Employee Retention Credit – A Tale Of 3 Employers

The Employee Retention Credit seemingly has some gray areas. Small businesses across the United States in a variety of industries are wondering what their company qualifies for as a result of The CARES Act and Families First Coronavirus Response Act due to the onset of the COVID-19 crisis. You may relate to the following scenarios that our clients are experiencing and the questions they are asking.

Employer #1 With More Than 100 Employees In 2019

Widgets Unlimited had 130 employees in 2019. In 2020, their gross receipts were down over 60%, and the company retained 48 actively working paid employees. All other employees were laid off and were not receiving payment from the company. John is concerned that Widget Unlimited is not eligible for a credit. Under this scenario, even though Widgets Unlimited meets the criteria for a significant decline in gross receipts, they will not receive a credit. The interpretation of the act infers that employers with more than 100 employees in 2019, will only receive a credit for wages paid to employees who did not work during the quarter. 

Employer #2 With Fewer Than 100 Employees In 2019

Fashion Incorporated had 30 employees in 2019. In 2020, their business was down over 50%, and they retained 20 employees all working and receiving compensation. Fashions Incorporated CFO was wondering if the company would be eligible for an Employee Retention Credit. For companies that averaged under 100 employees in 2019 and experienced a “significant decline in gross revenue,” the employer will receive an Employee Retention Credit equal to 50% of the gross wages paid to each employee receiving wages during the period of the “significant decline in revenue” up to $5,000 per employee. As such, Fashions could receive up to a $100,000 Employee Retention Credit. The actual amount will depend upon salary levels during the defined period.

Employer #3 Replaces An Employee That Quits

ABC Manufacturing had 20 employees in 2019 and a significant decline in gross receipts for the second quarter and third quarter of 2020. In the second quarter of 2020, the company has 10 employees who are working and getting paid over $10,000 during the quarter. In the third quarter, two employees quit and replaced with two new employees. All employees again were paid over $10,000 for the quarter. The CEO was wondering how much of a credit they will receive. Since ABC Manufacturing had a “significant decline in revenue” during the second quarter and third quarter and had less than 100 employees in 2019, they are eligible for a credit in each quarter. In the second quarter, the company will receive a $50,000 credit, $5,000 for each employee. In the third quarter, the company will receive a $10,000, $5000 for each of the new employees. The company had already received the maximum credit for the other 8 employees during the second quarter.

Frequently Asked Questions About The Employee Retention Credit

What is the maximum Employee Retention Credit?

The Employee Retention Credit is a fully refundable tax credit for employers equal to 50 percent of qualified wages (including allocable qualified health plan expenses) that eligible employers pay their employees. This Employee Retention Credit applies to qualified wages paid after March 12, 2020, and before January 1, 2021. The maximum amount of qualified wages taken into account for each employee for all calendar quarters is $10,000. So the maximum credit for an eligible employer for qualified wages paid to any employee is $5,000.

Who is an eligible employer?

Eligible employers, for the purposes of the Employee Retention Credit, are those that carry on a trade or business during the calendar year 2020, including a tax-exempt organization, that either:

• Fully or partially suspends operation 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 or

• Experiences a significant decline in gross receipts during the calendar quarter.

Note: Governmental employers are not eligible employers for the Employee Retention Credit. Also, Self-employed individuals do not qualify for this credit for their self-employment services or earnings.

Explain partial or full suspension of operations of a trade or business under the Employee Retention Credit?

The partial suspension of operations of a trade or business occurs if an appropriate governmental authority imposes restrictions upon the business. The suspension will affect operations by limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19. The company continues to operate but not at its regular capacity.

Example: A state governor issues an executive order closing all restaurants, bars, and similar establishments in the state to reduce the spread of COVID-19. However, the executive order allows those establishments to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis—the executive order results in a partial suspension of the operations of the trade or business.

What is a “significant decline in gross receipts”?

A significant decline in gross receipts begins with the first quarter in which an employer’s gross receipts for a calendar quarter in 2020 are less than 50 percent of its gross receipts for the same calendar quarter in 2019. The significant decline in gross receipts ends with the first quarter that follows the quarter in which the employer’s 2020 gross receipts are greater than 80 percent of its gross receipts for the same quarter of 2019.

Example: An employer’s 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 employer had a significant decline in gross receipts year over year. On the first day of the first quarter of 2020, gross receipts were less than 50% of the same quarter in 2019. Gross receipts did increase. On the first day of the third calendar quarter of 2020, gross receipts were more than 80% of the same quarter in 2019. Thus the employer is entitled to a retention credit for the first and second calendar quarters.

How is the maximum amount of the Employee Retention Credit determined?

The credit equals 50 percent of the qualified wages (including qualified health plan expenses) that an eligible employer pays in a calendar quarter. The maximum amount of wages taken into account for each employee for all calendar quarters is $10,000. So the maximum credit for qualified wages paid to any employee is $5,000.

Example: Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to the employer for the qualified wages paid to Employee A is $5,000.

Example: Eligible employer pays Employee B $8,000 in qualified wages in Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to the employer for the qualified wages paid to Employee B is $4,000 in Q2 and $1,000 in Q3 due to the overall limit of $10,000 of qualified wages per employee.

What are “qualified wages”?

Qualified wages are wages, as defined in IRC Section 3121(a). Compensation, as defined in IRC Section 3231(e) paid by an eligible employer to employees after March 12, 2020, and before January 1, 2021, plus the employer’s qualified health plan expenses allocable to the wages. The definition of qualified wages depends on the average number of full-time employees, according to IRC Section 4980H, employed by the eligible employer during 2019.

For employers who averaged more than 100 full-time employees in 2019, qualified wages are due to an employee for time that the employee is not providing services due to either:

1. A full or partial suspension of operations by order of a governmental authority due to COVID-19

2. A significant decline in gross receipts.

For these employers, qualified wages taken into account for an employee may not exceed what the employee’s salary for working an equivalent duration during the 30 days immediately preceding the period of economic hardship.

For employers who averaged 100 or fewer full-time employees in 2019 – Qualified wages are the wages paid to any employee during any period of economic hardship described in (1) and (2) above.

Is an employer required to pay qualified wages to its employees under the CARES Act?

No. The CARES Act does not require employers to pay qualified wages. Also, eligible employers may elect not to claim the credit for the Employee Retention Credit. The FFCRA does require certain employers to pay sick, or family leave wages to employees who are unable to work or telework due to a COVID-19 circumstance. These employers may be entitled to a refundable tax credit for those wages paid, although the employers may elect not to claim the credit.

Can eligible employers claim the Employee Retention Credit for qualified wages paid in March 2020?

No. Eligible employers may claim the Employee Retention Credit for qualified wages that they pay after March 12, 2020, and before January 1, 2021. Therefore, an eligible employer may be able to claim the credit for qualified wages paid as early as March 13, 2020.

May an eligible employer receive the Employer Retention Credit for periods after December 31, 2020?

No. The Employee Retention Credit is only available for wages paid after March 12, 2020, and before January 1, 2021.

Against what employment taxes does the Employee Retention Credit apply?

The credit is allowed against the employer portion of social security taxes, and the portion of taxes imposed on railroad employers under the Railroad Retirement Tax Act (RRTA).

What makes the credit “fully refundable”?

The credits are fully refundable because the eligible employer may get a refund if the amount of the credit is more than certain federal employment taxes the eligible employer owes. If, for any calendar quarter, the amount of the credit exceeds the employer portion of the social security tax on all wages (or on all compensation for employers subject to RRTA) paid to all employees, then the excess is treated as an overpayment and refunded to the employer. Consistent with its treatment as an overpayment, the excess will be applied to offset any remaining tax liability on the employment tax return, and the amount of any remaining excess will be an overpayment on the return that is eligible to be refunded.

Example: Employer pays $10,000 in qualified wages to Employee A in Q2 2020. The Employee Retention Credit available to the employer for the qualified wages paid to Employee A is $5,000. The application of the qualified wages will reduce the employer’s share of social security taxes that the employer is liable for concerning all employee wages paid in Q2 2020. Any excess over the employer’s share of social security taxes is treated as an overpayment and refunded to the eligible employer after offsetting other tax liabilities on the employment tax return and subject to any other offsets.

How does an eligible employer claim the refundable tax credit for qualified wages?

Eligible employers will report their total qualified wages and the related credits for each calendar quarter on their federal employment tax returns, usually Form 941, Employer’s Quarterly Federal Tax Returns. In anticipation of receiving the credits, eligible employers can fund qualified wages by accessing federal employment taxes, including withholding taxes, that are required to be deposited with the IRS or by requesting an advance of the credit from the IRS.

Can an eligible employer paying qualified wages fund their payments of qualified wages before receiving the credits by reducing federal employment tax deposits?

Yes. An employer may fund the qualified wages by accessing federal employment taxes, including withholding taxes set aside for deposit to the IRS, for other wage payments made during the same quarter as the qualified wages. An eligible employer may reduce the amount of federal employment taxes it deposits for that quarter by half of the amount of the qualified wages paid in that calendar quarter. An employer can reduce federal taxes by paying qualified wages to its employees in a quarter before it is required to deposit federal employment taxes with the IRS. The eligible employer must account for the reduction in deposits using Form 941 for the quarter.

Example: An eligible employer paid $10,000 in qualified wages (including qualified health plan expenses) is entitled to a $5,000 credit. The employer’s required deposit is a total of $8,000 in federal employment taxes, including taxes withheld from all of its employees for wage payments made during the same quarter. The eligible employer has no paid sick or family leave credits under the FFCRA. The eligible employer may deposit $3,000 and keep the $5,000 and will not owe a penalty. It is a requirement for the eligible employer to deposit only the remaining $3,000 on its required deposit date. The eligible employer will later account for the $5,000 it retained when it files Form 941.

May an eligible employer reduce its federal employment tax deposit by the qualified wages that it has paid without incurring a failure to deposit penalty?

Yes. An eligible employer will not be subject to a penalty under IRC Section 6656 for failing to deposit federal employment taxes relating to qualified wages in a calendar quarter. For more information about the relief from the penalty for failure to deposit federal employment taxes on account of qualified wages, see Notice 2020-22 (PDF).

How can an eligible employer fund the payment of qualified wages if the eligible employer does not have sufficient federal employment taxes set aside for deposit to cover those payments? Can the employer get an advance of the credits?

Yes. Because wage payments occur before quarterly return filing due dates. Some eligible employers may not have sufficient federal employment taxes set aside for deposit to the IRS to fund their qualified wages. Accordingly, the IRS has established a procedure for obtaining an advance of the refundable credits.

The eligible employer should first reduce its remaining federal employment tax deposits for wages paid in the same calendar quarter by the maximum allowable amount. If the anticipated qualified wages credit exceeds the remaining federal employment tax deposits for that quarter, the employer claim an advance refund for the full amount of the anticipated credit for which it did not have sufficient federal employment tax deposits. The eligible employer can file the claim using Form 7200, Advance Payment of Employer Credits Due to COVID-19.

An employer should not file Form 7200 if an eligible employer:

1. Fully reduces its required deposits of Federal employment taxes due on wages paid to employees in the same calendar quarter

2. Anticipates receiving qualified wages credit

3 Has not paid over the threshold for qualified wages credit

If the employer files Form 7200, this will reconcile the advance credit and its deposits with the qualified wages on Form 941. Filing this form may show an underpayment of federal employment taxes for the quarter.

Example: An eligible employer paid $20,000 in qualified wages, and is entitled to a credit of $10,000. The employer’s deposit of $8,000 will include federal employment taxes, including taxes withheld from all of its employees on wage payments made during the same calendar quarter. The eligible employer has no paid sick or family leave credits under the Families First Coronavirus Response Act (FFCRA). The eligible employer can keep the entire $8,000 of taxes that the eligible employer was otherwise required to deposit without penalties as a portion of the credits it is otherwise entitled to claim on Form 941. The eligible employer may file a request for an advance credit for the remaining $2,000 by completing Form 7200.

May an eligible employer receive both the tax credits for the qualified leave wages under the FFCRA and the Employee Retention Credit under the CARES Act?

Yes, but not for the same wages. The amount of qualified wages for which an eligible employer may claim the Employee Retention Credit does not include the amount of qualified sick and family leave wages for which the employer received tax credits under the FFCRA.

May an eligible employer receive both the Employee Retention Credit and a Small Business Interruption Loan under the Paycheck Protection Program under the CARES Act?

No. An eligible employer may not receive the Employee Retention Credit if the eligible employer receives a Small Business Interruption Loan under the Paycheck Protection Program under the CARES Act. An eligible employer that receives a paycheck protection loan should not claim Employee Retention Credits.

Your business may have experienced financial fluctuations in the last 12 months, and you aren’t sure whether your organization will qualify for the available relief. Now is the time to consider leaning on your accountant for cash flow guidance, tax deadlines, completing SBA and CWCA loan applications, Family First tax credit calculations, and interpreting the CARES Act. Our accountants are available, and we have the knowledge, skill, and information that you need right now to address your financial needs in a timely fashion adequately.

By Carla O’Brien and By Greg DeFeo

Carla O’Brien is an accountant for Wilke & Associates, CPAs & Business Advisors.  She is an experienced tax accountant serving real estate investors and clients who are investing in the oil, gas, and energy industry. Carla also has experience in all areas of the balance sheet, income statement, and income tax preparation.

Greg DeFeo is a consulting manager with the advisory services division of Wilke & Associates, CPAs & Business Advisors. He has over twenty years of executive leadership experience.  Greg helps businesses with funding, strategic planning, mergers & acquisitions, and ownership transitions.