As post-COVID recovery efforts gain momentum, many businesses are taking a fresh look at some federal stimulus and tax relief programs they had not previously considered. One such program, the employee retention credit contained in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, could be especially useful in helping companies bring back furloughed or laid-off employees.
In addition to helping reduce employment tax obligations, it could also help cash-strapped companies of any size improve cash flow during times of reduced revenue.
How the Credit Works
The employee retention credit is a refundable and advanceable credit against the 6.2 percent Social Security payroll tax that employers must pay to match their employees’ Social Security payroll deductions. The goal of the credit is to help companies keep employees on the payroll, but because it is both refundable and advanceable, it also can help generate cash flow relief in the short term.
Eligible companies may claim a credit equal to 50 percent of the “qualified wages” they pay to employees between March 13, 2020 and the end of the year, up to a maximum credit of $5,000 per employee. The definition of “qualified wages” and the amounts allowed as a credit depend on whether the employer averaged more or fewer than 100 full-time employees during 2019. The term “qualified wages” also includes certain health plan costs for both working and furloughed employees.
Qualifying for the Credit
The initial purpose of the credit was to encourage businesses to keep employees on the payroll if they were forced to close or partially suspend operations due to a mandatory government shutdown order. But companies that continued operating or are now reopening can also qualify for the credit if their quarterly gross receipts decline by more than 50 percent when compared to the same quarter last year. They may continue to claim the credit until their quarterly revenues recover to at least 80 percent of their year-ago level or until they reach the $5,000 per employee maximum.
Update December 28, 2020: Borrowers can now qualify for the Employee Retention Credit retroactively to March 2020. Under the CARES Act, a borrower could not obtain a PPP loan and qualify for the Credit. The COVID-Related Tax Relief Act of 2020, signed by President Trump on December 27, 2020, eliminates this prohibition. The same payroll costs cannot be used for both the Retention Credit and PPP loan forgiveness so borrowers should evaluate the eligible expenses being used to claim PPP loan forgiveness. If a borrower is eligible for the Retention Credit claiming less payroll costs for forgiveness and using those costs to claim the credit can increase cash flow while not impacting the loan amount forgiven.
There are some other limitations to the credit as well. For example, employers cannot claim the credit for the same wages that are covered by other tax credit programs, such as the paid sick leave or emergency family leave credits under the Families First Coronavirus Relief Act. Wages paid to family members or to any individual who owns more than 50 percent of the business are also ineligible for the credit. In addition, any amount allowed as a credit is not deductible on the employer’s federal income tax return.
Claiming the Credit
Unlike a PPP loan, there is no application or approval process needed to receive this credit. An employer may simply retain all payroll taxes and withholdings up to the amount of the anticipated credit and then claim the credit on its quarterly employment tax return.
The IRS has revised Form 941 to accommodate this. The credit for wages paid in both the first and second quarters can be claimed on the Form 941 filed for the second quarter. If the available credit amount exceeds the payroll taxes due, the excess will be refunded to the employer, who can then use the funds for any other purpose. In addition, employers can accelerate cash flow benefits by claiming an advance credit using IRS Form 7200.
Currently, Congress is working on another economic stimulus package that contains several enhancements to the Employee Retention Credit making it an even more attractive tax incentive. Watch our website for updates to see which provisions are included in the final legislation.
For companies that are struggling to resume operations with reduced revenues—and that either chose not to participate in the PPP or did not qualify—the employee retention credit can help offset some of the costs of retaining their employees. In addition, it could potentially generate additional funds to help with other immediate cash flow needs.
To learn more about the employee retention credit or other emergency-related tax credits, please contact us.