The COVID-19 pandemic is upending business operations around the world and has likely ended the longest period of economic expansion in United States history. Organizations are racing 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 recent legislative developments may help ease the related short-term cash flow burden. There are also medium to long-term opportunities available to companies with respect to payroll tax refunds and credits at the federal and state levels. Highlighted below are a sample of short-term and long-term opportunities for organizations to manage and reduce federal and state payroll taxes to help address their cash flow concerns.
Payroll tax credits
The recently enacted Families First Coronavirus Response Act (FFCRA) can help businesses generate cash savings and maintain cash flow through refundable payroll tax credits. Specifically, the FFCRA requires certain employers to provide paid sick leave and expanded family and medical leave to employees for COVID-19-related reasons, the cost of which is fully funded by a new refundable paid sick leave credit and new paid childcare leave credit that eligible employers can claim against payroll taxes.
The employers subject to the new paid leave requirements and eligible for the payroll tax credits are those businesses and tax-exempt organizations with fewer than 500 employees that are required to provide these leaves under FFCRA from April 1, 2020, through Dec. 31, 2020. The amount of leave required to be provided and eligible for the payroll tax credits is subject to employee-per-day caps and aggregate caps depending on the reason for, and duration of, any required paid leave. Employers will be able to retain an amount of payroll taxes equal to the amount of qualifying sick and childcare leave paid, rather than deposit them with the IRS. The payroll taxes available for retention include withheld federal income taxes and the employee and employer shares of Social Security and Medicare taxes with respect to all employees. If there are insufficient payroll taxes to cover the cost of qualified sick and childcare leave paid, employers will be able to file a refund request, which the IRS expects to process in less than two weeks. This opportunity can represent a significant savings opportunity for organizations with respect to dollar-for-dollar reduction in payroll tax liabilities by offsetting actual leave payments made.
Employee retention credit
The Coronavirus Aid, Relief, and Economic (“CARES”) Act creates a 50% refundable credit for paying up to $10,000 in wages per employee for a business that was fully or partially suspended due to a government order or that saw a greater than 50% reduction in gross receipts for the first quarter beginning in calendar year 2020 compared to the same quarter in the prior year. Tax-exempt entities are eligible under the business suspension test. If the gross receipts test has not been met in the first quarter, employers may remeasure their gross receipts in each subsequent quarter to determine eligibility for the credit. Only wages paid from March 12, 2020, through Dec. 31, 2020, are taken into account for the credit. Wages remain eligible through the quarter in which the business is no longer suspended or the quarter in which gross receipts exceed 80% of the prior year. The legislation does not expand on the meaning of “partially suspended.”
For employers with more than 100 full-time equivalent (FTE) employees in 2019, only wages paid when an employee is not providing services are eligible. For employers with 100 or fewer FTE employees, all wages for all employees up to the per-employee cap are eligible when a business was fully or partially suspended or during a quarter its gross receipts dropped by more than the 50% threshold. Employers are subject to aggregation rules when determining the 100 FTE employee threshold. Three aggregation rules apply when determining the 100 FTE threshold: (1) parent-subsidiary group, (2) brother-sister group, and (3) combination of both (1) and (2). These aggregation rules are the same rules used to define a “control group” for purposes of non-discrimination testing of qualified retirement plans, health and welfare plans and Affordable Care Act (ACA) informational reporting. Wages also include qualified health plan expenses. The term “qualified health plan expenses” is defined as amounts paid or incurred by the employer to provide and maintain a group health plan as defined in Section 5000(b)(1). We anticipate further guidance from the IRS and Treasury on how to allocate such qualified health plan expenses and how to determine the amount of a qualified health plan cost.
The credit is allowed against the employer’s share of Social Security taxes but is reduced by any payroll credits taken for required paid leave (detailed above) pursuant to the FFCRA. Tax-exempts can claim the credit based on a full or partial suspension of a trade or business.
Grant Thornton Insight: This version of the employee retention credit is considerably different than other versions offered after natural disasters in the past. Those versions allowed a credit for paying employees whose principal work location was inoperable, regardless of whether the employee worked somewhere else. Under this credit, employers with more than 100 FTE employees will be required to establish that the employees provided no services for their wages while the business was suspended, or gross receipts dropped. Similar to prior versions, this provision disqualifies wages from counting toward both this credit and the work opportunity tax credit. However, wages cannot count toward this credit and the Section 45S credit for paid family and medical leave. The credit is also not available for taxpayers taking small business interruption loans under the stimulus bill.
Deferral of tax payments
The CARES Act allows employers to defer deposits of the 6.2% employer portion of the Social Security tax for Old Age, Survivors, and Disability Insurance (OASDI) from March 27 through the end of 2020. Half of the deferred payment amount is due by Dec. 31, 2021, with the other half due by Dec. 31, 2022. Individuals paying self-employment tax are provided with similar relief for 50% of SECA tax. The CARES Act does not delay the deposit dates for federal income tax, Medicare tax or Social Security tax withheld from an employee’s wages or the employer’s share of Medicare tax.
Grant Thornton Insight: The combination of this statutory relief from payroll tax payment obligations and the IRS’s recent administrative relief for income and estimated tax payments due on April 15 is almost unprecedented and should provide significant cash-flow flexibility.
In addition, many states have enacted legislation and issued executive orders to provide business taxpayers with various payment, withholding and payroll tax relief. States have extended the deadlines to file their state payroll returns or deposit state payroll taxes without penalty and interest. Payroll taxes that are available for deferred payment include state withholding taxes as well as quarterly state unemployment insurance (UI) taxes. The extension for payment of taxes is geared to help businesses maintain immediate cash flow as well as provide additional time to complete tax filings without penalties since there may be staffing issues due to closures imposed by the COVID-19 pandemic. Due to the extended deadline for employer quarterly payroll tax payments (for some states, as long as 90 days), there is no immediate cash outlay for companies, which helps ease cash flow in the short term.
Unemployment insurance benefit charges
With the financial and economic impact of COVID-19 forcing layoffs, many employees will file for unemployment benefits with states to help supplement their income during the crisis. States have passed Unemployment Insurance Act amendments to temporarily waive certain provisions of the state’s UI law to require that UI benefits paid in connection with COVID-19 will not be charged to employer accounts. Unemployment benefit charges are generally included in the calculation of an employer’s UI tax rate, with the rate rising as costs on the account increase.
As a result, the benefit-charge waiver may help prevent tax rates from increasing and may provide long-term savings for the employers. The benefit waiver will help maintain the employer’s experience rating without increasing the tax rate, resulting in tax savings for quarterly UI tax payments. With respect to UI tax rates, employers may want to look at strategies to lower their UI tax rate and realize savings and reduction in overall UI tax burden by either voluntary contributions to offset benefit charges used in UI rate calculations or by formation of a joint account that permits two or more legal entities to combine their state experience rating factors and obtain a single, favorable UI tax rate.
Payroll tax refunds
For businesses that have undergone significant reorganizations in the past few years, an opportunity may exist for payroll tax refunds, especially in the case of mergers, acquisitions and spinoffs. When an employer merges with or acquires another employer and transfers the employees of the predecessor employer, there may be significant payroll tax overpayments. These overpayments result from wages already paid by the predecessor employer for Social Security, federal unemployment and state unemployment taxes within the same calendar year.
Under certain circumstances, the successor company may not have to restart the wage base and pay these taxes again. It may also be able to reduce its UI cost based on the experience rating of the predecessor’s unemployment insurance account. To avoid leaving significant savings on the table, many acquiring companies are undertaking payroll tax refund reviews to quantify the refunds available with respect to these corporate transactions and begin the process of claiming them.
Businesses may also be able to obtain a favorable UI rate by applying the methods mentioned above to changes in workforce or employee movements stemming from M&A activity. An in-depth cost-benefit analysis should be performed to optimize savings as a result of certain corporate transactions.
Strategies and opportunities to maximize immediate and ongoing cash flow will be at a premium as organizations get a better understanding of their COVID-19 related business challenges. Identifying opportunities that can result in deferment of taxes or realize immediate tax savings will be the primary tools companies need to manage cash outlays. Companies should thoroughly review their internal processes, requirements and opportunities and consult with outside advisors to ensure they are not leaving any tax credits or tax savings on the table.
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