Guidance covers payroll tax credits for employers impacted by COVID-19
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides an employee retention credit to employers that keep employees on their payroll despite facing an economic hardship due to COVID-19. After enactment of the CARES Act on March 27, 2020, the IRS issued 17 questions and answers (FAQs) regarding the employee retention credit. The IRS subsequently expanded the FAQs to cover 95 questions and answers.
On May 7, 2020, the IRS revised, deleted and renumbered various questions so that there are once again 94 questions and answers. In particular, the IRS revised its position on determining qualified health plan expenses for certain employees who are furloughed or working reduced hours, and on the interaction between the employee retention credit and Paycheck Protection Program loans. Here is a summary of the IRS guidance including the updates from May 7, 2020.
General information (Q&A 1-15). The employee retention credit is a refundable payroll tax credit of up to $5,000 per employee for the year (50% of up to $10,000 of qualified wages paid March 13, 2020 to Dec. 31, 2020, including allocable health plan expenses). The credit is available for employers that carry on a trade or business and either (1) fully or partially suspend operations during 2020 due to orders from a governmental authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to COVID-19, or (2) experience a significant decline in gross receipts. The credit is allowed against the employer’s share of social security taxes due for all employees and is claimed on the employer’s payroll tax returns. For employers subject to the Railroad Retirement Tax Act (RRTA), the credit applies against the portion of RRTA taxes that corresponds to social security taxes.
For employers that averaged 100 or fewer full-time employees in 2019, qualified wages are the wages paid to any employee during a period of economic hardship as described above. For employers with more than 100 full-time employees in 2019, qualified wages are the wages paid to employees for the time that they are not providing services due to the economic hardship. Qualified wages are taxable income to employees subject to payroll taxes, and are considered wages for purposes of other employer benefits, such as contributions to 401(k) plans.
Private sector and tax-exempt employers (Q&A 16, 17 and 20). In general, a private-sector employer or tax-exempt organization of any size (regardless of the number of employees) that is carrying on a trade or business can claim the credit if its operations are fully or partially suspended by a COVID-19 governmental order or it has a significant decline in gross receipts. A private-sector employer is carrying on a trade or business if the facts and circumstances indicate that its primary purpose is to make a profit and it conducts its activities on a regular and continuous basis. Tax-exempt organizations under section 501(c) are deemed to be carrying on a trade or business by the IRS and may be eligible employers if they otherwise meet the credit requirements. Employers that obtain a Paycheck Protection Program (PPP) loan are not eligible to claim the employee retention credit.
Other employers (Q&A 18, 19, 21-24). Special rules apply to the following employers:
- Federal, state and local governmental employers and their instrumentalities are not eligible to claim the credit. Although the Internal Revenue Code (IRC) does not define governmental instrumentalities, the IRS has a long established test to determine an organization’s status as an instrumentality of a governmental entity under rules set forth in Rev. Rul. 57-128.
- Indian tribes are distinct governmental organizations with authority to regulate their internal affairs. If a tribe or tribal entity operates a trade or business, the tribe or tribal entity may be an eligible employer and claim the credit if it otherwise meets the requirements. The IRS indicates that additional information will be forthcoming regarding the determination of qualified wages for, and application of the aggregation rules to, tribal organizations.
- Employers in U.S. Territories (e.g., Puerto Rico) that otherwise meet the requirements and pay qualified wages may claim the credit.
- Self-employed individuals may not claim the credit based on their own self-employment earnings, but may claim the credit on qualified wages paid to their employees if they otherwise meet the eligibility requirements.
- Household employers are not eligible for the credit with respect to their household employees because they are not operating a trade or business. If the household employer reports household wages in combination with trade or business wages on a quarterly payroll tax return, the employer cannot consider the household wages in calculating the credit.
Aggregated employers (Q&A 25-27). The FAQs provide guidance on the aggregation rules that treat more than one entity as a single employer. The aggregation rules affect whether an employer (1) has a trade or business operation suspended by a COVID-19 governmental order or has a significant decline in gross receipts, (2) has more than 100 full-time employees, or (3) is unable to claim a credit because another member of the aggregated group received a PPP loan.
For the employee retention credit, the CARES Act treats individual businesses and organizations as a single employer if they are an aggregated group under section 52(a), 52(b), 414(m) or 414(o). Members of an aggregated group must apportion the employee retention credit based on each group member's proportionate share of the qualified wages included in the credit computation.
Under section 52(a), businesses are in an aggregated group if they are members of a parent-subsidiary controlled group, a brother-sister controlled group or a combined group. A parent-subsidiary controlled group exists when a parent corporation has more than 50% voting control or owns more than 50% of the value of one or more subsidiary corporations. An employer is a member of brother-sister controlled group when (1) five or fewer individuals, estates or trusts have at least 80% of the voting control or share values of those corporations and (2) more than 50% of the voting control or ownership is identical. A combined group exists when the parent corporation of a parent-subsidiary group is also a member of a brother-sister group. Section 52(b) applies rules substantially similar to the corporate rules to partnerships, limited liability companies, sole proprietorships, trusts and estates.
Section 414(m) treats businesses and organizations as being a single employer if they have sufficient common business relationships and possibly common ownership to require, for benefit plan purposes, aggregation of the employers as affiliated service or management groups. With regard to section 414(o), the IRS has issued regulations that treat a tax-exempt organization that controls another entity’s board of directors (whether the other entity is tax-exempt or not) as a single employer.
Economic hardship due to governmental order
Orders from an appropriate governmental authority (Q&A 28). An employer that carries on a trade or business may be eligible for the employee retention credit if it fully or partially suspends operations during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to COVID-19. An order from an appropriate governmental authority limits commerce, travel or group meetings in a manner that affects an employer’s operation of its trade or business, including orders that limit hours of operations. This includes orders, proclamations or decrees from any federal, state or local government that has jurisdiction over the employer’s operations.
An employer is an eligible employer when a governmental order is in place, without regard to the level of enforcement of the order. Governmental orders include (1) an order from a city’s mayor closing all non-essential businesses for a specified period of time, (2) a state’s emergency proclamation that residents must shelter in place (other than employees of essential businesses) for a specified period of time, or (3) an order from a local official imposing a curfew on residents that impacts the operating hours of a trade or business for a specified period of time.
Voluntary suspension of operations (Q&A 29). When an employer is not subject to a governmental order but voluntarily suspends operation of a trade or business, the employer is not generally eligible to use the ‘fully or partially suspended’ provisions (but might be able to use the 50% decline in gross receipt provisions, if applicable). However, special rules apply if the company operates in multiple jurisdictions and some of the company locations are subject to governmental orders while other locations are not. See further discussion below.
Full or partial suspension rules for essential and nonessential businesses (Q&A 30-32). In general, the FAQs provide that essential businesses might not have a partial suspension of operations even if governmental orders requiring non-essential businesses to close may affect their operations. Furthermore, if the sole effect of a governmental order on a company is a decrease in customers, the FAQs treat the essential business as not having a partial suspension of operations. However, the company may be eligible for the employee retention credit if it has a significant decline in gross receipts.
Example: A governmental order designates an automobile repair service business as an essential business. It is not required to close its locations or suspend its operations. Other governmental orders limit travel and require members of the community to stay at home except for essential travel, such as going to the grocery store. Because of the order, the company’s business has declined significantly. The FAQs treat the company as not having fully or partially suspended operations due to a governmental order.
However, an essential business may have a partial suspension of operations if the company’s suppliers suspend operations, and the company cannot obtain critical goods or materials.
Example: Employer A operates an auto parts manufacturing business that is an essential trade or business in the jurisdiction where it operates. Employer A’s supplier of raw materials is required to shut down its operations due to a governmental order. Employer A is unable to procure these raw materials from an alternate supplier so is unable to perform its operations. Under these facts and circumstances, Employer A would be considered an eligible employer because its operations have been suspended because of a governmental order that suspended operations of its supplier.
Continuing operations under a stay-at-home order (Q&A 33). If a government orders an employer to close, but the employer is able to continue operations comparable to its operations prior to the closure by requiring its employees to telework, then the employer’s operations are not fully or partially suspended.
Operating under a partial shutdown order (Q&A 34 and 35). If a governmental order closes some of a company’s operations but allows reduced operation, the FAQs provide that the company’s operations may be partially suspended. Likewise, if a governmental order requires a company to have limited operating hours, the company’s operations may be partially suspended.
Example 1: A governmental order forces a restaurant to close its sit-down dining, but allows carryout or delivery sales. The company’s operations are treated as partially suspended due to the order.
Example 2: A governmental order forces a retail business to close its retail locations, but allows it to continue to fulfill online orders. The company’s operations are treated as partially suspended due to the order.
Companies or related groups of companies operating in multiple jurisdictions (Q&A 36 and 37). If a company operates a trade or business in multiple jurisdictions and is subject to governmental orders limiting operations in some, but not all, jurisdictions, the FAQs treat the entire company as having partially suspended operations. This is the case even when a company chooses to suspend operations in all of its locations to follow general COVID-19 guidelines even though not all locations are required to suspend operations.
Example: A company is a national retail store chain with operations in various states. In some jurisdictions, the company is required to close its stores, but it can still provide curbside service to pick up items ordered online. In other jurisdictions, stores are not required to close. The retailer establishes a company-wide policy, in compliance with local governmental orders and consistent with the CDC and DHS recommendations and guidance, to close all stores and operate only curbside pick-up, even in jurisdictions where the business was not subject to a governmental order. Because governmental orders required closure of some stores, the FAQs treat the entire company as having partially suspended operations.
The same rules apply to an aggregated group of companies.
Example: A restaurant chain operates through multiple subsidiary corporations located in various jurisdictions. In some jurisdictions, entities have been ordered to close, while entities in other jurisdictions remain open. Because government orders have required certain entities to suspend or limit operations, the FAQs treat all members of the aggregated group as partially suspending operations due to governmental orders.
Suspended operations once governmental order is lifted (Q&A 38). An employer only has full or partial suspension of operations while a governmental order is in effect. Therefore, it can only claim the employee retention credit for qualified wages paid to employees during the time the order is in force.
Economic hardship due to significant decline in gross receipts
Significant decline calculation (Q&A 39). An employer that experiences a significant decline in gross receipts may be eligible for the employee retention credit. If an employer’s gross receipts in a calendar quarter in 2020 are less than 50% of gross receipts in the same calendar quarter in 2019, the employer is treated as having a significant decline in gross receipts. If the employer’s gross receipts later increase and are greater than 80% of its gross receipts for the same calendar quarter in 2019, the significant decline ends on the first day of the following calendar quarter in 2020. The employee retention credit does not continue into 2021.
Example: Company gross receipts were $100,000, $190,000, and $230,000 in the first, second, and third calendar quarters of 2020, respectively. Its gross receipts were $210,000, $230,000, and $250,000 in the first, second, and third calendar quarters of 2019, respectively. Thus, the employer’s 2020 first, second, and third quarter gross receipts were approximately 48%, 83%, and 92% of its 2019 first, second, and third quarter gross receipts, respectively. Accordingly, the company had a significant decline in gross receipts commencing on the first day of the first calendar quarter of 2020 (the calendar quarter in which gross receipts were less than 50% of the same quarter in 2019). The company’s significant decline period ends on the first day of the third calendar quarter of 2020 (the quarter following the quarter in which the gross receipts were more than 80% of the same quarter in 2019). Thus, the company is entitled to the employee retention credit with respect to the first and second calendar quarters.
Definition of gross receipts (Q&A 40 and 43). Gross receipts are defined in section 448(c) and generally include total sales (net of returns and allowances) and all amounts received for services. Gross receipts also include income from investments and from incidental or outside sources (e.g., interest, dividends, rents, royalties and annuities). Gross receipts are generally not reduced by cost of goods sold, but are generally reduced by the employer’s adjusted basis in capital assets sold.
For a related group of companies, the gross receipts test must be determined using the gross receipts of the aggregated group. Even if one of the companies has a significant decline in gross receipts, if the related group of companies, in the aggregate, does not have a significant decline, no member of the related group can claim the employee retention credit using the significant decline in gross receipts test.
Relationship of a significant decline to COVID-19 (Q&A 41). Under the CARES Act, a company is not required to prove a significant decline in gross receipts was directly related to COVID-19. However, all records related to a significant decline in gross receipts for relevant calendar quarters in 2019 and 2020 may be reviewed by the IRS and should be retained for at least four years.
Claiming the employee retention credit after Jan. 1, 2021 (Q&A 42). In the event an employer determines in 2021 that a significant decline in gross receipts occurred during 2020, it may claim the employee retention credit on qualified wages paid during 2020. Generally, the employer would claim the credit by filing a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.
Special rules for companies starting in 2019 or 2020 (Q&A 44 and 45). The FAQs provide special rules for determining the significant decline in gross receipts for companies that started business after the first quarter of 2019. In addition, the FAQs provide special look-back rules for a company purchased in 2020:
- The buying company can look back to the prior company information (if the information is available).
- The buying company may estimate the gross receipts it would have had if it owned the company for the full quarter or may use the gross receipts for the portion of the quarter for which it owned the business.
Gross receipts test for a tax-exempt entity (Q&A 46). The FAQs state that the IRS will issue future guidance on how tax-exempt organizations determine their gross receipts for purposes of the employee retention credit.
Determining the credit amount
Employee retention credit limit (Q&A 47). The employee retention credit is 50% of qualified wages for each employee (including qualified health plan expenses), capped at $10,000 for all quarters. Thus, the maximum employee retention credit available to an employer is $5,000 per employee for the year. This credit amount can be claimed across multiple quarters if the full amount is not used in the first quarter(s) that the credit is applied.
Determining qualified wages (Q&A 48-61). Qualified wages are wages as defined in section 3121(a) and, thus, are wages subject to social security and Medicare taxes (i.e., FICA wages). For railroad employers, qualified wages are compensation as defined in section 3121(e). Qualified wages also include qualified health plan expenses allocated to the wages. Qualified wages are calculated without regard to federal taxes imposed or withheld, and only include wages paid to employees from March 13, 2020 to Dec. 31, 2020, while employed.
Qualified wages do not include:
- Wages for paid sick leave or paid family leave for which the employer receives a credit under the Families First Coronavirus Response Act (FFCRA).
- Wages taken into account by the employer for the paid family and medical leave credit under section 45S.
- Wages paid to certain relatives of individuals owning more than 50% of an entity or having certain other relationships to the entity.
- Payments to former employees after termination of employment, including severance payments.
- Amounts paid that are exempt from social security and Medicare taxes, such as payments to individuals who are not employees.
In addition, employees included for the work opportunity tax credit under section 51 may not be included for the employee retention credit.
Qualified wages are considered for the employee retention credit by an eligible employer based on the average number of full-time employees it employed in 2019. For this purpose, a ’full-time employee’ is an employee who, in any calendar month in 2019, averaged 30 or more hours of service per week or 130 hours of service in the month. Special rules apply if the employer did not operate in all months of 2019 or started operating in 2020. The aggregation rules explained above are applied when determining the number of full-time employees of an employer.
For employers with 100 or fewer full-time employees in 2019, qualified wages include wages paid to any employee when the employer’s operations are fully or partially suspended due to a governmental order or the business has had a significant decline in gross receipts. These wages include paid vacation, sick and other leave (except for paid sick leave or paid family wages under the FFCRA) that employees receive pursuant to a pre-existing policy.
For employers with more than 100 full-time employees in 2019, qualified wages include wages paid to employees when they are not working because the employer’s operations are fully or partially suspended due to a governmental order or the employer has had a significant decline in gross receipts. The following special rules apply to these employers:
- Wages paid to hourly, exempt salaried and non-exempt salaried employees for hours that the employees are not providing services are qualified wages. This includes hours when an employee is not working at all (such as when furloughed) and hours not worked because the employee is on a reduced schedule (such as when working only part of a day or week). An employer cannot treat an employee's hours as having been reduced based on a decrease in productivity during working hours.
- Wages for paid time off (such as vacations, paid holidays, sick days, etc.) cannot be treated as qualified wages. This is because these wages are paid pursuant to existing leave policies that represent benefits accrued during a prior period in which the employees provided services, and are not wages paid for time when the employees are not providing services due to the economic hardship.
- The employee retention credit cannot be claimed for any increase in wages paid to an employee over the amount the employee would have been paid for working an equivalent duration during the 30 days immediately prior to the economic hardship. For example, if an employer gives an employee previously earning $20 an hour a $2 an hour raise to encourage the employee to work during the economic hardship, the employee retention credit can only be claimed for hours not worked, and only on the $20 and not on the additional $2. For employees who do not have a regular schedule or fixed pay amount, the employer can use any reasonable method to determine the amount paid for working an equivalent duration in a prior period.
Updated guidance on determining qualified health plan expenses (Q&A 62-71). Qualified wages include an allocable portion of the qualified health plan expenses paid or incurred by an employer. On May 7, 2020, the IRS changed its position on the allocation of health plan expenses for certain employees as explained below. This change applies to health plan expenses paid or incurred between March 13, 2020 and Dec. 31, 2020 during an employer’s period of economic hardship due to COVID-19.
Per the IRS FAQs prior to May 7, 2020, employers that averaged 100 or fewer full-time employees in 2019 could allocate 100% of the health plan expenses to wages paid to employees working their normal hours or reduced hours. However, these employers could not claim the employee retention credit for health plan expenses allocated to employees laid off or furloughed if they were not receiving wages during that time. Under the revised IRS guidance, these employers can claim the employee retention credit for health plan expenses allocated to employees laid off or furloughed even though they are not receiving wages during this time. Consequently, employers that averaged 100 or fewer full-time employees in 2019 can allocate all of their health plan expenses to all of their employees regardless of their employees’ work hours or receipt of wages for hours not worked.
Employers that averaged more than 100 full-time employees in 2019 can only claim the employee retention credit for health plan expenses for employees not providing services. Previously, the IRS only allowed health plan expenses to be claimed if the employees were receiving pay during the time they were not providing services. However, the IRS reversed its position on May 7, 2020. Consequently, the following rules now apply to employers that averaged more than 100 full-time employees in 2019:
- Employers that lay off or furlough employees without pay but continue their health coverage can claim the employee retention credit for the qualified health plan expenses paid or incurred for these employees while they are not working.
- Employers that reduce their employees’ hours can claim the employee retention credit for the qualified health plan expenses allocated to the hours not worked. This is the case even if the employees are not paid for the hours not worked. For example, if an employer reduces its employees’ hours and pay by 40% but continues to provide full health coverage, 40% of the health plan expenses can be considered for the employee retention credit.
- Health plan expenses allocated to employees for time periods when they are providing services cannot be included for the employee retention credit.
Qualified health plan expenses include employer and employee pretax contributions for group health plan coverage (but not employee after-tax contributions). Employers with fully-insured group health plans may use any reasonable method to determine and allocate the plan expenses including using the COBRA rate, one average premium rate for all employees, or a similar method that takes into account the average premium rate determined separately for employees with self-only and other than self-only coverage. If one average premium rate is used for all employees, the employer may determine a daily rate to allocate to qualified wages pursuant to Q&A 68. Employers that sponsor self-insured group health plans also may use any reasonable method to determine and allocate health plan expenses including using the COBRA rate or any reasonable actuarial method to determine the estimated annual expenses of the plan.
Qualified health plan expenses for an employee also include contributions to that employee’s health reimbursement arrangement (HRA) or health flexible spending account (FSA). Contributions to health savings accounts (HSAs), Archer medical savings accounts and qualified small employer health reimbursement arrangements (QSEHRAs) are not included as qualified wages. In addition, health plan expenses allocated to paid sick leave or paid family wages under the FFCRA cannot be allocated to wages for purposes of the employee retention credit.
Claiming the credit
How to claim the employee retention credit (Q&A 72-74 and 76-77). The updated IRS FAQs provide a reiteration of the general rules for claiming the employee retention credit while adding some clarification on the mechanics. After calculating the credit, the general procedure is to claim the credit on the applicable lines of an employer’s Form 941, Employer’s Quarterly Federal Tax Return. Note the IRS has determined that the credit for the period from March 13 through March 31 in the first quarter of 2020 will be claimed on the Form 941 for the second quarter of 2020. The IRS is currently working on revising the Form 941 to accommodate the credits under the CARES Act and the FFCRA.
However, employers do not have to wait to file their quarterly Form 941 in order to obtain the cash associated with the employee retention credit. The FAQs outline specific steps an employer can take to obtain cash immediately.
In anticipation of the credit, an eligible employer can reduce its federal employment tax deposits during the quarter by the amount of the credit. This will give the employer an immediate boost to its cash flow by foregoing cash deposits it otherwise would make on its required payroll deposit schedule. The employer may hold back the amount of the credit from all components of a federal employment tax deposit including from the employees’ federal income, social security and Medicare tax withholdings plus the employer’s share of the social security and Medicare taxes.
Importantly, the amount by which the employer reduces its deposits cannot exceed the anticipated employee retention credit, or the employer could be subject to failure to deposit penalties under section 6656. The IRS provides three conditions that must occur for an employer to avoid this penalty:
- The employer paid qualified wages to its employees in the calendar quarter before the required deposit.
- The total amount of federal employment taxes that the employer does not timely deposit, reduced by (a) any amount of the employer's share of social security tax deferred under section 2302 of the CARES Act, and (b) any amount of federal employment taxes not deposited in anticipation of the credits claimed for paid sick and/or family leave under the FFCRA, is less than or equal to the amount of the employer's anticipated employee retention credit for the qualified wages for the calendar quarter as of the time of the required deposit.
- The employer did not seek payment of an advance credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, with respect to any portion of the anticipated credits it relied upon to reduce its deposits.
The advance credit under Form 7200 mentioned above is a way for employers to create additional cash flow prior to filing their Forms 941. An employer can use Form 7200 to claim advance payment of the credit if the credit exceeds its federal employment tax deposits. Please note that the calculation on the Form 7200 factors in wages paid for paid sick leave and paid family leave pursuant to the FFCRA as well.
The employer must reconcile the employee retention credit, the reduced federal employment tax deposits and any advance credits on its quarterly Form 941.
How to claim the employee retention credit – aggregated entities (Q&A 75). The FAQ makes clear that eligible employers, who are otherwise grouped under the aggregation rules (as discussed above), will still file their credit claims on their own payroll tax returns without regard to such aggregation. However, the amount of the credit will be apportioned according to their proportionate share of qualified wages within the aggregated group.
Interaction with other credits (Q&A 78 and 80-83). The most significant limitation on the employee retention credit is the exclusion for employers that have received a loan under the Paycheck Protection Program. This has the effect of excluding the entire aggregated group if any member of the employer’s aggregated group receives a PPP loan. The guidance also notes that eventual forgiveness (or lack thereof) of a PPP loan does not factor in to eligibility for the employee retention credit. Once an employer or a member of its aggregated group receives a PPP loan, that employer and the entire aggregated group appear to be permanently excluded. However, see the guidance below about repayment of PPP loans.
As noted earlier, the employee retention credit cannot be taken on wages claimed for the paid family and medical leave credit under section 45S, and an employee cannot be included for the employee retention credit if included for the work opportunity tax credit.
Updated guidance on Paycheck Protection Program loans (Q&A 79). On May 7, 2020, the IRS updated the FAQ about employers that repay PPP loans. If an employer applies for a PPP loan, receives payment and repays the loan by May 18, 2020 (previously May 7, 2020), the employer will be allowed to claim the employee retention credit if otherwise eligible. There are specific rules that the employer needs to follow regarding this repayment that are detailed in the Limited Safe Harbor With Respect to Certification Concerning Need for PPP Loan Request section of the Interim Final Rule issued by the Small Business Administration (SBA) effective on April 28, 2020.
Employee income and deductions (Q&A 84). The guidance confirms that qualified wages cannot be excluded from employee income as qualified disaster relief payments under section 139. Even though the COVID-19 pandemic is a qualified disaster, qualified wages are not excludable qualified disaster relief payments because they are what the employee would otherwise earn as compensation and are not payments to offset any particular expenses incurred as a result of COVID-19.
Employer income and deductions (Q&A 85-86). The employer’s deduction for wages expense must be reduced by the amount of the employee retention credit under rules similar to section 280C(a). Accordingly, an employer that receives an employee retention credit is not required to include any portion of the credit in gross income.
Use of third-party payers (Q&A 87-92). Third-party payers include payroll reporting agents, professional employer organizations (PEO), certified professional employer organizations (CPEO), payroll service providers and agents as defined under section 3504. An eligible employer (also known as the common law employer), who is otherwise eligible to receive the credits, is entitled to employee retention credits regardless of whether it uses a third-party payer to report and pay its federal employment taxes. The third-party payer is not entitled to the employee retention credits regardless of whether the third-party payer is considered an ’employer’ or ’co-employer’ for other purposes of the IRC.
Rules for claiming and reporting the credits vary depending on the type of third-party payer the employer uses:
- Payroll reporting agents will need to reflect the employee retention credit on the Form 941 it files on the employer's behalf.
- A CPEO or 3504 agent will report the credits for the employer on its aggregate Form 941 and Schedule R, Allocation Schedule for Aggregate Form 941 Filers that it already files. An employer can submit its own Form 7200 to the IRS to claim the advance credit; however, it will need to provide a copy of the Form 7200 to the CPEO or 3504 agent so these third-parties can properly report the credit on the Form 941.
- A PEO (also known as non-certified PEO) will report the credits for the employer on an aggregate Form 941 and separately report the credits allocable to the employer on an accompanying Schedule R. The PEO does not have to complete Schedule R with regard to employers for which it is not claiming a credit. The employer will need to provide a copy of any filed Form 7200 to the PEO so it can properly report the credit on the Form 941.
Although employers may submit their own Form 7200, payroll reporting agents are also able to sign and file the Form 7200 on the employer’s behalf if the agent already has the authority (via Form 8655, Reporting Agent Authorization) to sign and file employment tax returns for the employer and receives written authorization from the employer to file the Form 7200. The reporting agent’s signatory must be the same signing party listed on the agent’s e-file application. Existing rules regarding signature mediums and methods apply (see Rev. Proc. 2005-39, 2005-28 I.R.B. 82). If the reporting agent does not have signing authority, the reporting agent may still prepare the form, but must have the employer sign before filing.
Third-party payers who are authorized to claim the employee retention credit on an employer’s behalf must obtain all relevant information before filing. This includes information on any other credits the employer may be claiming (including any credits under the FFCRA or section 45S), or whether the employer has received a Paycheck Protection Program loan. The responsibility for avoiding ’double benefit’ or duplicate claims between the employee retention credit and the section 45S credit falls on both the employer and the third-party payer, and both will be liable for any unpaid employment taxes that are due in relation to improperly claimed credits.
When obtaining the necessary information to claim the credit on behalf of an employer, a third-party payer may rely on the employer’s information regarding eligibility; the third-party payer does not need to maintain the actual records proving eligibility. However, if the IRS requests proof of eligibility, the third-party payer must then obtain and provide the records. The third-party payer and the employer will both be liable for unpaid employment taxes that are due in relation to improperly claimed credits. The IRS has not provided a list of specific documents that the third-party payer must obtain as proof of eligibility; however, in general, the third-party payer must provide any records that support the employer’s eligibility for the credit.
Election to forego the employee retention credit (Q&A 93-94). An employer may forego claiming the employee retention credit for any calendar quarter by not claiming it on the Form 941 for that quarter. If the employer later decides to claim the credit for a prior quarter, it may do so by filing Form 941-X. If an employer elects to forego the credit in one calendar quarter, it may still claim the credit in a subsequent quarter on qualified wages paid in that subsequent quarter (provided it otherwise meets the requirements). However, an employer may not claim a credit in a subsequent quarter for wages paid in a prior quarter. For example, an employer could not claim a credit in the third quarter for qualified wages paid in the second quarter.
The expanded FAQs from the IRS provide welcome guidance to employers with business operations impacted by COVID-19. Employers are encouraged to work with their advisors when determining their eligibility for the credit, calculating the amount of the credit, and claiming the credit on the IRS forms.
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