April 2, 2020
These are trying times for small business owners; for many, the continued viability of their life’s work is in doubt on a daily basis. In recent weeks, Congress has done its part, enacting well in excess of $2 trillion in relief measures, many targeted specifically at those businesses with fewer than 500 employees. Well-intentioned as the relief may have been, it has created no shortage of confusion, as some provisions force employers to pay family and sick leave wages that were previously not required, while others create new categories of payroll tax credits.
Making matters more confusing, recent guidance from the IRS governing the new payroll tax credits has differed wildly from the underlying legislative text. The guidance, however, has been VERY favorable to small employers; thus, it’s vital that all business owners are aware of the opportunities being afforded to them to maximize cash over the coming weeks and months.
Let’s take a look at the three new payroll credits created in the past month — credits for paying mandated family and sick leave related to COVID-19 and a credit for continuing to pay employees throughout a downturn — before then examining how guidance from the IRS will allow employers to reap the benefit of those credits much sooner than the new law originally allowed.
Family and Sick Leave Credits
As part of the Coronavirus Relief Act, Congress modified the Family and Medical Leave Act of 1993 to require employers with fewer than 500 employees to pay 10 weeks of family leave and two weeks of sick pay to eligible employees impacted by COVID-19.
These rules take effect April 1, 2020, and on a high level, they work like this:
Any employee who has been employed for at least 30 days is required to receive 12 weeks of leave —the last 10 of which must be paid — related to COVID-19 for one reason and one reason only: the employee is “unable to work (or telework) due to a need for leave to care for the son or daughter under 18 years of age of such employee if the school or place of care has been closed, or the child care provider of such son or daughter is unavailable due to a public health emergency.”
As a result, an employee is NOT required to receive paid leave because the business shut its doors — voluntarily or at the behest of the government — or because the employee has been temporarily furloughed. In fact, an employee isn’t even entitled to 10 weeks of paid leave when the EMPLOYEE gets sick; rather, the leave is reserved for a situation where the employee must care for a minor child.
Any employee that fits that description is entitled to 12 weeks of leave. The first two weeks of leave can be unpaid, or the employee can elect to use accrued vacation or sick time. Alternatively, as we’ll see below, the employee could receive two weeks of required sick pay during that stretch. After the first two weeks, however, the Act requires that the next 10 weeks of family leave MUST be paid, and must be paid based on the number of hours the employee would work during that period at 2/3 of the employee’s regular rate of pay. The required family leave is capped, however, at $200/day per employee and $10,000 in the aggregate.
Lastly, family pay is not subject to the employer’s 6.2% share of the Social Security tax.
Example. On April 1, 2020, A takes 12 weeks of leave from his job at X Co. to take care of A’s 12-year old son, whose school has been shut down by COVID-19. A would normally work 400 over a ten-week period, and his regular rate of pay is $24/hour.
For the ten weeks, A is required to be paid at least $16/hour for the full 400 hours. This is pay of $128/day, which does not exceed the limit of $200/day, and total compensation of $6,400, which does not exceed the aggregate cap of $10,000. Thus, A is paid $6,400 for the final 10 weeks of his 12 week leave.
The Coronavirus Relief Act also permits any employee — regardless of length of service — to receive two weeks (80 hours) of paid sick leave if the employee is:
If the sick pay is based on reasons 1-3, it is paid at the employee’s regular rate for 80 hours (for a full-time employee). The compensation is capped, however, at $510/day and $5,110 in the aggregate.
If sick pay is made for the latter three reasons, the 80 hours is paid at 2/3 of the employee’s regular rate. Sick pay, like family pay, is not subject to the employer’s share of Social Security tax.
Example. Continuing the example above, on April 1, B takes two weeks of sick leave from X Co. because her doctor asked her to self-quarantine after being exposed to someone with COVID-19. B’s regular rate of pay is $30/hour. Because this is reason #2 for leave — something is wrong with the EMPLOYEE — X Co. is required to pay B her full rate of pay, or $2,400. Because this amount does not exceed the aggregate cap of $5,110, B is paid the full amount.
Employer Payroll Credits
It may strike you as odd that Congress would force employers to make additional wage payments during a time when most are struggling to fund their standard payroll. The idea, however, is that payment of the family and sick leave should come at no net cost to the employers.
This result is achieved through two new payroll tax credits: effectively, an employer required to pay family or sick leave is allowed to claim a credit against the employer’s 6.2% share of the Social Security taxes paid on all wages. Any credit in excess of this amount is fully refundable.
The credit is increased by the employer’s group health care costs allocable to the family and sick leave paid, and is also increased by the employer’s 1.45% share of Medicare tax. To prevent double dipping, the employer must reduce its deduction for wages by the amount of the credit it receives (in other words, the employer will not receive both a deduction and a credit for the family and sick leave wages paid).
Example. Building on our continuing example, X Co. is required to pay $6,400 in family leave to A and $2,400 in sick leave to B. Assume that X Co.’s health care costs allocable to those wages was $200. In addition, X Co. pays $127 in Medicare taxes on the $8,800 in wages.
As a result, X Co. is entitled to a credit against its 6.2% share of Social Security taxes on ALL wages paid of $9,127, the exact amount X Co. was required to pay in family and sick wages, payroll tax, and allocable health care costs. Under normal procedures, X Co. would make all of its normal payroll deposits, and when it files its quarterly Form 941, claim a credit and request for refund of $9,127.
As we’ll see shortly, however, the IRS is allowing employers like X Co. in the above example to not have to wait to file a payroll tax return in order to receive a refund of excess credits. But first, there’s one more credit we’ve got to throw in the mix....
Employee Retention Credits
In addition to the family and sick leave credits, a third payroll tax credit was born as part of the recently-enacted CARES Act. This credit rewards employers for continuing to pay employees even when the business has been required to close by a government agency or has suffered a large drop in revenue.
But before we focus on who can claim the new “employee retention credit,” we should mention who CAN’T: any business that intends to borrow amounts pursuant to the new “Paycheck Protection Loan” program created by the CARES Act. This loan program, which allows a small business to borrow 250% of its average monthly payroll and then have the first eight weeks of payroll costs as well as mortgage, rent and utility payments FORGIVEN, promises to be extremely popular, and the CARES Act makes clear that any taxpayer borrowing under this program is ineligible for the employee retention credit.
Paycheck Protection Loans are only available to those with fewer than 500 employees, however; the employee retention credit has no such limit. As a result, there will be plenty of large employers who utilize the credit, and it works like so...
To have any hope of claiming the credit, an employer must identify a calendar quarter in 2020 in which one of the following two events occurred:
For any eligible quarter, an employer can claim a payroll credit against its 6.2% share of Social Security tax equal to 50% of the “qualified wages” it paid during the quarter. Qualified wages, in turn, will depend on the employer’s number of employees.
If an employer has more than 100 employees - after aggregating employees of related employers — the only wages that are “qualified” are those paid during the eligible quarter to those employees who are being paid NOT TO WORK.
If, however, an employer has fewer than 100 employees, the qualified wages are ALL WAGES paid to any employee for that quarter, whether the employee is working or not.
In either case, however, the qualified wages taken into account for any one employee is capped at $10,000 for ALL QUARTERS. In addition, by definition, qualified wages can only be paid from March 12, 2020 to December 31, 2020; once we get to 2021, the credit disappears.
As mentioned, once qualified wages are identified, the credit is equal to 50% of those wages. Thus, for any one employee, the credit tops out at $5,000. Similar to the family and sick leave credits, the credit is increased by the health care costs allocable to the qualified wages (subject to the cap of $10,000), and the employer’s deduction for wages must be reduced by the amount of the credit.
One other important interaction between the family and sick credits and the employee retention credit: you can’t claim both credits for the same wages paid. So if an employer pays $5,000 in sick wages to a taxpayer during a quarter in which gross receipts has dropped more than 50% from the prior year, you are entitled to a sick leave credit, but not also an employee retention credit.
Example. X Co. was in business for all of 2020. From April 1 through June 30th, X Co. had to shut its doors by government order, and its 6 employees were sent home. They were still paid wages of $6,000 each for the quarter. From July 1st through September 30th, the business reopens its doors, but gross receipts are only 30% of what they were for the same period in 2019. The 6 employees are paid $5,000 each for this quarter. From October 1, 2020 through December 31, 2020, the gross receipts of X Co. returns to 85% of the prior year’s 4th quarter.
Because X Co. has fewer than 100 employees, it can count the wages paid to its six employees for both the 2nd and 3rd quarters of 2020, up to $10,000 each. The credit for Q2 is $18,000 (50% * $36,000). The Social Security liability was $2,232. Thus, X Co. will get a credit of $15,768.
For Q3, X Co. will get a credit of $24,000 (6 employees * $4,000, because qualified wages are capped at $10,000). The credit is $12,000 and the Social Security tax is $1,860; thus, the refund is $10,140.
Thus, between Q2 and Q3, X Co. will generate a credit of $30,000. Assume that the allocable heath care costs on the qualified wages for each quarter was $2,000, for a total credit of $34,000: $20,000 for Q1 and $14,000 for Q3. Assume further that the qualified wages paid by X Co. were not a duplication of the family and sick leave wages paid in the earlier example.
[Note: If X Co. had 110 employees who were each paid $6,000 in Q2 and $5,000 in Q3, because X Co.’s total employees exceeded 100, X Co. could only count as qualified wages those wages paid to the 110 employees during times the employees were not working in Q2. X Co. could not count the wages paid to employees during the drop in gross receipts period because it has more than 100 employees. Thus, the credit would be limited to 50% of $6,000 of wages each.]
Instant Cash for Creditable Amounts
If you’ve stuck with me this long, you’ve learned that the family, sick, and employee retention credits are designed to reduce the employer’s 6.2% share of Social Security taxes on all wages paid, with any excess credit being refundable to the employer. As discussed above, however, this would put a burden on employers, because they would be required to make their monthly or bi-monthly payroll deposits as scheduled, only to then have to wait to file a payroll tax return in order to claim the credit and corresponding refund.
This morning, however, the IRS finalized Form 7200, Advance Payment of Employer Credits Due to COVID-19, which builds on previous guidance issued under IR-2020-57 and is very friendly to employers. The two forms of guidance allow an employer to:
It’s best to illustrate the leniency afforded by IR-2020-57 with an example:
Example. Building on our previous example, X Co. had $9,127 in family and sick leave credits and $20,000 in total employee retention credits in Q2, 2020. Assume that during the months of April, May, and June, X Co. would have been required to make payroll deposits totaling $40,000: $25,000 in federal income tax withholding on the employees’ wages and $15,000 in employer and employee share of Social Security and Medicare taxes.
Rather than remit payment of $40,000 and then request a refund upon the filing a quarterly Form 941, X Co. may reduce its required payroll deposits by the anticipated amount of family, sick, and employee retention credits of $29,127. As a result, X Co. will make only $10,873 of deposits, and have the additional $29,127 available to pay the family and sick leave, as well as qualified employee retention wages equal to the amount of the eventual credit.
To allow employer’s to pocket required deposits for federal withholding and employee payroll taxes in order to pay wages currently is extremely forgiving. But what if the amount of an employer’s credits will exceed the required payroll deposits? That’s where new Form 7200 comes in. An employer who anticipates generating credits in excess of its required payroll deposits may file Form 7200 to request an advance of the refund amount. Form 7200 can be filed at any time during the quarter in which the employer pays wages giving rise to the credits, and it must be filed before the end of the month following the quarter. The IRS has promised to pay the advance refund within 2 weeks.
Example. Building on our previous example, in Q3, X Co. has no family or sick leave credits, but does have $14,000 in employee retention credits. Assume that the total amount of federal income tax withholding and payroll taxes during the quarter is $12,000. When making its payroll deposits for Q3, X Co. may retain the $12,000 in withholding and payroll taxes and instead use the $12,000 to pay the qualified wages. X Co. is still owed $2,000, however, as the credit of $14,000 exceeds the total of all withholding and payroll taxes by $2,000. At any time during Q3 — or as late as the end of the month following Q3 — X Co. may file Form 7200 to request an immediate refund of the additional $2,000, even before X Co. has filed the Form 941.
Employers will need as much cash on hand as possible to weather the turbulence of the coming months. By allowing small business owners to reduce their required payroll deposits by the anticipated sick, family and employee retention credits, IR-2020-57 and Form 7200 represent positive steps in that direction.
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