In response to the COVID-19 pandemic, Congress created four payroll tax relief programs for employers via the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Families First Coronavirus Response Act (FFCRA) in the spring of 2020 and later expanded those in the Consolidated Appropriations Act (CAA) passed in late December 2020. These programs provide a tax deferral or tax credit against employer payroll costs (i.e. the employer portion of certain payroll taxes) attributable to certain wages paid to employees. Eligible employers may qualify for one or more of the following four programs: (1) payroll tax deferral, (2) employee retention credit, (3) paid sick leave credit or (4) paid family leave credit. The tax deferral and credits are reportable on an employer’s Form 941, Employer’s Quarterly Federal Tax Return, starting with the second calendar quarter of 2020.
The following is a brief description of each of the four payroll tax relief programs and the steps employers can take to utilize these programs.
Payroll tax relief programs
Payroll tax deferral
Due to the CARES Act, all employers can defer for up to two years the deposit and payment of their share of the social security tax on employee wages. Amounts normally due between March 27, 2020 and Dec. 31, 2020, can be deferred with 50 percent required to be paid by Dec. 31, 2021, and the remaining 50 percent by Dec. 31, 2022. The deferral only applies to employer social security taxes and does not apply to employer Medicare taxes or tax withholdings from employees. Self-employed individuals are also eligible to defer 50 percent of the social security tax imposed on their net earnings from self-employment.
Initially, employers that received Paycheck Protection Program (PPP) loans could not defer payroll taxes on amounts due after they received notification of forgiveness of the loan. However, the Paycheck Protection Program Flexibility Act enacted on June 5, 2020, eliminated this restriction. Consequently, employers with PPP loans can now make payroll tax deferrals even after forgiveness of their loans.
For more payroll tax deferral information, see the IRS FAQs and RSM’s summary of the law and the FAQs. While the CAA extended other payroll relief items into 2021, this deferral ended Dec. 31, 2020. However, some employers are considering paying some of the deferred taxes earlier than required which is discussed here.
Employee retention credit
The employee retention credit under the CARES Act gives employers a payroll tax credit for certain wages and health plan expenses paid while an employer is experiencing an economic hardship due to COVID-19. Eligibility for the employee retention credit was originally not available for PPP borrowers, but the CAA retroactively changed that so that wages not used for PPP loan forgiveness may still be used for the employee retention credit.
There are two events that qualify as an economic hardship for purposes of the employee retention credit. First, employers may qualify for the credit if their business if fully or partially suspended by a governmental order due to COVID-19. Governmental orders include federal, state or local orders that limit commerce, travel or group meetings (for commercial, social, religious or other purposes) including stay-at-home orders and orders closing or limiting operations or business hours. The second event is a significant decline in the employer’s gross receipts that occurs when its gross receipts for a calendar quarter in 2020 are less than 50 percent of its gross receipts in the same quarter in 2019. The decline ends after the employer’s gross receipts for a quarter in 2020 are greater than 80 percent of its gross receipts in the same quarter in 2019.
For 2021, the CAA changed the significant decline in gross receipts to less than 80 percent of the corresponding quarter in 2019 (or employers can choose to use the immediately preceding quarter as compared to that same quarter in 2019).
The employee retention credit is based on the qualified wages paid to employees, plus related health plan expenses, during the employer’s period of economic hardship. For 2020, employers averaging 100 or fewer full-time employees (working at least 30 hours per week) in 2019 can take the credit on all wages and health plan expenses paid to all employees during the economic hardship, whether or not the employees were performing services during this time. However, employers with more than 100 full-time employees in 2019 can only claim the credit on wages and health plan expenses for employees while not performing services during the employer’s economic hardship, such as when they are laid-off, furloughed or working reduced hours. For 2021, this limit goes up to 500 or fewer instead of 100 or fewer.
Health plan expenses include employer and employee pretax contributions for group medical, dental and vision coverage, plus contributions to health reimbursement arrangements (HRAs) and health flexible spending accounts (FSAs). The IRS recently reversed its position regarding the treatment of health plan expenses for employees not performing services. Originally, its interpretation of the law was that employees had to be paid wages while not working in order for their health plan expenses to qualify for the credit. However, on May 7, 2020, the IRS decided that health plan expenses could qualify for the credit even if the employees received no wages (such as while laid-off or furloughed) or received reduced wages for working reduced hours.
The employee retention credit is 50 percent of wages paid between March 13, 2020 and Dec. 31, 2020, plus related health plan expenses, and is limited to $5,000 per employee (50% of wages and health plan expenses of up to $10,000) for 2020. For Jan. 1, 2021 through Jun. 30, 2021, the credit is 70 percent of wages paid up to $10,000 per quarter per employee. The calculation of the employee retention credit amount is impacted if the employer also claims other credits such as the FFCRA paid sick leave or paid family leave credits, the section 45S family and medical leave credit or the section 51 work opportunity credit, and any wages used for the employee retention credit cannot also be used for PPP loan forgiveness.
For further details, see the IRS FAQs about the employee retention credit and RSM’s summary of the FAQs for 2020. For more information on the 2021 changes to the employee retention credit, see RSM’s video about these taxpayer-friendly changes.
Paid sick leave credit and paid family leave credit
Employers with fewer than 500 employees must provide paid sick leave and paid family leave to employees impacted by COVID-19 from April 1, 2020 to Dec. 31, 2020, pursuant to the FFCRA. The CAA extended this date to Mar. 31, 2021. When calculating the number of employees for related employers, aggregation rules under the Family and Medical Leave Act apply.
Employees are eligible for up to 80 hours of paid sick leave if they are unable to work or telework due to a need to quarantine or seek a medical diagnosis for COVID-19, care for someone quarantined, or care for a child because the child’s school or daycare facility is closed or daycare provider is unavailable due to COVID-19 precautions. Employees receive their regular pay, or the applicable minimum wage if greater, up to $511 per day ($5,110 in total) for leave for self-care or 2/3 of pay up to $200 per day ($2,000 in total) for leave to care for others or a child.
Employees are entitled to paid family leave if they are unable to work or telework because they are caring for a child due to closure of the child’s school or daycare facility or unavailability of a daycare provider due to COVID-19 precautions. After using their paid sick leave, eligible employees can receive up to 10 weeks of paid family leave at 2/3 of their regular pay up to $200 per day ($10,000 in total).
Employers paying sick leave and family leave wages are entitled to a credit for the wages paid, plus the related employer Medicare tax and health plan expenses for these employees. Health plan expenses include employer and employee pretax contributions for group medical, dental and vision coverage and contributions to HRAs and health FSAs. This refundable credit is applied against employer social security taxes on wages paid to all employees. The FFCRA gives a further tax break to employers since the paid leave wages are exempt from the employer’s share of social security tax.
Department of Labor (DOL) guidance about required paid sick leave and paid family leave includes FAQs and temporary regulations. Additional helpful information is available on the DOL’s FFCRA website. The IRS has issued FAQs regarding the payroll tax credits associated with paid leave. RSM has summarized the DOL FAQs about paid leave and the IRS FAQs about the related payroll tax credits.
Payroll tax relief program utilization
The first step in utilizing the payroll tax relief programs is identifying whether an employer is eligible for a given program. As noted above, the eligibility requirements vary among the programs so an employer could be eligible for some, but not all, of the programs. Determining eligibility for the employee retention credit can be especially challenging due to the aggregation rules for related employers, and the need to determine economic hardship by reviewing multiple governmental orders and/or compiling various financial data. Employers may need to work with their professional advisors to determine eligibility.
Once an employer determines it is eligible for a program, it must identify the employees and their expenses (such as wages, payroll taxes and health plan expenses) that are taken into account under the program. These will differ based on the requirements of each program. The eligible expenses must be identified before the amount of the deferral or credits for a quarter can be computed.
Employers may need to utilize new payroll codes to identify eligible wages for certain employees. Some employer payroll systems may not be set up to automatically track the relevant expenses so employers may need to compile some or all of the needed data through other processes. In addition, employers using third-party payroll providers will want to obtain a clear understanding of which information the payroll provider can obtain directly from the payroll system and which additional information the employer needs to provide.
Deferral and credit calculation and funding
The next step in the process is to calculate the amount of the payroll tax deferral and credits. An employer’s systems may not automatically perform these calculations so the amounts may need to be determined by other means. The role that a third-party payroll provider has in this step will vary based on the provider and on the payroll tax relief program. Third-party payroll providers’ systems may readily accommodate the payroll tax deferral, but may not calculate the tax credits without additional input from the employer.
In an effort to allow employers to retain cash during the COVID-19 pandemic, Congress permits employers to obtain the payroll tax credits through reduced payroll tax deposits or advance refunds. First, an employer computes its payroll tax credits for a given period and compares the credits to the federal employment taxes due. The employer can then reduce its next scheduled deposit of federal employment taxes (both employer taxes and employee withholdings) by the amount of the anticipated credits.
If the credits exceed the amount of the deposit due, the employer can either reduce subsequent federal employment tax deposits or request advance refund(s) of the credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19. Alternatively, the employer can wait until it files its quarterly Form 941 to obtain the cash associated with the credit.
The Form 7200 can be filed at any time before the end of month following the quarter in which the qualified wages were paid. However, the form cannot be filed after the Form 941 for the fourth quarter has been filed or to request an advance payment for any anticipated credit for which deposits were previously reduced.
Example 1: An employer calculated a credit of $50,000 and has $80,000 of federal employment taxes due on wages for all of its employees for a given period. The employer can withhold the $50,000 anticipated credit from the $80,000 of taxes due and deposit the remaining $30,000 on its normal deposit schedule. Alternatively, the employer can deposit the full $80,000 and obtain a $50,000 refund for the credit after filing its quarterly Form 941.
Example 2: An employer calculated a credit of $100,000 and has $80,000 of federal employment taxes due for a given period. The employer can withhold $80,000 for the anticipated credit from the federal tax deposit(s) due. It can then file Form 7200 to obtain the additional $20,000, or wait and obtain the additional $20,000 by requesting a refund on its quarterly Form 941. Alternatively, if the employer chooses not to withhold $80,000 for the anticipated credit from its federal tax deposits, then it could receive a $100,000 refund after filing its quarterly Form 941.
In general, employers are protected from penalties for reducing their federal employment tax deposits for these anticipated credits per IRS Notice 2020-22. To avoid penalties, employers must have (1) paid qualified wages to its employees in the calendar quarter prior to the time of the required deposit, (2) reduced the deposit by no more than the anticipated credit, and (3) not filed Form 7200 to seek an advance refund.
Additional guidance on advance payments of the extended employee retention credit provided by the CAA is not yet available.
Deferral and credit reporting
The Form 941 was not revised for the first calendar quarter of 2020 to reflect the provision to claim deferral of deposits from March 13 for the employee retention credit and March 27 for the FICA deferral. However, the Form 941 and the accompanying instructions were revised for the second, third and fourth quarters of 2020 to reflect the applicable employment tax deferrals. Any credits calculated for the first quarter can be claimed on the revised second quarter Form 941.
Employers will report their deferrals and credits on this form and reconcile these amounts with any reduced federal employment tax deposits or advance refunds. If the payroll tax credits exceed the employer social security tax due, the excess can be refunded to the employer or applied to the next calendar quarter.
The revised Form 941 includes a worksheet which is used to calculate the employee retention credit. The output of the worksheet is used to populate Pages 1 and 2 of Form 941 and determine the final credit due after allowance for and prior FICA deferral or advance credits claimed.
In order to complete the revised Form 941, employers will need to know the following information for the calendar quarter:
- Deferred amount of the employer share of social security tax
- Qualified sick leave wages and qualified family leave wages and allocable health plan expenses
- Qualified wages for the employee retention credit and allocable health plan expenses
- Qualified health plan expenses allocable to paid sick leave and family leave wages.
- Any amount claimed under the Work Opportunity Tax Credit (WOTC) as reflected on Form 5884-C.
- The amount of any Research Payroll Tax Credit claimed on Form 8974
- Total advances received from filing Forms(s) 7200 for the quarter
- For the second quarter return only, qualified wages for the employee retention credit and allocable health plan expenses paid in the first calendar quarter from March 13, 2020 through March 31, 2020, as the IRS determined that they should be reported on the second quarter Form 941 rather than the first quarter Form 941
If an employer is unable to accurately determine and report this information on its Form 941 for a given quarter, it can modify the return later. An employer can correct a prior return by timely filing Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.
These payroll tax relief programs offer an opportunity to employers to save money by reducing their 2020 and 2021 payroll taxes. However, the rules for the programs are complex and employers may need to work closely with their advisors and payroll providers to utilize these programs.
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