IRS Procedures Address Employee Retention Tax Credit Under CARES Act | Practical Law

IRS Procedures Address Employee Retention Tax Credit Under CARES Act | Practical Law

The Internal Revenue Service (IRS) has provided FAQ guidance addressing the employee retention tax credit for certain employers impacted by the COVID-19 outbreak in the US, as provided for in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The employee retention tax credit, which is 50% of up to $10,000 in qualified wages paid by an employer for each employee, is intended to help employers keep employees on their payrolls.

IRS Procedures Address Employee Retention Tax Credit Under CARES Act

Practical Law Legal Update w-024-7989 (Approx. 6 pages)

IRS Procedures Address Employee Retention Tax Credit Under CARES Act

by Practical Law Employee Benefits & Executive Compensation
Published on 03 Apr 2020 • USA (National/Federal)
The Internal Revenue Service (IRS) has provided FAQ guidance addressing the employee retention tax credit for certain employers impacted by the COVID-19 outbreak in the US, as provided for in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The employee retention tax credit, which is 50% of up to $10,000 in qualified wages paid by an employer for each employee, is intended to help employers keep employees on their payrolls.
The IRS has issued FAQ guidance addressing the employee retention tax credit for certain employers impacted by the US outbreak of COVID-19, the disease that results from SARS-CoV-2. The employee retention credit, which incentivizes eligible employers impacted by the COVID-19 outbreak to keep employees on their payroll, was included in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. No. 116-136, § 2301 (Mar. 27, 2020); see Legal Update, CARES Act Contains Numerous Employee Benefit and Executive Compensation Provisions, Including Changes to COVID-19 Testing Mandate). The credit, which is fully refundable, equals 50% of up to $10,000 in qualified wages paid by an employer for each employee. (The Senate Committee on Finance also issued FAQs concerning the credit.)
For a continuously updated collection of resources addressing COVID-19, see Practical Law's Global Coronavirus Toolkit.

Overview of Employee Retention Tax Credit

An employer is eligible for the employee retention credit if it carries on a trade or business during 2020 that either:
  • Fully or partially suspends operation during any quarter in 2020 because of an order from a governmental authority restricting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19.
  • Experiences a significant decline in gross receipts during a quarter.
Although tax-exempt organizations are eligible for the credit, state and local governments are not. In addition, self-employed individuals are not eligible for the credit as to their self-employment services and earnings.

Meaning of Partial Suspension and "Significant Decline in Gross Receipts"

For credit eligibility purposes, a partial suspension from a governmental authority order is triggered even if a business's operations can continue to operate – but not at their normal capacity. For example, this would include a state governor's order closing all restaurants and bars in a state, but permitting these establishments to continue food or beverage sales through carry-out, drive-through, or delivery methods.
A significant decline in gross receipts occurs in the first quarter that an employer's gross receipts for a quarter in 2020 are less than 50% of its gross receipts for the same quarter in 2019. The significant decline in gross receipts ends with the first quarter that follows the first quarter for which the employer's 2020 gross receipts for the quarter are greater than 80% of its gross receipts for the same quarter during 2019.

Retention Credit Amount

Employers may claim as a credit against employment taxes an amount equal to 50% of up to $10,000 in qualified wages paid for each employee after March 12, 2020, and before January 1, 2021. (In other words, employers may claim the retention credit for qualified wages paid beginning March 13, 2020.)
The maximum amount of qualified wages taken into account regarding each employee for all quarters is $10,000. As a result, the maximum credit for an employer for qualified wages paid to any employee is $5,000.
Employers may claim the credit by either:

Meaning of "Qualified Wages"

Qualified wages consist of wages (as defined in Section 3121(a) of the Internal Revenue Code (Code)) and compensation (see Code Section 3231(e)) paid by an employer to employees after March 12, 2020, and before January 1, 2021 (26 U.S.C. §§ 3121(a), 3231(e)). Qualified wages also include qualified health plan expenses that are properly allocable to the wages (see Legal Update, IRS Penalty Relief Addresses Employment Taxes and COVID-19 Paid Leave: Tax Credits Related to Expanded FMLA and Sick Leave Requirements).
In general, the definition of qualified wages depends (in part) on the average number of full-time employees (applying the meaning of this term under the Affordable Care Act's employer mandate rules) employed by the employer during 2019 (26 U.S.C. § 4980H; see Practice Note, Employer Mandate Under the ACA: Determining Full-Time Employees for Employer Penalties).
If an employer averaged more than 100 full-time employees in 2019, qualified wages are the wages paid to an employee for time that the employee is not providing services because of either:
For these employers, qualified wages for an employee may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately before the economic hardship period.
If an 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 under the full/partial suspension of operations or significant decline in gross receipts provisions described above.

How Employers Claim Retention Credit

Employers report their total qualified wages (see Meaning of "Qualified Wages") and the related credits for each quarter on their federal employment tax returns (in most cases, Form 941 (Employer's Quarterly Federal Tax Return)). Form 941 is used to report:
  • Income, Social Security, and Medicare taxes withheld from employees' wages.
  • The employer's portion of Social Security and Medicare tax.
Employers that expect to receive the credit can fund qualified wages by either:
  • Accessing federal employment taxes (including withheld taxes) that are required to be deposited with the IRS.
  • Requesting an advance of the credit from the IRS.

Use of Federal Employment Tax Deposits

An employer may pay for qualified wages by accessing federal employment taxes that are set aside for deposit with the IRS (including amounts already withheld by the employer) for other wage payments made during the same quarter as the qualified wages.
This means that an employer that pays qualified wages to its employees in a quarter before the employer must 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 the quarter. The employer must account for the reduction in deposits on the Form 941 for the quarter.

Failure to Deposit Penalties

Employers may reduce their federal employment tax deposits by qualified wages they have paid without incurring failure to deposit penalties under Code Section 6656 (see 26 U.S.C. § 6656). The IRS has provided a process, which is similar to the process for qualified leave wages, under which employers will not be subject to Code penalties regarding qualified wages (see Legal Update, IRS Penalty Relief Addresses Employment Taxes and COVID-19 Paid Leave). Under this process:
  • The employer must have paid qualified wages to its employees in the quarter before the required deposit.
  • The amount of federal employment taxes that the employer does not timely deposit (reduced by any amount of federal employment taxes not deposited in anticipation of the paid sick or family leave credits claimed under the FFCRA) must be less than or equal to the amount of the employer's expected employee retention credit for the qualified wages for the quarter as of the time of the required deposit.
  • The employer must not have sought payment of an advance credit (by filing Form 7200) regarding any portion of the anticipated credits it relied on to reduce its deposits.

Refund Process for Retention Credit

The retention credit is allowed against:
  • The employer portion of Social Security taxes (under Code Section 3111(a) (26 U.S.C. § 3111(a)).
  • The portion of taxes imposed on railroad employers (under the Railroad Retirement Tax Act (RRTA)) that corresponds to the Social Security taxes.
(See Practice Note, Payroll (FICA) Taxes.)
As noted, the credits are fully refundable, and permit an employer to obtain a refund if the credit amount is more than certain federal employment taxes owed by the employer. As a result, if for any quarter the amount of an employer's credit exceeds the employer portion of 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 (see 26 U.S.C. §§ 6402(a) and 6413(a)). The excess, if any, is used to offset any remaining tax liability on the employment tax return. After that, the amount of any remaining excess is reflected as an overpayment on the return.

Receiving Advance Payment of Retention Credits

The IRS has acknowledged that because quarterly returns are not filed until after qualified wages are paid, some employers may not have enough federal employment taxes set aside for deposit to the IRS to fund their qualified wages. As a result, there are procedures for obtaining an advance of the refundable credits.
Under these procedures, an employer first reduces its remaining federal employment tax deposits for wages paid in the same quarter by the maximum allowable credit amount. If the anticipated credit for the qualified wages is more than the remaining federal employment tax deposits for that quarter, the employer can file Form 7200 to claim an advance refund for the full amount of the expected credit for which it did not have sufficient federal employment tax deposits.
However, if an employer fully reduces its required deposits of federal employment taxes otherwise due on wages paid to employees in the same quarter in anticipation of receiving the credits, and it has not paid qualified wages that exceed this amount, the employer does not file Form 7200. (If an employer files the Form 7200, it would need to reconcile this advance credit and its deposits with the qualified wages on Form 941, and it could have an underpayment of federal employment taxes for the quarter.)

Interaction with Families First Leave Credits

Under the Families First Coronavirus Relief Act (FFCRA), certain employers must pay sick or family leave wages to employees who cannot work or telework due to certain circumstances related to COVID-19 (see Article, Expert Q&A: COVID-19 and Employment). Employers are entitled to a refundable tax credit for the required leave paid, up to specified limits (see Legal Update, IRS Penalty Relief Addresses Employment Taxes and COVID-19 Paid Leave).
Although an employer may receive both the tax credits for qualified leave wages (under the FFCRA) and the employee retention credit (under the CARES Act), the same wages cannot be counted for both credits. The amount of qualified wages for which an employer may claim the employee retention credit does not include the amount of qualified sick and family leave wages for which the employer received tax credits under the FFCRA.

Practical Impact

Employers that are interested in claiming the employee retention credit under the CARES Act, but that also plan to claim credits related to qualified leave wages under the FFCRA, will want to pay close attention to how the two credits interact. The IRS guidance issued to date treats the two provisions as companions, and, as discussed above, has made clear that the same wages cannot be counted for both credits (see Legal Update, IRS Penalty Relief Addresses Employment Taxes and COVID-19 Paid Leave).