November 19, 2020

COVID-19 Federal Wage-Related Tax Credits

Tax & Business

Three fully refundable federal credits were born out of the COVID-19 crisis: the emergency paid sick leave credit, the expanded family leave credit (expanded Family and Medical Leave Act, or FMLA), and the employee retention credit. This article presents a comparative analysis of the three credits.

Emergency Paid Sick Leave Credit

Purpose
The emergency paid sick leave and expanded family leave credits were enacted into law by the Families First Coronavirus Relief Act (FFCRA). The FFCRA permits certain employees to take up to two weeks of paid sick leave and up to 12 weeks of expanded FMLA leave. Employers are able to take a corresponding credit for the amount of federally required leave pay.

How much is the credit?
The maximum credit is based on the reason for the employee’s absence. If the employee is absent to care for their own health, they are entitled to up to $511 per day of paid sick leave, or a maximum of $5,110. If the employee is absent to care for another person such as a child or parent, they are entitled to 2/3 of their regular rate of pay, up to $200 per day or a maximum of $2,000. The employer is not required to pay the employee the full amount of their regular wages. They are only obligated to pay the employee up to the maximum they are entitled to by law.

Who is eligible to claim the credit?
Private employers with fewer than 500 employees are required to pay emergency paid sick leave and are thus eligible for the credit. There is a small business exception for employers with fewer than 50 employees, but the exception only applies in certain limited circumstances. [The small business exception is beyond the scope of this article; please reach out to your Marcum advisor to discuss this further if applicable.]

What expenses are eligible for the credit?
If an employee is unable to work or telework for one of the six reasons related to COVID-19 defined in the FFCRA, sick leave wages up to a certain threshold are eligible for the credit.

The six circumstances for COVID-19-related sick leave as explained in the FFCRA are:

The employee is subject to a Federal, State, or local quarantine or isolation order related to COVID-19.
The employee has been advised by a health care provider to self-quarantine due to concerns related to COVID-19.
The employee is experiencing symptoms of COVID-19 and seeking a medical diagnosis.
The employee is caring for an individual who is subject to an order as described in reason 1 or 2 above.
The employee is caring for a son or daughter whose school or daycare is closed for reasons related to COVID-19.
The employee is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretary of the Treasury and the Secretary of Labor.

The credit is equal to the wages paid up to the maximum per day (either $511 per day or $200 per day), plus the 1.45% Medicare tax, plus the employer-paid health insurance (including health, dental, vision, prescription drug, and possibly HRA or health FSA contributions). Health insurance should be reduced by the amount of employee contributions.

Full-time employees are eligible for 80 hours of sick leave. Part-time employees are eligible for the average number of hours typically worked in a 2-week time span.

Emergency paid sick leave is in addition to the employer’s existing sick leave policies. The employer cannot require employees to use other paid leave first. Employees are eligible for leave regardless of the length of their employment. (This is in contrast to expanded FMLA which requires employees to be employed for the previous 30 days.) The sick leave must be taken when the employer has work for the employee to do. If there’s no work for the employee to do as a result of a shelter-in-place or stay–at-home order, the employee is not qualified for the credit.

What are the effective dates?
The credit is effective for wages paid April 1 through December 31, 2020.

How to claim the credit
The credit can be claimed on form 941, the employer quarterly payroll tax returns. However, an employer may request an advance payment of the credit on form 7200. The employer can file multiple forms 7200 per quarter.

Interaction with PPP loan, income taxes, and other credits
Sick leave wages are taxable income to the employee, and subject to federal withholding, Social Security, and Medicare taxes. However, sick leave wages up to the daily limit are not subject to the 6.2% Social Security payroll tax to the employer. If the employer elects to pay the employee regular wages which exceed the maximum required federally, any amount beyond the limit are considered regular wages and would be subject to 6.2% Social Security payroll tax.

To report the credit on the annual income tax return, include the full amount of the credit in gross income. Then, expense wages, health insurance expense, and the Medicare 1.45% payroll tax as usual. Even though the credit is included in income, the net effect is zero because the correlating costs are expensed.

Sick leave wages for which a credit is received are not eligible wages attributable for Paycheck Protection Program (PPP) loan forgiveness.

Documentation and retention period
The employer is obligated to retain an employee statement that includes basic information to substantiate the reason for the leave. The IRS requires written documentation to be retained.

Additionally, the employer should retain documentation of the qualified health plan expenses and credit calculations. After claiming the credit on form 941, the taxpayer should retain all documentation for at least four years.

Provisions for self-employed
Taxpayers who are self-employed are also able to take advantage of the sick leave credit. The tax benefit would be netted against self-employment tax liability, usually paid quarterly through estimated tax payments. The credit is not reported on form 941. Instead, a self-employed individual can claim the credit on form 1040, or reduce their quarterly estimated tax vouchers for the corresponding credit. If self-employed individuals would like to request advance payment, they should complete form 7202, which is specifically designed for self-employed individuals.

Expanded Family Leave Credit

Purpose
Emergency sick leave is effective for two weeks only. However, expanded FMLA is effective for up to 12 weeks. In expanded FMLA, the first two weeks are unpaid, and the next 10 weeks are paid. The two credits work in tandem to create a total of 12 paid weeks.

COVID-19-related FMLA is called “expanded” FMLA because the FMLA credit was implemented effective January 1, 2018, under §45S. The Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded allowable reasons to encompass caring for a child whose school or place of work is closed (or child care provider is unavailable) related to COVID-19.

How much is the credit?
The maximum credit is 2/3 of an employee’s regular rate of pay, up to $200 per day or a maximum of $10,000. (The benefit is $2,000 from sick leave plus $10,000 from expanded FMLA for a total of $12,000.) The employer is not required to pay the employee the amount of their regular wages. They are only obligated to pay the employee up to the maximum they are entitled to by law.

Who is eligible to claim the credit?
Private employers with fewer than 500 employees are required to pay expanded FMLA and are thus eligible for the credit. There is a small business exception for employers with fewer than 50 employees, but the exception only applies in certain limited circumstances. [The small business exception is beyond the scope of this article; please reach out to your Marcum advisor to discuss this further if applicable.]

What expenses are eligible for the credit?
The credit is equal to the FMLA wages paid (max $200 per day), plus the 1.45% Medicare tax, plus the employer-paid health insurance (including health, dental, vision, prescription drug, and possibly health reimbursement arrangement (HRA) or health FSA contributions). Health insurance should be reduced by the amount of employee contributions.

Expanded FMLA requires employees to have been employed by the employer for the previous 30 days. The FMLA leave must be taken when the employer has work for the employee to do. If there’s no work for the employee to do, as a result of a shelter-in-place or stay-at-home order, any wages paid would not be qualified for the credit.

What are the effective dates?
The credit is effective for wages paid April 1 through December 31, 2020.

How to claim the credit
The credit can be claimed on form 941, employer quarterly payroll tax return. However, an employer may request an advance payment of the credit on form 7200. The employer can file multiple forms 7200 per quarter.

Interaction with PPP loan, income taxes, and other credits
Expanded FMLA wages are taxable income to the employee, and subject to federal withholding, Social Security, and Medicare taxes. However, the wages are not subject to the 6.2% Social Security payroll tax to the employer. If the employer elects to pay the employee regular wages which exceed the maximum allowed credit, any amount above the limit are considered regular wages and would be subject to 6.2% Social Security payroll tax.

Additional wages paid on top of the required federal amounts could be eligible for the expanded family leave credit under §45S.

Expanded FMLA wages for which a credit is received are not eligible for PPP forgiveness.

Additionally, the employer should retain documentation of the qualified health plan expenses and credit calculations. After claiming the credit on form 941, retain all documentation for at least four years.

Taxpayers who are self-employed are also able to take advantage of the expanded FMLA credit. The tax benefit would be netted against self-employment tax liability, usually paid quarterly through estimated tax payments. The credit is not reported on form 941. Instead, a self-employed individual can claim the credit on form 1040, or reduce their quarterly estimated tax vouchers for the corresponding credit. If self-employed individuals would like advance payment, they should complete form 7202, which is specifically designed for self-employed individuals.

Employee Retention Credit

Purpose
The Paycheck Protection Program (PPP) received most of the attention in the Coronavirus Aid, Relief & Economic Security (CARES) Act, but another important provision was the employee retention credit. If your business missed out on taking the PPP loan and still suffered a full or partial shutdown, or a significant decline in gross receipts (defined later), the next best course of action is to take advantage of the employee retention credit. In some cases, the employee retention credit could be more beneficial than taking a PPP loan.

Unlike the emergency sick leave or expanded FMLA, employers are not obligated to pay retention wages. This credit is available when an employer electively moves forward with paying its employees despite a full or partial shutdown, or a significant decline in gross receipts. (Please see discussion below regarding different specifications for employers with more or less than 100 employees.)

How much is the credit?
The credit is equal to 50% of wages paid, up to $10,000 per employee ($5,000 credit maximum).

Who is eligible to claim the credit?
The employee retention credit is open to employers of any size, in the private sector or nonprofit sector. The employer should experience one of the following conditions to be eligible for the credit:

The employer suspends operations either partially or fully during any quarter in 2020 due to government regulation or limitations, or
The employer has a significant decline in gross receipts.

A “significant decline in gross receipts” is defined as gross receipts of less than 50% of the gross receipts in the same calendar quarter of the prior year. There are two significant dates: the quarter in which the >50% decline is met (beginning quarter), and the quarter following the quarter in which the employer achieves 80% of the gross receipts from the prior year calendar quarter (ending quarter). For the purposes of this credit, use gross receipts as defined in §448C.

A shelter-in-place or stay-at-home order is not considered a full or partial suspension of operations. However if a business is shut down for a reason such as a supplier being unable to deliver raw materials due to a shelter-in-place order, that could be reason for a partial suspension of operations.

There are special provisions for businesses formed in 2019 or acquired in 2020; however, that discussion is beyond the scope of this article. If this is a circumstance that applies to your business, reach out to your Marcum advisor for additional information.

What expenses are eligible for the credit?
The most complicated part of the employee retention credit is the different specifications relative to one magic number: 100 employees (use §4980H rules for applicable large employers for the definition of “full time.” Full time is defined as an employee who averages at least 30 hours per week, and at least 130 hours per month).

For employers with more than 100 employees
The retention credit has greater restrictions for employers with more than 100 employees versus those with fewer. The basic difference is the employer may only take a tax credit for time paid to employees for hours not worked. In other words, the employer continues to pay wages to its employees despite not having work for them, as in the case of a shutdown.

Wages paid for vacation, PTO, sick time, and holidays are not considered eligible wages. Severance wages and wages not subject to Medicare tax are also ineligible for the credit. The maximum credit the employer can claim is based on the wages the employee earned in the previous 30-day period, having worked the same number of hours, up to the maximum cap per day.

For employers with 100 employees or less
The employee retention credit gives much broader access to employers with fewer than 100 employees. Wages to all employees, whether or not the hours were actually worked, are eligible for the credit. Severance wages and wages not subject to Medicare tax are ineligible for the credit.

What are the effective dates?
The credit is effective for wages paid March 13 through December 31, 2020. Please note: if an employee earned wages at the end of 2020, but the wages were not paid until 2021, the wages paid in 2021 are ineligible for the credit. We recommend running a special payroll as of December 31 to true up any wages eligible for the employee retention credit.

How to claim the credit
The credit can be claimed on form 941. However, an employer may request an advance payment of the credit on form 7200. The employer can file multiple forms 7200 per quarter. Wages paid between March 13 and 31 should be reported on the Q2 941. It is possible that a company could file its form 941 before it is able to calculate if there is a significant decline in gross receipts in a quarter. In that case, the employer should file a form 941X, amended quarterly payroll tax filing, to claim the credit.

Interaction with PPP loan, income taxes, and other credits
If a business received a loan under the Paycheck Protection Program, the business is ineligible for the employee retention credit. However, if the business repaid the PPP loan before May 14, 2020, it is still eligible for the employee retention credit.

The credit may not be claimed on wages for which the employer is already taking the work opportunity credit, emergency sick leave, or FMLA credits. In other words, the same wages cannot be used for more than one credit.

The wages paid under this credit are subject to employee and employer shares of Social Security taxes, unlike the sick and family leave credits.

Documentation and retention period
Employers should retain documentation of the calculations of decline in gross receipts. Calculations of the credit and documentation of qualified health plan expenses should also be retained. After claiming the credit on form 941, retain all documentation for at least four years.

Provisions for self-employed
Self-employed taxpayers are ineligible for the employee retention credit for their own work hours. Wages paid to related individuals, such as a child or parent, are also ineligible for the credit.

Summary

All of the COVID-19 credits are fully refundable. If the credit is greater than the employer payroll tax liability on form 941, the employer will receive a refund upon the 941 filing. If an error is made on form 7200, advanced payment request, a corrected form cannot be filed. Instead, true up any difference on the quarterly form 941. If there is a mistake made on a quarterly form 941, file an amended quarterly payroll tax return, form 941X.

To accommodate all of these changes, form 941 has received a major makeover. The emergency sick leave credit is reported on line 5a(i) and expanded FMLA as reported on line 5a(ii), and such wages are exempt from the 6.2% Social Security tax. If an employee has achieved the Social Security maximum pay base of $137,700 before taking sick leave, do not report these wages on line 5a(i) and 5a(ii). However, the wages are still reported on yet another new component of the form, worksheet one.

With these significant changes come many questions. If your business needs further guidance on taking advantage of these credits, reach out to your Marcum advisor for additional resources.