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IRS Addresses Reconciliation and Recapture Rules for COVID-19-Related Tax Credits
Practical Law Legal Update w-026-6987 (Approx. 6 pages)
IRS Addresses Reconciliation and Recapture Rules for COVID-19-Related Tax Credits
by Practical Law Employee Benefits & Executive Compensation
| Published on 28 Jul 2020 • USA (National/Federal) |
The Internal Revenue Service (IRS) has issued temporary and proposed regulations addressing the process for recapturing erroneously refunded employment tax and employee retention credits under the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The credits were made available under FFCRA and CARES Act provisions enacted in response to the US outbreak of COVID-19, the disease that results from SARS-CoV-2.
On July 24, 2020, the IRS issued temporary regulations addressing the employment tax credits for qualified leave wages paid to employees under the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. No. 116-127 (2020); Pub. L. No. 116-136 (2020)). The FFCRA and the CARES Act are two key pieces of federal legislation enacted in response to the US outbreak of COVID-19, the disease that results from SARS-CoV-2 (see Practice Note, COVID-19 Compliance for Health and Welfare Plans: Federal Legislation Enacted in Response to COVID-19).
The temporary regulations address the IRS's process for:
- Reconciling advance payments of refundable employment tax credits provided under the FFCRA and the CARES Act.
- Recapturing the benefit of the credits when necessary.
Accompanying IRS proposed regulations authorize the assessment of erroneous refunds of the credits paid under the FFCRA and the CARES Act.
For a continuously updated collection of COVID-19-related resources, see Practical Law's Global Coronavirus Toolkit.
FFCRA Paid Leave and Payroll Tax Credit Provisions
As background, the FFCRA requires employers with fewer than 500 employees to provide the following two types of paid leave wages for COVID-19-related absences:
- Qualified sick leave wages under the FFCRA's "Emergency Paid Sick Leave Act" (EPSLA) (for example, if an employee cannot work or telework because the employee is subject to a COVID-19-related federal, state, or local quarantine or isolation order).
- Qualified family leave wages under the FFCRA's "Emergency Family and Medical Leave Expansion Act" (EFMLEA), which amended the Family and Medical Leave Act of 1993 (FMLA) to require certain employers to pay expanded family and medical leave to employees who cannot work or telework for COVID-19-related reasons.
The two types of FFCRA wages are collectively referred to as "qualified leave wages."
Employers that must pay FFCRA qualified leave wages are eligible for fully refundable payroll tax credits equal to the amount of the leave wages (see Article, IRS Guidance on COVID-19 Paid Leave Tax Credits Under the FFCRA). These credits also may reflect "qualified health plan expenses" (for example, the cost of insured health plan coverage) that are allocable to the wages.
For each quarter, the refundable tax credits are allowed against the employer's share of:
- The Social Security portion of Federal Insurance Contributions Act (FICA) taxes (26 U.S.C. § 3111(a); see Practice Note, Payroll (FICA) Taxes).
- The Social Security and Medicare portions of Railroad Retirement Tax Act (RRTA) taxes (26 U.S.C. § 3221(a)).
If the credit amounts exceed the employer's portion of Social Security taxes, the excess is treated as an overpayment and refunded to the employer. Consistent with its treatment as an overpayment, the excess is applied to offset any remaining tax liability on Form 941 (Employer's Quarterly Federal Tax Return). The amount of any remaining excess is reflected as an overpayment on Form 941 (see Article, IRS Guidance on COVID-19 Paid Leave Tax Credits Under the FFCRA). In issuing its temporary regulations, the IRS indicated that it has revised Form 941 to reflect the tax credits, including to provide that:
- Any credits that exceed applicable taxes will be credited against other employment taxes.
- Any remaining balances will be refunded to an employer.
Employee Retention Credits Under the CARES Act
The CARES Act also made available an employee retention credit to certain employers who pay qualified wages to their employees, subject to a per-employee limit (see Legal Update, IRS Procedures Address Employee Retention Tax Credit Under CARES Act). The employee retention credit is a fully refundable tax credit for employers equal to 50% of qualified wages, which – as with the employment tax credits – may include an employer's qualified health plan expenses allocable to the wages. Regarding employer eligibility and related requirements for employee retention credits under the CARES Act, see CARES Act: Small Business Emergency Relief Chart and Practice Note, COVID-19 Compliance for Health and Welfare Plans: Employee Retention Credits Under CARES Act.
Importantly, the same wages or compensation cannot be counted for both the FFCRA leave credits and the CARES Act employee retention credit.
Advance Payment of Credits; Erroneous Refunds
The CARES Act amended the FFCRA to permit anticipated credit amounts to be advanced, and the IRS created Form 7200 (Advance Payment of Employer Credits Due to COVID-19) for this purpose (see Article, IRS Guidance on COVID-19 Paid Leave Tax Credits Under the FFCRA: Process for Advance Payment of Credits). Employers use Form 7200 to request an advance of the FFCRA leave credits, the employee retention credit under the CARES Act, or both if applicable. However, employers must reconcile any advance payments they claim against total credits claimed and total taxes due on their employment tax returns. In issuing its temporary regulations, the IRS indicated that a refund, credit, or advance of any part of the credits to an employer that is more than the amount to which the employer is entitled is an erroneous refund for which the IRS will seek repayment through a recapture process.
Under the temporary regulations:
- Erroneous refunds of the paid leave tax and employee retention credits are treated as underpayments of taxes imposed under the relevant Internal Revenue Code (Code) employment tax provisions.
- The IRS may assess any portion of the credits erroneously credited, paid, or refunded in excess of the amount allowed as if those amounts were tax liabilities under the employment tax provisions.
The calculation of erroneously refunded credit amounts must reflect any credit amounts advanced to an employer.
Role of Third-Party Entities
In issuing its temporary regulations, the IRS also recognized that third-party payors may sometimes claim credits on behalf of their clients (that is, common law employers). As a result, the temporary regulations provide that erroneous refund amounts can be assessed against third-party entities that are treated as employers under the Code (for example, certified professional employer organizations (CPEOs); see Standard Document, PEO Client Service Agreement: IRS Final Regulations (May 2019) and Guidance Addressing CPEOs).
Effective Date
The temporary regulations are scheduled to be published in the Federal Register on July 29, 2020, and will be effective on that date.
Practical Impact
As this latest guidance and other recent developments make clear, the FFCRA and CARES Act tax credits, while intended to help employers endure the COVID-19 outbreak, come with a fair amount of complexity from employment tax and payroll perspectives (for more information, see Legal Update, IRS Addresses Employer Reporting Rules for FFCRA Credits and Self-Employed Individuals). Relatedly, employers and third-party payors will need to become familiar with the relevant IRS tax forms in this space, some of which are either entirely new or revised to reflect the administrative aspects of funding the credits.