Congress responded to the COVID-19 pandemic by passing numerous laws, such as the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), with four payroll tax relief programs that offered deferrals or credits against federal employment taxes.
Employers and their advisors need to understand how these programs operate to maximize their savings potential and save on employment tax deposits each quarter.
Employee Retention Credit (ERC)
If your small business kept employees on payroll during the COVID-19 pandemic, the Employee Retention Credit (ERC) may help offset some of its payroll tax liability. First introduced as part of the Coronavirus Aid, Relief, and Economic Security Act in March 2020 and amended three times since, eligibility depends on which law was in place when wages were paid to retain staff as well as whether you took out a Paycheck Protection Program loan (PPP).
Qualifying wages for the Earned Retention Credit are those paid to your workers when your business was forced to close due to government orders restricting commerce, travel or group meetings; or when gross receipts dropped significantly between quarters. Wages paid out to family members who worked at your company do not count towards qualifying wages; cash tips of $20 or more per month must also be factored into this calculation. While ERC payments do not count as taxable income, they do impact payroll deductions and, eventually, your taxable profit; therefore claiming this credit requires amending prior year income tax returns accordingly.
Given the complexity of tax law, it’s wise to consult with a professional when attempting to determine your eligibility and maximize this credit. A tax professional can assist in understanding any limitations to eligibility as well as educate on income tax implications.
Alternatively, eligible small businesses that wish to claim the Employment Recovery Credit must file an adjusted quarterly employment tax return with Form 941-X and report its refundable credit for qualified wages paid during your period of claiming it by April 30. Businesses eligible to claim retroactive refunds in either 2020 or 2021 by filing this way can file Form 941-X instead; although this process can be time consuming and confusing.
Social Security Deferral
Beginning March 27, 2020, employers have been allowed to defer depositing employee Social Security taxes pursuant to the Coronavirus, Aid Relief and Economic Security Act (CARES Act). The IRS has provided FAQs that explain specific issues surrounding this program – such as coordination with paid leave credits under Families First Coronavirus Response Act (FFCRA) Section 7001 and employee retention credits provided under section 2301 of CARES Act.
If an employer chooses to defer deposit of its Social Security taxes, it must also reduce its federal employment tax deposits by the anticipated credits or refunds resulting from FFCRA and/or employee retention credits. Normally this should occur quarterly; if however they anticipate receiving credits or refunds that exceed what was deferred they can make an optional quarterly deposit only of what remains deferred Social Security taxes for that quarter.
The IRS has also clarified that an employer’s deferral of Social Security taxes must be repaid by January 3, 2023 or it will receive a CP256V notice containing its total outstanding liability and instructions on how it may be settled.
Many third-party payroll providers have already modified their systems to accommodate this deferral and increase take-home pay for workers. If this hasn’t happened yet, it is imperative that you speak with your vendor and create a plan as soon as possible so your workforce has access to funds they require for functioning properly.
Once an employer has finished withholding and repaying deferred Social Security taxes to the IRS, they should submit Form W-2c, Corrected Wage and Tax Statement, to both the Social Security Administration as well as affected employees. In addition, according to IRS recommendations an employer should send written communications outlining how their increased take-home pay from deferred Social Security taxes will eventually be offset by obligations they owe back later from federal authorities.
Paycheck Protection Program (PPP) Forgiveness
The PPP is a new government program created to ensure small business employees remain paid during the COVID-19 pandemic. This credit covers up to 70% of qualified wages reported quarterly on Form 941 and may be combined with ERC to maximize payroll tax relief for businesses.
For your small business to qualify for the PAVAD-19 Program Loan Partnership (PPP), they must have been adversely impacted by the pandemic and be unable to restore pre-pandemic business levels during the covered period. You will also need lender approval of your loan application; once approved you must allocate 60% of loan funds towards payroll expenses.
Employer Identification Number. Lenders accept applications through online portals and will make their decision within 60 days after receiving it. You must use the loan proceeds for payroll costs and eligible expenses.
Based on the purpose of your PPP loan, it may be necessary to amend your payroll tax returns accordingly. If any excess amount remains from qualified wages after using up all available funds from PPP loans in one quarter, carryover could apply in subsequent quarters.
Documenting how you are spending PPP funds to ensure you are making the best use of them is vital to receiving loan forgiveness from PPP funds. This could involve hiring or firing workers as necessary and must all be documented carefully for loan forgiveness consideration.
One common error made by many businesses is omitting forgiven loan proceeds as income when filing their taxes, leading to significant penalties if discovered by the IRS. Recently, they issued guidance regarding this topic.
Remember if you own a corporation, as its owner your salary must be recorded on payroll – even if your salary does not reflect regular payout. A subchapter S corporation could help avoid this problem but may make tax filing more complex.
Earned Income Tax Credit (EITC)
The Earned Income Tax Credit (EITC) is a refundable tax credit available to working low- and moderate-income individuals and families, whose filing status and number of qualifying children determine its size. It increases with earned income but phases out at certain income level plateaus depending on filing status; for single filers it typically remains virtually zero until more children come into the household; its size thus strengthens work incentives during its phase-in range, but lessens as more are added – strengthening work incentives in one range but weakening them in its phase-out range.
The high marginal rate in the EITC’s phase-out range, which does not impact labor supply for workers with no children, could be explained by recipients using all or part of their credit as a tax refund rather than spending it to increase income and consumption (the substitution effect), or institutional labor market constraints such as fixed work hours. Research demonstrates that EITC increases work participation rates among single mothers while simultaneously helping lift millions out of poverty annually with children making up at least half of this number.
Although EITC benefits are considerable, its complexity and unequal treatment based on marital status may pose compliance challenges for working families. Furthermore, its effects on labor supply are compounded by its dual use as either tax payment or refund.
Complex credits increase the chance of errors and underpayment, compounded by filing multiple forms to obtain them. This can become particularly troublesome for lower-income families who tend to file tax returns at lower rates than their more affluent peers.
To address these challenges, various proposals aim to streamline the EITC by consolidating exemptions and credits into one credit that all families can claim. Jason Furman and the Economic Policy Institute’s budget proposal “Investing in America’s Economy” would even go so far as eliminating it entirely and replacing it with a simpler credit available regardless of filing status or number of qualifying children in a household.