IRS Issues FAQs and Form 7200 for Advance Payment of COVID-19 Employer Tax Credits

The FFCRA provides that employers that are required to pay qualified sick and family leave wages during the period beginning April 1, 2020 and ending December 31, 2020 are eligible for refundable tax credits to offset the cost of providing this leave on a dollar-for-dollar basis. The credit is allowed against the taxes imposed on employers by Section 3111(a) of the Internal Revenue Code (i.e., the Old-Age, Survivors and Disability insurance tax (commonly referred to as social security tax)) and Section 3221(a) of the Internal Revenue Code (the Railroad Retirement Tax Act) on all wages paid by the employer to all employees. The tax credits may be increased to include the cost of qualified health plan expenses and the employer portion of Medicare taxes allocable to the sick and family leave wages. Qualified health plan expenses are any amounts paid or incurred by the employer to provide and maintain a group health plan, but only to the extent the amounts are not treated as taxable income to the employee. If the amount of the qualified sick and family leave wages paid by an eligible employer (plus allocable qualified health plan expenses and Medicare taxes) exceeds the amount of the employer’s portion of social security tax due on all employees’ wages for a calendar quarter, then the excess is treated as an overpayment and refunded to the employer.

Employers must withhold income tax and the employee’s share of social security and Medicare taxes from qualified sick and family leave wages; however, these wages are not subject to the employer portion of social security tax. Qualified sick and family leave wages are treated the same as regular wages paid by the employer for purposes of employee benefit plans, and may be subject to deductions for contributions to health plans, 401(k) and other retirement plans or any other employee benefit plans. If an eligible employer receives tax credits for qualified sick and family leave wages, those wages are not eligible as “payroll costs” for purposes of receiving loan forgiveness with respect to a paycheck protection loan under Section 1106 of the CARES Act. The IRS has issued frequently asked questions regarding the qualified sick and family leave tax credits, and the Department of Labor has issued frequently asked questions and temporary regulations regarding qualified sick and family leave.   

Determining Employee Retention Tax Credit

As detailed in Pillsbury’s Client Alert issued on March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the Cares Act) permits certain employers that are subject to a full or partial closure order due to COVID-19, or that experience a significant decline in gross receipts, to take a tax credit in connection with retaining employees. The credit is equal to 50 percent of qualified wages, paid to employees after March 12, 2020 and before January 1, 2021, up to $10,000 in wages for each employee for all calendar quarters during this period. The maximum credit for eligible wages paid to any employee is $5,000. A “significant decline in gross receipts” begins with the first quarter in 2020 in which the employer’s gross receipts for the calendar quarter are less than 50 percent of its gross receipts for the same calendar quarter in 2019, and ends with the first calendar quarter for which its gross receipts are greater than 80 percent of its gross receipts for the same calendar quarter in 2019.

The amount of qualified wages eligible for the credit varies based on the average number of full-time employees employed by the employer during 2019. It the employer averaged more than 100 full-time employees in 2019, qualified wages includes only wages paid to an employee for time that the employee is not providing services due to either the full or partial closure order or the significant decline in gross receipts (and wages may not exceed what the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period of economic hardship). If the employer averaged 100 or fewer full-time employees, qualified wages include wages paid to any employee during the period of economic hardship. Qualified wages include the employer’s qualified health plan expenses that are properly allocable to the wages.

An employer who receives a paycheck protection loan under Section 1102 of the CARES Act is not eligible to take the employee retention tax credit. An eligible employer may take both the employer retention tax credit and the credit for qualifying sick and family leave wages, but may not take the employee retention tax credit with respect to any qualifying sick and family leave wages for which it receives the tax credits under the FFCRA. The IRS has issued FAQs regarding the employee retention tax credit.

How to Claim Sick and Family Leave and Employee Retention Tax Credits

Claiming Credit Prior to Filing Quarterly Employment Tax Return

Eligible employers will report their total qualified sick leave wages, qualified family leave wages and qualified wages eligible for the employee retention tax credit, and claim the related tax credits, for each quarter on their federal employment tax returns (e.g., Form 941, Employer’s Quarterly Federal Tax Return filed quarterly). Form 941 is used to report income tax and social security and Medicare taxes by employers with respect to wages. In anticipation of claiming the credits on their quarterly returns, eligible employers can benefit from the credits earlier by reducing the amount of payroll taxes deposited with the IRS. The payroll taxes that can be offset include withheld income tax and both the employee and employer portions of social security and Medicare taxes with respect to all wages paid to all employees. The employer must then account for the reduction in deposits on the employer’s employment tax return filed for that quarter.

Filing for Advance Payment of Credits

To the extent the eligible tax credits for a quarter are greater than the amount of employment tax deposits that would otherwise be due by the employer during the quarter, the employer can file Form 7200 (Advance Payment of Employer Credits Due to COVID-19) to request the advance payment from the IRS of the excess credits. The IRS has indicated that it expects to begin processing refund requests in April 2020. Employers may not reduce their payroll tax deposits and file a Form 7200 for the same expected credit amount. Employers will need to reconcile the reduction in deposited payroll taxes with any advanced credits reported by the employer on Form 7200.

If the amount of qualified sick leave and family leave credits and the employee retention credit exceeds the eligible employer’s tax deposits and the employer does not file Form 7200 to receive advance payment, the excess amount for the calendar quarter is treated as an overpayment. The excess amount will be applied to offset any remaining tax liability on the Form 941 filed for the quarter, and the amount of any remaining excess will be reflected as an overpayment and eligible for refund to the employer.

For example, if an employer is entitled to a credit of $5,000 with respect to qualified sick leave wages (including related health plan expenses and the employer portion of Medicare tax on the sick leave wages) and is otherwise required to deposit $8,000 in employment taxes, the employer can reduce the amount of its deposits by $5,000 and would then only be required to deposit $3,000. If the employer’s qualified sick leave wage credit is $10,000 and the employer is required to deposit $8,000 in employment taxes, the employer can retain the entire $8,000 and file Form 7200 to request advance payment of the remaining $2,000 credit. The employer would then reconcile the amount of employment taxes deposited with the amount of the credit on Form 941 filed at the end of the calendar quarter.

Substantiation Requirements for Sick and Family Leave Tax Credits

The IRS FAQs regarding the sick and family leave tax credits provide guidance on the information and records eligible employers should gather and retain to substantiate their eligibility to take the sick and family leave credits.

The IRS FAQs indicate that eligible employers should receive from an employee and maintain the following information:

• The employee’s name;
• The date or dates for which leave is requested;
• A statement of the COVID-19 related reason the employee is requesting leave and written support for such reason; and
• A statement that the employee is unable to work, including by means of telework, for such reason.

With respect to a leave request based on a quarantine order or self-quarantine advice, the employee’s statement should include:

• The name of the governmental entity ordering the quarantine or the name of the health care professional advising self-quarantine; and
• The name of the person subject to quarantine or advised to self-quarantine, and relationship to the employee, if that individual is not the employee.

With respect to a leave request related to a school closing or the unavailability of a childcare provider, the employee’s statement should include:

• The name and age of the child (or children) to be cared for;
• The name of the school that has closed or place of care that is unavailable;
• A representation that no other person will be providing care for the child during the period for which the employee is receiving family medical leave; and
• With respect to the employee’s inability to work or telework because of a need to care for a child older than 14 during daylight hours, a statement that special circumstances exist requiring the employee to provide care.

To substantiate eligibility for the credits, the employer must create and maintain records that include the following information:

• Documentation to show how the employer determined the amount of qualified sick and family leave wages paid to eligible employees, including records of work, telework and qualified sick and family leave provided;
• Documentation to show how the employer determined the amount of qualified health plan expenses allocated to qualified sick and family leave wages;
• Copies of any completed Forms 7200 filed with the IRS to claim the credits in advance; and
• Copies of completed Forms 941 quarterly employment tax returns submitted to the IRS. If the employer uses a third party to file quarterly employment tax returns, the employer should maintain records of the information provided to the third party payer regarding the employer’s entitlement to the credits claimed on Form 941.

The IRS FAQs indicate that employers should retain all records of employment taxes, including records to substantiate eligibility for the credits, as well as Forms 941 (Employer’s Quarterly Federal Tax Return), Forms 7200 (Advance of Employer Credits Due to COVID-19) and any other applicable filings made to the IRS requesting the credits, for at least four years after the date the tax becomes due and is paid, whichever comes later.

Other Considerations

Calculating qualified health plan expenses for purposes of the sick and family leave credits

Eligible employers can increase the amount of the qualified sick and family leave tax credit by the amount of qualified health plan expenses allocable to the sick and family leave wages. The qualified health plan expenses must be allocated on a pro-rata basis among covered employees (e.g., the average premium for all employees covered by a policy) and pro rata based on the periods of coverage (e.g., relative to the time periods of leave). The IRS FAQs provide that qualified health plan expenses are amounts paid or incurred by an eligible employer to provide and maintain a group health plan that are excluded from the employee’s gross income under Section 106(a) of the Internal Revenue Code. The expenses include both the portion of the cost paid by the employer on a pre-tax basis and the portion of the cost paid by the employee with pre-tax salary reduction contributions. Qualified health plan expenses are determined separately for each plan, and then must be allocated pro-rata among the plan participants. The FAQs provide examples for how to allocate expenses for both fully insured and self-insured group health plans. Qualified health plan expenses do not include amounts contributed by employees to health savings accounts or Archer medical savings accounts, or amounts contributed to a qualified small employer health reimbursement arrangement, but do include amounts contributed to a health reimbursement arrangement or a health flexible spending arrangement (based on the amount of contributions). The amount of qualified health plan expenses attributable to a high deductible health plan is allocated in the same manner as fully insured or self-insured plans, as applicable.

Third Party Payors

An employer that is otherwise eligible to receive the qualified sick or family leave credits is still eligible to take the credits, regardless of whether the employer uses a third party to report and pay employment taxes. An employer that uses a professional employer organization (PEO) remains eligible for the credits as long as the employer is considered the common law employer. The PEO would not be eligible to take the credits. The IRS FAQs provide additional guidance regarding the reporting requirements if the employer uses a PEO or certified PEO.