Internal Revenue Service guidance on various aspects of the recently passed economic stimulus bills continues to be released on a fast and furious pace. The most recent release, Notice IR-2020-62, adds clarification to the Employee Retention Credit (ERC) included in the Coronavirus Aid, Relief and Economic Security (CARES) Act, enacted on March 27, 2020. This very important credit is intended to provide immediate economic relief for qualifying companies.
The purpose of the provision is to encourage eligible employers to keep employees on their payrolls, despite experiencing economic hardship related to the COVID-19 pandemic. On March 31, 2020, the Treasury Department and the Internal Revenue Service “launched” the Employee Retention Credit.
This fully refundable tax credit is equal to 50% of qualified wages to paid to employees by an Eligible Employer whose business has been financially impacted by COVID-19. This 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, so that the maximum credit for an Eligible Employer for qualified wages paid to any employee is $5,000.
Many details about the main points of the provision are included below. Additional information can be found on the IRS Employer Retention Credit FAQs page.
Employer Qualification and Eligibility
The credit is available to all employers regardless of size, including tax-exempt organizations.
There are only two exceptions:
- State and local governments and their instrumentalities, and
- Small businesses who take small business loans.
Qualifying employers must fall into one of two categories:
- The employer’s business is fully or partially suspended in any calendar quarter by government order due to COVID-19 during the calendar quarter.
- The employer experienced a significant decline in gross receipts from the comparable quarter in 2019. These measures are calculated each calendar quarter.
Partial Suspension for Purposes of the Employee Retention Credit
The operation of a trade or business may be partially suspended if an appropriate governmental authority imposes restrictions upon the business operations by limiting commerce, travel or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 such that the operation can still continue to operate but not at its normal capacity.
Example: A state governor issues an executive order closing all restaurants, bars and similar establishments in the state in order to reduce the spread of COVID-19. However, the executive order allows those establishments to continue food or beverage 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 establishments in the state that provided full sit-down service, a dining room or other on-site eating facilities for customers prior to the executive order.
“Significant Decline in Gross Receipts”
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.
Example: An employer’s gross receipts were $100,000, $190,000 and $230,000 in the first, second and third calendar quarters of 2020, respectively. Its gross receipts were $210,000, $230,000 and $250,000 in the first, second and third calendar quarters of 2019, respectively. Thus, the employer’s 2020 first, second and third quarter gross receipts were approximately 48%, 83% and 92% of its 2019 first, second and third quarter gross receipts, respectively.
Accordingly, the employer had a significant decline in gross receipts, commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50% of the same quarter in 2019), and ending on the first day of the third calendar quarter of 2020 (the quarter following the quarter for which the gross receipts were more than 80% of the same quarter in 2019). Thus, the employer is entitled to a retention credit with respect to the first and second calendar quarters.
Calculating the Credit
The credit equals 50% of the qualified wages (including qualified health plan expenses) that an eligible employer pays in a calendar quarter. 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 one employee is $5,000.
Example 1: Eligible Employer pays $10,000 in qualified wages to Employee A in Q2 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 Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to the eligible employer for the qualified wages paid to 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.
Determination of Qualifying Wages
Qualified wages are wages, as defined in section 3121(a) of the Internal Revenue Code (the Code) and compensation, as defined in section 3231(e) of the Code, paid by an Eligible Employer to employees after March 12, 2020, and before January 1, 2021. Qualified wages include the Eligible Employer’s qualified health plan expenses that are properly allocable to the wages.
The definition of qualified wages depends, in part, on the average number of full-time employees (FTEs), as defined in section 4980H of the Code, employed by the Eligible Employer during 2019.
If the Eligible Employer averaged more than 100 FTEs in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services due to either:
- A full or partial suspension of operations by order of a governmental authority due to COVID-19, or
- A significant decline in gross receipts. For these employers, qualified wages taken into account for an employee may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.
If the eligible employer averaged 100 or fewer FTEs in 2019, qualified wages are the wages paid to any employee during any period of economic hardship described in (1) and (2) above.
Is the ERC Available for Wages Paid in March 2020?
Eligible Employers may claim the Employee Retention Credit for qualified wages that they pay after March 12, 2020, and before January 1, 2021. Therefore, an eligible employer may be able to claim the credit for qualified wages paid as early as March 13, 2020.
What Taxes May be Offset by the Employee Retention Credit?
The credit is allowed against the employer portion of social security taxes, and the portion of taxes imposed on railroad employers under the Railroad Retirement Tax Act (RRTA) that corresponds to the social security taxes under the Code.
What Does “Fully Refundable” Mean?
The credits are 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. That is, 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 (or on all compensation for employers subject to RRTA) paid to all employees, then the excess is treated as an overpayment and refunded to the employer.
Consistent with its treatment as an overpayment, the excess will be applied to offset any remaining tax liability on the employment tax return, and the amount of any remaining excess will be reflected as an overpayment on the return. Like other overpayments of federal taxes, the overpayment will be subject to offset under section 6402(a) of the Code prior to being refunded to the employer. That is to say, simply, that should the Eligible Employer have other unpaid taxes due the Internal Revenue Service, any overpayment will be offset against the overpayment prior to the refund of the balance, if any.
Example: Eligible Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to the Eligible Employer for the qualified wages paid to Employee A is $5,000. This amount may be applied against the employer share of social security taxes that the Eligible Employer is liable for with respect to all employee wages paid in Q2 2020.
Any excess over the employer’s share of social security taxes is treated as an overpayment and refunded to the Eligible Employer after offsetting other tax liabilities on the employment tax return and subject to any other offsets under section 6402(a) of the Code.
How to Get the Employee Retention Credit
Employers can be immediately reimbursed for the credit by reducing their required deposits of payroll taxes that have been withheld from employees’ wages by the amount of the credit.
Eligible Employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns or Form 941 beginning with the second quarter (June 30, 2020). If the employer’s employment tax deposits are not sufficient to cover the credit, the employer may receive an advance payment from the IRS by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19.
If an eligible employer is suffering economic stress earlier, it can also request an advance of the Employee Retention Credit by submitting Form 7200.
Using the ERC to Reduce Federal Employment Tax Deposits
An Eligible Employer may fund the qualified wages by accessing federal employment taxes, including those that the Eligible Employer already withheld, that are set aside for deposit with the Internal Revenue Service, for other wage payments made during the same quarter as the qualified wages. 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 Internal Revenue Service 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.
Note that the Eligible Employer must account for the reduction in deposits on the Form 941, Employer’s Quarterly Federal Tax Return, for the quarter.
Example: An Eligible Employer paid $10,000 in qualified wages (including qualified health plan expenses) and is, therefore, entitled to a $5,000 credit. The Eligible Employer 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 it 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 for the quarter.
The Employee Retention Credit and Payroll Protection Program Loans
An Eligible Employer may not receive the Employee Retention Credit if it receives a Small Business Interruption Loan under the Paycheck Protection Program that is authorized under the CARES Act. (see related post) As such, an Eligible Employer that receives a Paycheck Protection loan should not claim Employee Retention Credits.
The Employee Retention Credit offers an astounding opportunity for Eligible Employers to obtain almost immediate relief by reducing quarterly payroll deposits for any qualifying wages paid after March 12, 2020. Unfortunately, the credit is not permitted if the Eligible Employer anticipates applying for a small business loan under the Paycheck Protection Program.
Determining which of the relief opportunities afforded by the CARES Act is right for you and your company can be challenging. Grossman Yanak & Ford LLP is here to assist you in making that decision.