What is the Employee Retention Credit? How It Works and What Businesses Qualify
May 7, 2020: Recent guidance clarifies the Paycheck Protection Program loan in relation to the employee retention credit.
May 11, 2020: The IRS clarified when you can use health expenses for purpose of the employee retention credit.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law in late March, provides economic relief to businesses and individuals. The stimulus package, which made $370 billion in funding available to small business, contains a provision allowing certain employers to claim a tax credit for retaining employees during the crisis.
This provision – the employee retention credit – allows eligible employers to take a payroll tax credit for retaining employees during this crisis. Eligible employers will be able to claim a credit against 50 percent of wages paid per quarter, up to $10,000 per employee annually for wages paid between March 13, 2020 and the end of the year.
It's important to note that all guidance originally released since the implementation of the CARES Act has indicated that any employer taking a Paycheck Protection Program (PPP) loan is not eligible for the employee retention credit. Additionally, any employer that is a member of aggregated group (controlled and affiliated service groups) who receives a PPP loan, will impact the other members. None of the members will be eligible for the retention credit if even one member receives a PPP loan.
However, the Small Business Administration (SBA) and the U.S. Treasury Department issued new guidance that addresses the interaction of the PPP and the employee retention credit. The new guidance now allows employers that have taken a PPP loan and repaid the loan by May 14, 2020 under the SBA safe harbor, will now be eligible to take advantage of the credit.
This is a complex evaluation, but you can start with evaluating if you are eligible for the retention credits. IRS informal guidance can help clarify whether you qualify and how these credits work to help you make an informed decision.
The IRS has provided robust unofficial guidance in the form of FAQs to flesh-out how the credit works for employers. While this guidance is only informational, not legal authority, it gives the general direction the IRS intends to go with these credits.
Here is a brief overview of what employers need to know about the credit. Employers should refer to the IRS FAQs on the employee retention credit to find more details.
What employers can qualify for the employee retention credit?
Generally, most employers, including tax exempt organizations, can qualify for the credit. There are specific entities that cannot qualify including self-employed income (employee wages can be included), household employers, and government employers including instrumentalities
Eligible employers’ qualification is determined by one of two factors, and one of these factors must apply in the calendar quarter the employer wishes to utilize the credit:
- Trade or business that is fully or partially suspended due to a government order. The credit applies only for the portion of the quarter the business is suspended, not the entire quarter. This factor may apply if businesses are required to reduce business hours due to government order. The IRS clarified that some businesses that operate in multiple geographies where only some of their locations are ordered closed, may still qualify under this first factor if they apply the suspension rules across their locations. Additionally, aggregated groups are treated as a single employer.
The IRS also clarified which businesses do not meet this factor test. Generally, businesses that are consider essential would not qualify under this factor, unless they have supply of critical material/goods disrupted in manner that affects their ability to continue to operate. It does not matter if some of these essential businesses are impacted by non-essential orders that impact revenue. Additionally, businesses shuttered but able to continue their operations largely intact through telework do not qualify under this first test. However, any of these businesses still may qualify for the credit with the second factor test.
- An employer that has a significant decline in gross receipts. In general, the employer is first considered eligible for the credit under this factor test when gross receipts in a calendar quarter is below 50% of gross receipts when compared to the same calendar quarter in 2019. They are no longer eligible under this factor test the calendar quarter immediately following the quarter gross receipt exceed 80% compared to the same calendar quarter in 2019.
The IRS clarified that an employer can go back and amend the Form 941 filing if they determine later that they qualified for the credit. The IRS also qualified rules for new businesses that allow them to use the gross receipts for the quarter they started business as a reference for any quarter which they do not have 2019 figures because they were not in business, using estimates if they started mid-quarter. It’s important to note that a member of controlled or affiliated service groups are considered a single employer, so they must aggregate their gross receipts to determine when and if they qualify under this test.
Another important note: If any member of these aggregated groups got a PPP loan, then this single employer grouping negates the ability for all other members from utilizing the employee retention credit in 2020, unless the loan is repaid by May 14, 2020, under the SBA safe harbor, according to the most-recent guidance issued by the SBA and the U.S. Treasury Department. Keep in mind, the PPP does not aggregate the group, so members would apply separately. This could have significant ramifications on these aggregate groups.
What is the amount of the employee retention credit?
The employee retention credit is 50% of qualified wages (including health benefits). The maximum amount of qualified wages is $10,000 per employee. Essentially, the maximum credit is $5,000 per employee (50% of $10,000) for the year.
What wages qualify when calculating the retention credit?
In general, wages/compensation and qualified health expenses paid after March 12, 2020 through the end of the year qualify. Wages/compensation are defined as those amounts subject to FICA. Additionally, paid leave wages required under the Families First Coronavirus Response Act (FFCRA) paid leaves are not included in qualified wages. The IRS clarified pay to terminated employees such as severance payments are not included in qualified wages. Also, pay to certain individuals related to the employer are excluded.
To determine the qualified health expenses, the IRS has devised various ways of calculating depending on circumstances. Generally, they include the employer and employee pretax portion and not any after-tax amounts. Additionally, the IRS clarified that employers, that qualify the retention credit, may utilize the health plan expenses as qualified wages even if there are no or reduced hours/wages. This may lessen some of the financial burden on employers who qualify for this credit if they choose or are required to continue health benefits.
Generally, the qualified wages that an employer may include depend on if they had more or less than 100 employees in 2019. The 100-employee threshold utilizes 4980H (employer shared responsibility provision in the ACA) calculation of employee count to determine if the employer exceeds the 100 full-time and full-time equivalent threshold.
Employers with more than 100 employees can only use the qualified wages of employees not providing services because of the suspension or decline in business. Wages paid for sick, vacation or other days off due to an existing employer policy, cannot be included in qualified wages for larger employers. So, these larger employers can only utilize the credit to pay for employees not working.
Additionally, there are guardrails to prevent certain wage increases, after the employer is eligible for this credit, to count toward the credit. Employers with 100 or less employees can use all employee wages, including those still providing services and any time away from work outside of FFCRA paid leave.
The IRS has also ensured there is no double-dipping for credits. Consequently, employers who take this credit on certain wages cannot take the credit on those wages for paid family medical leave under section 45S of the Internal Revenue Code. Additionally, an employee included for the Work Opportunity Tax Credit under section 51 of the Internal Revenue Code may not be included for purposes of the employee retention credit. Essentially, employer’s taking these other credits should evaluate which credit is more financially advantageous to them.
How do the credits work?
The employee retention credit is allowed against the employer’s share of social security taxes. However, the credit is fully refundable. What this means is, if the credit exceeds the employer’s total liability of the portion of Social Security in any calendar quarter, the excess is treated as an overpayment and refunded to the employer.
The IRS FAQs permit a dollar-for-dollar offset against payroll taxes owed (including taxes withheld from employees) to allow employers to access these funds prior to the quarter end. Additionally, the IRS has designed an expedited refund process if these credits still exceed the employer’s total payroll taxes.
Employers can take advantage immediately of the advance payments by filing Form 7200 to receive these credits in excess of the payroll taxes. This is the same form that is utilized to expedite the refund of the FFCRA paid leave credit. Remember both credits may be claimed by the same employer, but not on the same wages.
Keep in mind, that although aggregated employer groups are treated as a single employer for determining whether they qualify for the credit, once they qualify, each entity must claim and reconcile the credit individually. However, the aggregate group will still need to apportion the qualified wages limits across the entities.
Reconciliation of the tax credit
At the end of the quarter, the amounts of these credits will be reconciled on the employer’s 941. The IRS is redesigning the 941 to accommodate reconciling this credit in addition to the FFCRA leave credit. The IRS released a draft of the revised Form 941. While this is not the final form, it gives a good indication of how the IRS will approach reconciliation.
These changes have added increased complexity to an employer’s quarterly filing. It is complicated to add this layer to reconcile payroll tax liability that an employer may not have paid due to these credits, with the 7200 advances in addition and ensuring the credit is calculated correctly. This is all in addition to the regular reconciliation of employer federal payroll tax liability.
How does a PEO client employer reconcile?
Some employers utilizing PEO do not file their own 941, so it’s important for them to understand how they would reconcile this information and receive the credit. The IRS posted guidance to clarify how it would work.
If an eligible employer uses a CPEO, the CPEO will report the retention credit on its aggerate Form 941 and Schedule R. The employer can still claim the credit in advance by filing Form 7200. They will need to provide a copy of their Form 7200 to their CPEO, so the credits can be properly reconciled.
If an eligible employer uses a non-certified PEO, the PEO will report the retention credit on its aggregate Form 941. The PEO will also separately have to file a Schedule R only for the employers who are claiming the credit, in order to appropriately allocate the credit. Again, the employer can claim the credit in advance on Form 7200 and provide the PEO a copy so they may appropriately reconcile.
While we still await formal guidance on the credits and a finalized 941 to reconcile them, employers can start to evaluate how they gather all the information necessary to determine the credits for which they qualify. They should also consider evaluating other sources of federal funding such as the PPP loan to determine which source of federal funding is most advantageous to their particular circumstance. Remember, you will not qualify for a retention credit if you received or any member in your aggregate group received a PPP loan, regardless of how much of that loan is forgiven.