Determining Eligibility for the Employee Retention Credit
Employee Retention Credit
One provision of the Coronavirus Aid Relief and Economic Security (“CARES”) Act provides eligible employers with a refundable payroll tax credit for certain wages paid.
The 2020 credit is equal to 50 percent of up to $10,000 of qualified wages paid to employees after March 12, 2020, and before January 1, 2021. The 2021 credit is equal to 70 percent of up to $10,000 of qualified wages paid to employees after December 31, 2020 and on/before October 1, 2021. Eligible employers can get immediate access to the funds by reducing employment tax deposits they are otherwise required to make. Or, if the employer’s employment tax deposits are less than the credit, the employer can get a refund from the IRS by filing Form 7200.
Employers, including tax-exempt organizations, are eligible for the credit if they operated a trade or business during calendar year 2020 and experience either: (1) the full or partial suspension of the operation of their trade or business during any calendar quarter because of governmental orders limiting commerce, travel, or group meetings due to COVID-19, or (2) a significant decline in gross receipts.
What constitutes a suspension?
In determining whether a business’ operations are fully or partially suspended due to a government order limiting commerce, travel, or group meetings due to COVID-19, an employer must take into account (1) the manner in which the government order affects an employer’s business operations and (2) the period of time during which the government order for the business’ jurisdiction is in place. The order must be from a government that has jurisdiction over the employer’s operations.
Examples of governmental orders include an order from a mayor closing all non-essential businesses for a specified time, a state shelter-in-place order for a specified time for all workers other than those employed by an essential business, and a government curfew on residents that affects the operating hours of a business. Businesses that can operate by requiring employees to telework are not considered to have a suspension of operations, even if the government order requires the employer to close the workplace.
What is a significant decline in gross receipts?
An employer is considered to have a significant decline in gross receipts for the period beginning with the first calendar quarter in 2020 for which its gross receipts are less than 50 percent of gross receipts from the same calendar quarter in 2019 and ending with the earlier of January 1, 2021, or the first calendar quarter after the quarter for which gross receipts are greater than 80 percent of gross receipts for the same calendar quarter in 2019.
Wages paid to an employee that are subject to Medicare tax and paid after March 12, 2020, and before January 1, 2021, during a period in which the employer had its business operations fully or partially suspended due to a governmental order or a quarter in which the employer experiences a significant decline in gross receipts are eligible for the credit. Wages are increased by the group health plan costs, both the employer’s and the pre-tax employees’ share, properly allocable to wages. This total amount is limited to $10,000.
For employers averaging 100 or fewer full-time employees in 2019, all qualifying wages paid during any period in which the business operations are fully or partially suspended due to a governmental order or any quarter the business is experiencing a significant decline in gross receipts are eligible for the credit.
If an employer averaged more than 100 full-time employees in 2019, qualified wages are only amounts paid when an employee is not providing services due to the full or partial suspension of the business or during a quarter in which there is a significant decline in gross receipts. The payment of PTO, vacation pay or sick pay is not considered wages paid when the employee is not providing services. If an employee’s wages are maintained, but their working hours are reduced, the payment for the hours that are not worked can be used to support a retention credit. For these employers, qualified wages cannot exceed what the employee would have been paid during the 30 days immediately before the full or partial suspension of operations or the first day of the calendar quarter in which the employer experienced a significant decline in gross receipts. Qualified wages do not include payments of mandated paid FMLA and sick leave pay wages under the Families First Coronavirus Response Act, wages for which the employer is claiming a credit for paid family medical leave under section 45S, or a Worker Opportunity Tax Credit employee’s wages. Payments to former employees, including severance payments, and wages paid to related parties are not qualified wages.
Claiming the Credit
An employer claims the employee retention credit by reducing its payroll tax deposits and reconciling these amounts on the quarterly Form 941. If tax deposits are not sufficient to fund the credit, employers can file Form 7200, requesting an advance payment of the credit. Employers using as third-party payer (e.g., a Professional Employer Organization or a reporting agent) are entitled to the credit for wages paid their common law employees. The third-party payer is not eligible for the credit.
Any credits paid for wages paid during the first quarter of 2020 should be claimed on the second quarter 2020 Form 941. Employers deferring payment of the employer share of Social Security wages (6.2% of wages up to $137,700 for 2020) should first reduce their employment tax deposits by the tax deferral amount and then reduce the tax deposits for the employee retention credit and the credit for mandated paid FMLA and sick leave. IRS Notice 2020-22 reduces the penalty for failure to deposit taxes to the extent that the amount not deposited is equal to the amount of refundable employee retention credits and the mandated paid FMLA and sick leave credits available to the employer.
Employers receiving an employee retention credit cannot deduct the portion of the wages paid, including the allocable health care costs, equal to the credit. Neither the portion of the credit that reduces the employer’s applicable employment taxes, nor the refundable portion of the credit, is included in the employer’s gross income.