Employee Retention Tax Credit Under The CARES Act: Alternative Tool for Businesses Not Utilizing The Paycheck Protection Program

For those businesses that were unable to take advantage of the small business loan forgiveness program known as the Paycheck Protection Program, the CARES Act also offers another provision to help businesses obtain funding to help with expenses during the COVID-19 pandemic. 

The goal of the Employee Retention Credit is to enable employers to keep paying their employees even while the business may be shut down or operating at a decreased capacity.  This article provides an update to the top level summary of the Tax Provisions in the CARES Act previously circulated.  

Employee Retention Credit

This provision allows a qualified employer to claim a credit against applicable employment taxes in an amount equal to 50% of the qualified wages (including qualified health plan expenses) paid in any calendar quarter occurring between March 13, 2020 and December 31, 2020.

Employer Eligibility

To be eligible, an employer must have been carrying on a trade or business during 2020, and either: (1) had to fully or partially suspend its operations during 2020 due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19; or (2) had to have experienced a decline in gross receipts of 50 percent or more from the gross receipts received during the same quarter of the prior year, beginning with the first calendar quarter after December 2019.  In addition, this provision contains a special aggregation rule which will need to be analyzed to determine what constitutes a “single employer.”  Government employers and self-employed individuals are not eligible for the employee retention credit. However, tax exempt organizations described under Section 501(c) of the Tax Code which had been carrying on a trade or business during 2020 and met the conditions set out in (1) above, are eligible to utilize the credits provided under this provision.

Qualified Wages

The credit is based on “qualified wages”.  Qualified wages are wages and compensation (as defined in Sections 3121(a) and 3231(e), respectively, of the Tax Code), plus the employer’s qualified health plan expenses which are allocable to the employee’s wages.  The type of expenses included in qualified health plan expenses are “amounts paid or incurred by the eligible employer to provide and maintain a group health plan… but only to the extent that such amounts are excluded from the gross income of the employee in accordance with Section 106(a).”  However, the method of allocation of the qualified healthcare expenses to the employee’s wages for the purposes of this provision of the CARES Act has not yet been provided. 

In addition to the above, the definition of qualified wages for the purposes of this provision differs based on whether the employer had more than or less than 100 employees.  Where the average number of full time employees working for the employer during 2019 was greater than 100, the employer’s qualified wages are limited to wages paid to an employee who was not able to provide services due to either a partial or full shut down of the business by the government or due to the significant loss of gross receipts by the business caused by the pandemic.  In addition, qualified wages for any employee may not exceed the amount that employee would have normally been paid for working the same amount of time during the 30 days immediately preceding the period at issue.  For employers employing 100 or fewer employees on average during 2019, qualified wages include all wages paid to employees during the same downturn of the business as described above. 

All employers must exclude any wages used in the calculation of qualified wages to determine credits due for the sick and/or family leave under the Families First Coronavirus Response Act (FFCRA) from the calculation of qualified wages used to calculate the retention credit under this provision.   

The determination of the “average number of full time employees” is set out in Section 4980H of the Tax Code.  Section 4980H defines a full-time employee as “an employee who is employed on average at least 30 hours of service per week with respect to any one month. “ However, other parts of this Section provide that full-time equivalents are treated as full-time employees.  Specifically, the statute instructs that in addition to the number of full-time employees for any month, you must include for such month a number of full-time employees determined by dividing the aggregate number of hours of service of employees who are not full-time employees for the month by 120.  Based on the above, it is unclear whether the retention credit provision seeks to include part-time employees in its calculation of the number of employees or their wages in the qualified wages number under this provision.  Also, it is worth noting that a business is not required to continue to pay an employee if that employee is not able to work; but if the business wants to pay the employee despite the inability of the employee to fully perform, the employer can continue to pay the employee and seek the applicable tax credit to help out with the cost through this provision. 

Limitations

The available tax credit is limited to 50% of qualified wages paid to employees from March 13, 2020 until December 31, 2020.  The maximum amount of qualified wages that can be included for each employee in total is $10,000.  Therefore, the maximum credit allowed related to each employee is $5,000 in total.  The business may apply the retention tax credit against “applicable employment taxes,” i.e., the employer’s portion of social security taxes under 3111(a) of the Tax Code and the portion of taxes imposed on the railroad employers under the Railroad Retirement Tax Act that corresponds to the social security taxes under Section 3111(a) of the Code.  However, the total retention tax credit cannot exceed the applicable employment taxes reduced by the following: (1) any credits allowed for the employment of veterans; (2) any credits allowed for research expenses; (3) any payroll credit given for required paid sick leave under FFCRA; and (4) any payroll credit given for required paid FMLA leave under FFCRA.  In addition, any employee who was the basis of a credit to the employer related to work opportunity credits under Section 51 of the Tax Code may not be included in the calculations under this provision, and any wages included in any credit allowed under this provision cannot be included in the calculation of any credit allowed under Section 45S of the Tax Code related to paid family medical leave.

The employee retention credit is not available to government employees, self-employed individuals or any business that received a loan under the Paycheck Protection Program. 

Procedure to Obtain Credit

A business can obtain the benefit of the credits in three ways: (1) by withholding or withdrawing the amount of federal employment taxes set aside for or on deposit with the IRS for other wage payments made during the same quarter as the applicable qualified wages; (2) by filing a Form 7200- Advance Payment of Employer Credits Due to COVID-19 to request an advance of the amount of the credit; or (3) a combination of the steps in (1) and (2) when the federal payroll taxes are not enough to provide the full amount of credit allowed under this provision. 

Under (1), the employer who has paid qualified wages to its employees in a calendar quarter before it is required to deposit the federal employment taxes with the IRS for that quarter can gain the benefit of the retention tax credit immediately by not depositing federal employment taxes due in an amount equal to up to 50% of the qualified wages for that quarter.  Not making this otherwise required deposit will be forgiven and no penalty assessed if the regulator determines that it was due to the anticipation of the retention credit. 

Under (2) and (3) above, if the business does not have any or enough federal employment taxes set aside for deposit to the IRS, the employer can seek an advance of the refundable credits.  First, the employer must exhaust any available federal employment tax deposits as addressed in (1) above.  Then, the employer can file a Form 7200 for the remaining amount of the retention credit.  A word of caution:  If the retention credit is fully funded by utilizing the federal employment tax deposits, then the business should not file Form 7200.  In this situation, if the Form 7200 is filed when there is no remaining credit to be given, the business will be required to provide a reconciliation on its regular Form 941 (or other applicable form), and it could end up with an under payment of federal employment taxes for the quarter.  If no advance funding is sought, the business should file its normal Form 941 and reflect that the retention credit was taken through the deposits.       

The CARES Act specifically states that any overpayment of employment taxes net of credits “shall be treated as an overpayment that shall be refunded under Sections 6402(a) and 6413(b) of the [Tax Code].”  However, the guidance that was released by the IRS March 31, 2020, states that if the business has other tax liabilities, the overpayment may be set-off against the other liability instead of refunded to the business.  This appears to contradict the express language of the CARES Act, so additional guidance could be needed to provide clarification.