Employee Retention Credit
The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act incentivized employee retention by offering a payroll tax credit equal to fifty (50%) percent of qualified wages (wages, including qualified health plan expenses allocable to the wages) paid by eligible employers during the period from March 13, 2020, to December 31, 2020. The credit is limited to the first Ten Thousand Dollars ($10,000) of qualified wages paid to an employee for the entire year – allowing up to a Five Thousand Dollar ($5,000) credit per employee. The credit is not available for any wages used in computing the sick leave or family medical leave credits under the Families First Coronavirus Response Act (“FFCRA”).
Any size employer is eligible for this credit if: (1) the employer’s operations were fully or partially suspended due to a COVID-19-related shutdown order; or (2) the employer’s gross receipts declined by more than fifty (50%) percent when compared with the same quarter in the prior year (the employer remains an eligible employer in subsequent quarters until its gross receipts exceed eighty (80%) percent of gross receipts compared with the same quarter for the prior year). If the employer has more than one hundred (100) employees, qualified wages include only wages paid to employees who are not working as a result of a COVID-19-related shutdown order or the significant decline in gross receipts. For employers with one hundred (100) or fewer employees, qualified wages paid during the period when the operations were fully or partially suspended or during a quarter in which gross receipts have significantly declined (i.e., by more than fifty (50%) percent as provided above) are eligible for the credit, even for wages paid to an employee who is still working. As such, large employers may only count as qualified wages those wages paid for services not rendered, whereas small employers can count all wages paid as qualified regardless of whether the employee works or not.
For example, assume a corporation’s operations are partially suspended from March 16, 2020 through April 30, 2020 as a result of a COVID-19-related shutdown order. A few of the corporation’s employees are able to work from home during the shutdown, but most are not. Regardless, the corporation continues to pay all employees. The corporation’s second quarter gross receipts decline by twenty-five (25%) percent relative to the same quarter in the previous year and then pick back up in the third quarter. If the corporation has more than one hundred (100) employees then it can claim the retention credit only with respect to the portion of qualified wages paid from March 16, 2020 through April 30, 2020 to employees unable to work. If the corporation has more than one hundred (100) employees, then the credit is not available for qualified wages paid to employees for work actually performed. If the corporation has one hundred (100) or fewer employees then it can claim the retention credit for all qualified wages paid from March 16, 2020 through April 30, 2020 for all employees regardless that some employees were able to work.
On Sunday, December 27, 2020, the Consolidated Appropriations Act 2021 was enacted (the “CAA 2021”). The CAA 2021 includes the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (“TCDTR”), which extends and expands upon the employee retention credit provided by the CARES Act. While most of the provisions are prospective, the TCDTR makes certain retroactive changes. These retroactive changes are effective as of the enactment date of the CARES Act. Specifically, the TCDTR reaffirms prior IRS guidance that group health plan expenses can be considered qualified wages even when no wages are paid to an employee. More importantly, the TCDTR provides that employers who received a Paycheck Protection Program (“PPP”) loan may still qualify for the employee retention credit so long as the wages that were used to support the payroll portion of the PPP loan forgiveness are not used to support the employee retention credit qualified wages or qualified health expenses.
Under the CAA 2021, an employer can support the PPP loan using any period of time within the PPP period (i.e., April 1, 2020 through December 31, 2020). Previously, employers were required to utilize an eight (8) or twenty-four (24) week period for the PPP loan. Due to this change, employers should have enough wages to support both PPP loan forgiveness and employee retention credit qualified wages. Employers will need to keep in mind that the definition of qualified wages is significantly different than the definition of payroll expenses for purposes of the PPP. As mentioned above, wages are qualified wages depending on the size of the employer. Further IRS guidance is expected on this interaction between PPP payroll amounts and employee retention credit qualified wages to allow employers to claim both for 2020.
If an employer had not previously claimed the employee retention credits on quarterly employment tax returns (Form 941) filed for 2020, and now wants to retroactively claim such credits, how does the employer do so? IRS guidance recently provided a “limited 4th quarter procedure” by which employers are able to report employee retention credit qualifying wages for the 2nd and/or 3rd quarters of 2020 on Line 11c or Line 13d (as relevant) of the employer’s original 4th quarter Form 941, along with reporting any 4th quarter employee retention credit qualifying wages paid. Unfortunately, the 4th quarter Form 941 was due by January 31, 2021. Therefore, most employers will need to instead file an amended return or claim for refund for the quarters ended in June, September and December of 2020 using Form 941-X.
In addition to the retroactive provisions, the TCDTR extends the employee retention credit for January 1, 2021 through June 30, 2021 with significant, favorable modifications. The limit for per-employee qualifying wages is changed from Ten Thousand Dollars ($10,000) for the year to Ten Thousand Dollars ($10,000) for each quarter, for a total of potentially Twenty Thousand Dollars ($20,000) of qualified wages for 2021. The employee retention credit rate is also changed from fifty (50%) percent to seventy (70%) percent of qualified wages. This increase entitles employers to a credit of up to Seven Thousand Dollars ($7,000) per employee per quarter with a potential Fourteen Thousand Dollar ($14,000) credit per employee for 2021. This is a significant increase from the Five Thousand Dollar ($5,000) per employee limit in 2020.
The large employer threshold related to claiming qualified wages is increased from one hundred (100) employees to five hundred (500) employees. This means that employers with five hundred (500) or less employees may count all eligible wages paid, whether the employee is working or not, as qualified wages. This increase greatly expands the amount of wages many employers can treat as qualified for purposes of the employee retention credit.
Lastly, the TCDTR reduces the gross receipts requirement for eligibility for the employee retention credit. Under the CARES Act, a company would be eligible for the credit if its quarterly gross receipts declined by more than fifty (50%) percent, compared to the same quarter in 2019. Under the TCDTR, employers whose gross receipts declined by more than twenty (20%) percent are now eligible for 2021.
The TCDTR also expands the periods of comparison for the employee retention credit. To determine eligibility for the quarter, an employer may elect to compare the gross receipts for the immediately preceding quarter and the same calendar quarter in 2019 to determine if the gross receipts in the immediately preceding quarter are less than eighty (80%) percent. This means that an employer may determine eligibility based on a decline in gross receipts by choosing to compare: (1) the first quarter 2021 gross receipts to the gross receipts from first quarter 2019; or (2) the fourth quarter 2020 gross receipts to the gross receipts from the fourth quarter of 2019. If either comparison demonstrates a more than twenty (20%) percent decline, then the employer is eligible for the employer retention credit. What is currently unknown is whether the election, once made, is permanent, requiring employers to look at the prior quarter to determine eligibility for the current quarter. Given these significant changes to the employee retention credit for January 1, 2021 through June 30, 2021, we should see more employers claiming these employee retention credits.
In order to claim the 2021 employee retention credit, eligible employers will report their total qualified wages and the related health insurance costs for each quarter on Form 941. IRS guidance allows employers access to the employee retention credit for the 1st and 2nd quarters of 2021 prior to filing Form 941 by reducing employment tax deposits. Employers with an average of five hundred (500) or less full-time employees in 2019 may file an Advance of Employer Credits Due to Covid-19 (Form 7200) to request advance payment of the employee retention credit after reducing employment tax deposits. Advance requests made on Form 7200 must reconcile with the employee retention credits for which the employer is eligible on Form 941 for the quarter. Furthermore, if an employer utilizes a payroll company, then the employer should advise the payroll company of any Forms 7200 submitted to avoid IRS advance payment and application of the same credit by the payroll company. This could result in underpayment of employment taxes leading to the employer being assessed penalties and interest.