Employment Tax Credit Incentives Added to Encourage Employers to Provide Relief to Employees

January 8, 2021 | Insights



By Greta Cowart

Extension of Credit for Paid Leave Provided When There Is No State or Local Law Mandating Such Paid Leave

The Consolidated Appropriations Act, 2021 (the “Act”) amended many provisions. It amended the employer credit under code section 45S(i), which provides a credit to an employer for providing paid family and medical leave to employees who are not eligible for the federal Family and Medical Leave Act. The credit ranges between 12.5% and 25% of the amount paid towards a paid leave. This is a tax credit added by the Tax Cuts and Jobs Act (TCJA), and it does not count paid leave that was mandated by any state or federal government. It does not apply to an employer who is subject to the federal Family and Medical Leave Act. It applies to employees who have been employed for one year or longer, and who in the preceding year had not had compensation greater than 60% of the highly compensated employee compensation limit for the prior year. The Act changed the deadline for expiration of this provision from December 31, 2020, to cover such paid leave amounts provided prior to January 1, 2026.

Families First Coronavirus Response Act (FFCRA) credits for Emergency Paid Leave and the Emergency Family and Medical Leave Extension were extended to March 31, 2021, separately from the above credit under Code section 45S(i). The provisions were amended to cover voluntarily provided Emergency Paid Sick Leave and Emergency Family and Medical Leave Extension. However, the dollar limit that applied to each employee was not increased. The credit for the Emergency FMLA Extension did not alter the per-day limit or the aggregate limit of $10,000 per employee. The tax credits were also coordinated to prevent double-dipping by using the same wages to support one of the various types of relief. For purposes of this credit, an “employer” generally includes all members of a controlled group including the employer using a 50% ownership or control threshold rather than the 80% test used in the consolidated corporate income tax return rules, and for partnerships it generally looks to common control.

Employee Retention Credit

The CARES Act Employee Retention Tax Credit

The CARES Act included an employee retention credit for eligible employers whose business operations would have been fully or partially suspended due to being subject to closure due to a COVID-19-related order from an appropriate governmental authority, or which had certain reductions in its gross receipts compared to the prior year’s gross receipts. The credit is applied against the employment taxes that would have been deposited following the processing of payroll, and the tax credit is equal to 50% of a qualified wages in a calendar quarter. This credit will consider up to $10,000 of wages per employee for all calendar quarters. In addition, the credit considers the cost to maintain the group health plan coverage for the employees, which is excluded from the employees’ income under Code §106(a).

The credit can be claimed by the employer against certain portions of the employment taxes and to the extent the credit claimed exceeds such employer’s payroll taxes, the credit is refundable. For purposes of this credit, an “employer” generally includes all members of a controlled group including the employer using a 50% ownership or control threshold rather than the 80% test used in the consolidated corporate income tax return rules, and for partnerships it generally looks to common control. It is important to remember the rule for determining who is the “employer” did not change and still considers members in the controlled group of corporations and considering entities described in Code section 414(m) and (o) as part of the controlled group.

This originally applied to any eligible employer who was carrying on a trade or business during 2020 and with respect to any calendar quarter during which the employer operates the business but the business operations are fully or partially suspended due to orders from an appropriate government authority limiting commerce, transit, or group meetings due to COVID-19. An eligible employer also includes an employer whose gross receipts were less than 50% of the gross receipts for the same calendar quarter in the prior calendar year. Other limits on the duration exist.

This credit has a number of unique definitions and requirements that need to be explored before it is determined to be applicable. The credit only applies for wages paid from March 12, 2020 through December 31, 2020.

Changes to the Employee Retention Credit in the Act Effective Through December 31, 2020

The CARES Act added an employee retention credit. The Act builds on the original requirements explained above and adds some clarifications for 2020 and some new rules for 2021.

The employee retention credit was scheduled to expire on December 31, 2020. The Act extends the employee retention credit to wages paid through June 30, 2021. The Act makes changes to the employee retention credit in a couple of different sections with different effective dates. The first set of changes apply to the current employer retention credit as it existed through December 31, 2020, as clarifications to the terms of such credit, and such changes continue into 2021.

One of the first clarifications was how a tax-exempt organization determines whether its gross receipts decreased an amount that is sufficient to make the tax-exempt organization eligible to claim the employee retention credit as an eligible employer. For tax-exempt organizations, the gross receipts reduction is determined using the gross receipts definition under section 6033 of the Internal Revenue Code of 1986, which defines how a tax-exempt organization counts its gross receipts for its annual federal tax report/return on Form 990.

The second clarification is that in calculating the amounts on which the credit is calculated, health plan costs can be included for an employee even if the employee is not being paid wages (e.g., for individuals serving under a vow of poverty).

The third clarification deals with calculating the employee retention credit with respect to health insurance provided to the employee whose wages are the basis for the claimed employee retention credit. The clarification states that the amounts paid by the eligible employer to “provide and maintain the group health plan” are included in the calculation, but only to the extent that such amounts are excluded from the gross income of the employee by reason of Code section 106. This means that amounts of discriminatory health benefits that are taxable to highly compensated or key employees are not eligible for claiming the employee retention credit.

The Act’s fourth clarification is that in calculating the amount of wages from the health insurance costs for an employee under the retention credit, only count the amounts which are properly allocated to such employee for such health benefit coverage. It indicates there will be guidance from the Secretary to explain what is a proper allocation made on a pro-rata basis among the period of coverage.

A new provision added to the CARES Act provision for the employee retention credit clarifies that if you claim the employee retention credit, you may also request and receive a Paycheck Protection Program loan. This is a significant change related to the Paycheck Protection Program. It also clarified that wages used under the employee retention credit under the CARES Act cannot be used as qualified wages to determine the employee retention credit for employers affected by qualified disasters under section 303(a)(D) of the Taxpayer Certainty And Disaster Relief Act of 2020. This is one of the no double dipping rules.

All of the above changes or clarifications are effective as if they were included in the CARES Act when it was enacted. If an employer had filed its payroll tax return prior to December 27, 2020, when the Act was signed, then the employer may elect to treat any applicable amount as an amount paid in the calendar quarter which includes the date of enactment of this Act, so any adjustment to an employer’s claimed employee retention credit for wages and benefits prior to October 1, 2020, can be claimed in the employer’s payroll tax return for the fourth calendar quarter in 2020. For this purpose, the applicable amount is the amount the employer claimed for an employee for whom there was no work who was retained as an employee. Such amount includes the healthcare plan expense and the wages paid to such an employee for whom there was no work which was claimed for this credit under the CARES Act that were paid in a calendar quarter that began after December 31, 2019, and prior to October 1, 2020, and that were not taken into account by the taxpayer in calculating the credit for the employee retention credit for such calendar quarter. In effect, the “applicable amount” is a way to catch up on amounts not taken as credits in earlier quarters in 2020.

More Employee Retention Credit Changes Applicable in 2021

The Act’s second section dealing with the employee retention credit has a different effective date and extends the employer’s ability to use the employee retention credit in time and amount. A significant change is that the original employee retention credit was 50% of the qualifying wages and health plan costs in 2020, and the Act changed this and increased the credit to 70% of the qualifying wages and health plan costs for such amounts paid in 2021.

Next, the Act changes the limit on the amount of wages per employee limitation from a $10,000 per employee in all calendar quarters, to a $10,000 limit per employee for any calendar quarter. Thus, an employer may claim the employee retention credit for each employee for up to $10,000 per calendar quarter beginning in 2021 through June 30, 2021. The credit has also been made available to more employers, because the gross receipts reduction threshold that an employer needed to satisfy now only requires that the employer have more than a 20% reduction in its gross receipts as compared to the employer’s gross receipt for the same calendar quarter in 2019 (instead of the 50% reduction in gross receipts originally required by the CARES Act) and if the employer was not in existence in 2019, then the gross receipts for the calendar quarter for same calendar quarter in 2020 is substituted in the gross receipts test for the employer to be eligible. The employer may also elect to use the gross receipts test applied based on an alternative quarter instead of for the immediately preceding calendar quarter in the prior calendar year.

The election to use the alternative prior calendar quarter for measuring the change in gross receipts is to be done by election for which guidance will be required.

The threshold for employer size that determines the wages eligible for the credit also changed from 2020 to 2021. For 2021, the qualifying wages paid by an employer who on the average employed more than 500 employees during 2019 are limited to wages paid to employees who are not currently providing services due to the circumstances related to the coronavirus outlined below.

However, if during 2019 the employer employed on the average fewer than 500 employees, and if the employer’s operations were suspended during the calendar quarter, then the amount paid to employees during such calendar quarter is used for the calculation of the credit. It is important to remember the rule for determining who is the “employer” did not change and still considers members in the controlled group of corporations with a 50% threshold for determining members and considering entities described in Code section 414(m) and (o) as part of the controlled group.

If the employer on the average during 2019 employed fewer than 500 employees and employers operations were not suspended, then the employee retention credit is calculated on the wages paid to such employees paid by the employer to employees during the quarter, but this does not include any wages which were paid as part of the FFCRA payment of required paid sick leave under the Emergency Paid Sick Leave Act (EPSLA) for any of three reasons:

  1. an employee who is subject to federal state or local quarantine or isolation orders related to COVID-19,
  2. the employee was advised by a healthcare provider to self-quarantine due to concerns related to COVID-19, or
  3. employees are experiencing symptoms of COVID-19 and seeking a medical diagnosis under the FFCRA.

The 2021 changes also clarify that the employee retention credit is not calculated on amounts paid under the FFCRA as either an EPSLA or Emergency Family Medical Leave Extension Act leave. The 2021 changes also make it clear that any wages used for calculating the employee retention credit in 2021 cannot be used for the paid family medical leave credit under Code section 45S (the first topic above) as well as a number of other credits.

In 2021, the general rule is that there will be no advance payments of the employee retention credit except in the case of small employers. A small employer is defined as an employer whose average number of full-time employees employed during 2019 was not greater than 500 employees. A full-time employee is a full-time employee as determined under the employer shared responsibility tax rules in Code section 4980H. An employer that qualifies as a small employer which had fewer than 500 full-time employees on the average in 2019 is eligible to elect to receive advance payments of the employee retention credit. There are special rules for counting seasonal employees and for employers not in existence in 2019. If an employer elects to receive advance payments, the employer will need to reconcile the credit they actually claim on their payroll tax forms with the advance payments they received, and any excess advance payment will be used to increase the employer’s payroll tax liability for that calendar quarter.

Employers using payroll service vendors should be aware that the forms and instructions require the customer for the payroll vendor to be responsible for the accounting for the employee retention credit and for a liability for improperly claimed credits, and they shall also require a certified professional employer organization or other third-party payer accurately report such tax credits based on the information provided by the customer. These rules apply to calendar quarters after December 31, 2020.

New Employee Retention Credit for Employers Affected By Qualified Disasters Other Than COVID-19

The Act included a smaller section Title III on disaster tax relief. For this purpose, a “qualified disaster area” is an area with respect to which a major disaster was declared by a federal government agency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act between January 1, 2020, and February 25, 2021. This does not include any area declared a major disaster with respect to COVID-19.

The employee retention credit for employers affected by qualified disasters is 40% of qualifying wages. The 40% is calculated on up to $6,000 of wages per each qualifying employee for any taxable year during the incident period that begins on the date FEMA declares the disaster (but it shall not be treated as ending 30 days after December 27, 2020). The employer must be engaged in an active trade or business in the qualified disaster zone, and the business in the qualified disaster zone must have been inoperable at any time during the “incident period” which began on the first day of the incident that constituted a qualified disaster and that was specified by FEMA.

The employee retention credit for employers affected by qualified disasters is 40% of qualifying wages. Qualifying wages are paid to an employee working at the time of the disaster in the trade or business impacted by the qualified disaster that became inoperable as the employee’s principal place of employment and before the earlier of (1) the date on which that trade or business has resumed significant operations at such location or (2) the date which is 150 days after the last day of the incident period. The trade or business must have been rendered inoperable due to the qualified disaster. The eligible employees on whose wages the credit may be calculated are employees whose principal place of employment with that employer, determined right before disaster occurred, was in a qualified disaster zone. Qualifying wages are wages paid or incurred any time after the date on which the business became inoperable due to the qualified disaster and before the earlier of the date the business has resumed significant operations or the day which is 150 days after the last day of the incident period.

An employer cannot benefit doubly from this credit and certain other specified tax benefits. The “employer” is determined under the controlled group rules of Code section 52.

Employee Retention Credit for Certain Tax-Exempt Organizations Affected by Qualified Disasters

The Act also adds an employee retention credit of 40% of qualifying wages up to $6,000 per year per employee wages paid to employees as qualifying wages. This credit is an amount that will be used against wages withheld under section 3111(a) of the code for FICA (OASDI and hospital insurance) taxes, and it must be reduced by credits and apply to such taxes.

The employee retention credit for tax-exempt employers suffering a qualified disaster is a credit that when combined with the payroll tax credits for the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Extension Act under the FFCRA, they cannot exceed the limit on such tax credits under the FFCRA. Since this is a high-level summary, this article will not go into other details regarding that tax calculation.

This is the second part of a series covering the impact of the Act on Employers and their payroll and benefit plans. Watch for additional summaries related to retirement and health plan changes coming next week.

Related Resources:

Please note: This article and any resources presented on the Jackson Walker Coronavirus microsite do not constitute legal or medical advice.