Relief provided by employee retention credit


The economic impact of COVID-19 is causing many organizations to race to address immediate business concerns while maintaining a steady cash flow. Payroll taxes are usually among the largest tax burdens in an organization’s overall expenses. But businesses adversely impacted by COVID-19 may find relief through the employee retention credit provided by the recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Under the provision, qualifying businesses may be eligible for a fully refundable credit of up to $5,000 against Social Security taxes for every employee retained during COVID-19. While this presents a significant opportunity for organizations to reduce their payroll tax burden and receive refunds, the credit may conflict with other benefits provided by the CARES Act. Therefore, businesses should carefully consider all options available to them to ensure a proper understanding of the rules, benefits, and limitations of each.




Aid for businesses impacted by COVID-19


The credit is available for businesses that fit within one of two categories. The category includes businesses with operations that are fully or partially suspended due to government orders. The second includes businesses with gross receipts that drop by more than 50% in a quarter compared to the same quarter in the prior year.

While the CARES Act does not define “fully or partially suspended,” the IRS recently issued informal guidance stating that business operations may be partially suspended if operations can continue but not at their “normal capacity” due to restrictions imposed by an appropriate governmental authority that limit commerce, travel or group meetings due to COVID-19. The legislation broadly defines group meetings as commercial, social, religious or meetings for other purposes. Businesses will be eligible for the employee retention credit through Dec. 31, 2020, if business operations are at least partially suspended through that date.

The gross receipts test requires a greater than 50% decrease in gross receipts for a quarter beginning in 2020 compared to the same calendar quarter in 2019. Businesses may first compare the first quarter of 2020 to the first quarter of 2019. If gross receipts have not dropped by more than 50%, the test is performed again in the second quarter and subsequent quarters in 2020. The business is eligible for the credit in the first quarter in 2020 in which its gross receipts drop by greater than 50% and each subsequent quarter in 2020 in which gross receipts are not greater than 80% of their 2019 comparable quarter gross receipts. Businesses continue to be eligible for the credit in the first quarter that gross receipts rebound to greater than 80% of a 2019 comparable quarter, but the business is ineligible for the credit as of the first day of the next quarter.

Businesses are not eligible for the credit if they receive a Small Business Interruption Loan under the Paycheck Protection Program (PPP) created by the CARES Act.

Businesses must also apply certain rules that treat related businesses as a single employer. These controlled and affiliated group rules apply for all purposes of the credit, including determining whether a business is eligible for the credit and the amount of qualified wages paid to employees.




Incentivizing employee retention


The employee retention credit applies to “qualified wages” paid between March 13, 2020, and Dec. 31, 2020, during the quarters the business is eligible for the credit. Eligible businesses will receive a credit equal to 50% of the qualified wages paid to each employee. Qualified wages include not only the cash paid to the employees, but also the employer’s cost of qualified health plan expenses. Qualified wages cannot exceed $10,000 per employee, which effectively caps the credit at $5,000 per employee. The credit is allowed against the employer’s share of Social Security taxes but is fully refundable.

Employers that defer their Social Security tax deposits otherwise due between March 27 and Dec. 31, 2020, to 2021 and 2022 under the CARES Act can reduce their other payroll tax deposits (including amounts withheld from employees) by the full amount of the credit, effectively receiving an immediate refund of the full amount of the credit.

Qualified wages include gross wages subject to Medicare tax but exclude family and sick leave paid under the Families First Corona Virus Act and wages taken into account when calculating the Work Opportunity Tax Credit. Wages taken into account for other the payroll-based credits are also qualified wages. In addition, wages paid to certain employees related to the business, including certain owners, are not qualified wages.

If a business had on average of 100 or fewer full time equivalent (FTE) employees in 2019, all employee wages paid during the applicable time periods above are qualified wages, even if the employees are still providing services. For businesses over that FTE employee threshold, qualified wages include only the wages paid to employees for time the employees are not providing services. If an employer over the 100 FTE threshold cuts back an employee’s hours or days but pays the employee an amount exceeding what the employee would otherwise earn for the cutback services, then the excess amount is a qualified wage eligible for the credit.

Qualified wages paid to an employee by an employer over the 100 FTE threshold may not exceed the amount the employee would have received had he or she performed the same work during the 30 days preceding the period the qualified wage is paid to the employee.

Qualified wages include employee health plan expenses paid or incurred by the employer to provide and maintain a group health plan. These expenses must be allocated to each employee based on the period of time the employee could receive a qualified wage.




Refunds available


If a business is eligible for the employee retention credit, the employer may reduce its entire payroll tax deposit with the government by the amount of the credit. This means an employer can keep amounts withheld from an employee’s wages for federal income tax, FICA taxes and the employer’s portion of Medicare tax up to the credit amount. In addition, the credit can reduce an employer’s payroll tax deposit for a payroll period after the payroll tax deposit is reduced by the employer’s share of Social Security tax that is deferred to 2021 and 2022. This is, in effect, an immediate refund of the full amount of the tax credit. The IRS will waive penalties for the late payments as long as the employer reasonably believes that the credit will be received. If an employer has already paid employment taxes for the quarter, the employer may be able to apply for a tax refund. Additionally, employers can request an advance of the credit by submitting Form 7200, Advance Payment of Employer Credits Due to COVID-19, at any point before the filing of the quarterly Form 941.




Next steps


The employee retention credit may provide companies short-term and long-term opportunities with respect to payroll tax savings and refunds. However, businesses should complete a thorough analysis of all options available to them before applying the credit or requesting refunds to ensure a proper understanding of the rules, benefits, and limitations of each.

For example, many businesses may be exploring applying for a loan under the PPP, which would make them ineligible to claim the employee retention credit. There is also no guarantee of approval and businesses may ultimately receive an allocation lower than their request. As such, it is important for businesses to determine their potential employee retention credit before applying for a PPP loan in the event their request is denied or reduced. Companies should also be aware of any uncertainties in the rules that may impact them. Guidance from the IRS on a number of issues has yet to be released, including how to allocate qualified health plan expenses and how to determine the amount of a qualified health plan cost for purposes of the employee retention credit.






Eric Gonzaga

Eric Gonzaga is a Principal and practice leader for the Human Capital Services (HCS) group in Minneapolis.

Minneapolis, Minnesota

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