee B is equal to $4,000 in Q2 and $1,000 in Q3 due to the overall limit of $10,000 on qualified wages per employee for all calendar quarters.

When and How to Claim the Credit?

Employers will report their total qualified wages and the related credits for each calendar quarter on their federal employment tax returns, namely, Form 941. The IRS stated that since Form 941 is not filed until after wages are paid, some employers may not have sufficient employment taxes set aside for deposit to the IRS to fund the qualified wages.

Therefore, the IRS established a procedure for obtaining an advance of the refundable credits:

• The 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 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.

Finally, the IRS advises that, if an employer fully reduces its required deposits of federal employment taxes in anticipation of receiving the credits, and it has not paid qualified wages in excess of this amount, it should not file Form 7200. If it files Form 7200, it will need to reconcile this advance credit and its deposits with the qualified wages on Form 941, and it may have an underpayment of federal employment taxes for the quarter.

The CARES Act added another layer of complexity to calculating and paying federal payroll tax. The Woods Rogers Tax practice group is ready to guide you through this challenging time.