The recently enacted Coronavirus Aid, Relief, and Economic Security Act (CARES Act) contains several business tax relief provisions, including provisions allowing for an employee retention credit and an employer payroll tax deferral.
Employee retention credit
As a general rule, the employee retention credit (the Credit) is a refundable credit that is equal to 50 percent of the “qualified wages” of each employee of an “eligible employer.” The Credit is calculated on a calendar quarter basis and is applied against “applicable employment taxes” of the eligible employer, although in application, only the employer portion of the Social Security Tax (6.2 percent of wages) is eligible for the Credit.
The mechanics of the Credit are complicated and work as follows:
The Credit is limited to wages paid between March 12, 2020 and December 31, 2020. Credited wages are capped at $10,000 per employee for all quarters. Given this wage cap and the 50 percent of qualified wages limit, the maximum Credit is $5,000 per employee.
An employer is an “eligible employer” if the employer was carrying on a trade or business during the 2020 calendar year and the operation of the trade or business with respect to any calendar quarter was fully or partially suspended due to orders from an appropriate governmental authority limiting business activity (commerce, travel or group meetings for commercial, social, religious or other purposes) due to the COVID-19 pandemic. In the case of a tax-exempt organization described in Code Section 501(a), the “COVID-19 test” is applied to all operations for such organization.
An employer will also be an “eligible employer” if the employer was carrying on a trade or business during the 2020 calendar year, even if the trade or business was not fully or partially suspended due to orders related to the COVID-19 pandemic, as long as there is a significant decline in gross receipts during a calendar quarter in 2020. Specifically, if the gross receipts for a calendar quarter are less than 50 percent of gross receipts for the same calendar quarter in the prior year, there will be a significant decline in gross receipts until the calendar quarter in which gross receipts are greater than 80 percent of the same calendar quarter in the prior year.
This alternate test allows the Credit to be available for the gross receipt declines, even if the decline is not COVID-19-related. An eligible employer can opt out of the Credit in any calendar quarter.
The Credit does not apply if an employer takes a loan through the Paycheck Protection Program (PPP). As noted below, the Internal Revenue Service (IRS) has authority to issue regulations and guidance regarding the Credit and one specific grant of authority relates to the ability of the IRS to recapture the Credit when a Paycheck Protection Program loan is obtained in a subsequent quarter.
The calculation of “qualified wages” depends on the average number of full-time employees of the eligible employer. If the average number of full-time employees during 2019 was greater than 100, wages are counted only to the extent that they are paid to an employee who is not providing services due to a COVID-19 order, or due to a significant decline in gross receipts. Wages for these employees cannot exceed the amount that such employees would have been paid for working an equivalent duration during the 30 days immediately preceding such period.
The key distinction for larger employers the two categories is that the 100 or less full-time employee category allows wages to be counted for all employees, even if the employees have not been prevented from providing services.
Note the following rules that are considered for purposes of calculating wages:
- Wages are not counted if taken into account under Section 7001 or Section 7003 of the Families First Coronavirus Response Act (FFCRA), which provide for refundable tax credits for most employers with fewer than 500 employees that pay qualified sick leave wages or qualified family leave wages to their employees;
- Wages include the eligible employer’s qualified health plan expenses that are allocated to the wages. These expenses are those related to employer-provided group health plan coverage where the cost of the coverage is excluded from the employee’s income; and
- The Credit rules use the same definition of wages as used under Section 3121(a) of the Internal Revenue Code of 1986 (the Code), as amended, for Social Security Tax purposes.
Generally, the amount of the Credit for any calendar quarter cannot exceed the applicable employment taxes on wages paid for the calendar quarter. In calculating the applicable employment taxes, any credits under Code Section 3111(e) (credit for employment of qualified veterans), Code Section 3111(f) (credit for research expenditures of qualified small businesses) and refundable tax credits under Section 7001 or Section 7003 of the FFCRA are applied first. In addition, if the Credit exceeds the employment tax limitation in any quarter, then the excess amount is treated as an overpayment and refunded to the employer, which benefits businesses who retain their employees during the crisis.
The IRS recently issued guidance on the mechanics for claiming the Credit. The Credit is used to reduce the required deposits of payroll taxes for each quarter that have been withheld from an employee’s wages. Under this approach, the employer keeps the withheld payroll taxes in an amount up to the Credit. This frees up cash flow by eliminating the deposit requirement. Starting with the second quarter of 2020, Credit amounts in excess of the required employment tax deposits can be refunded by filing Form 7200 to receive an advance refund of the Credit. The IRS is expected to comment on the timing of when the refund of the Credit will be sent to employers.
In addition to these calculation rules, there are a series of special operating rules:
- All employers treated as a single employer under the controlled group/common control rules of Code Section 52(a) and (b) or the affiliated service group rules of Code Section 414(m) and (o) are aggregated as one employer for purposes of the Credit rules, including determining the number of employees;
- Wages of certain parties related to the employer (using the principles of Code Section 51(i)(1)) as well as certain wages already subject to credits (using the principles of Code Section 280C(a)) are excluded;
- Federal, state and local governmental employers cannot take advantage of the Credit.
- If an employer is allowed a credit under Code Section 51 (work opportunity credit), the employer cannot also claim the Credit. Wages taken into account for the credit under Code Section 45S (employer credit for paid family and medical leave) cannot also be counted as wages for purposes of the Credit; and
- The IRS is required to waive any penalty for the failure to make a timely deposit of employment tax it determines that the failure was due to the reasonable anticipation of the Credit being allowed.
Payroll tax deferral
The Act allows for a deferral of “applicable employment taxes,” and it appears that the deferral can be used in conjunction with the Credit when the Credit does not result in a refund. As in the case of the Credit, the applicable employment tax for deferral purposes is the employer portion of the Social Security Tax (6.2 percent of wages), and in the case of a self-employed individual, the applicable employment tax is 50 percent of the self-employment tax based on 12.4 percent of self-employment income (including related estimated tax payments). The deferral does not apply to employee income tax withholding, the employee or employer portion of the Medicare Tax or the employee portion of the Social Security Tax.
Unlike the Credit, the deferral is not based on the taxpayer meeting eligibility requirements. The Deferral applies to the applicable employment taxes from March 27, 2020 through December 31, 2020. The payment of the tax is deferred, with 50 percent of the tax payable on December 31, 2021 and the remaining 50 percent of the tax payable on December 31, 2022. Deposits on this schedule will be treated as timely. This is a significant benefit, but as noted above, it only relates to the Social Security Tax (6.2 percent of wages) portion of the overall employment or self-employment tax.
The deferral is not applicable if a taxpayer has had indebtedness forgiveness under the PPP or the Main Street Lending Program.
If an employer designates an agent to deposit employment taxes, or uses a professional employer organization (PEO), the employer who directs the agent to defer the payment of employment taxes (or customer of the PEO) has the liability if the taxes are not timely paid by the applicable deferral date. Employers also remain responsible for the trust fund portion of withheld taxes (employee income tax withholding and employee portions of Social Security and Medicare taxes).
While these rules are complicated and require an analysis of the use of other credits under the Code recent legislation, employers should not miss the opportunity to take advantage of this significant relief.
John Eagan is a partner in the business department at White and Williams LLP in New York City. He focuses his practice on taxation matters, with particular emphasis on planning for US and international business clients.
L. Stephen Bowers is a counsel at White and Williams LLP in Philadelphia, Pennsylvania. He serves a broad array of corporate clients and has notable experience guiding employers of all types, including private companies, government entities, nonprofits and educational institutions through industry-specific employee compensation and benefits rules.