This is the second of a two part communication regarding the major provisions included in the CARES Act that affect small businesses. The first focused on items 1 and 2 below and can be found on our website. The purpose of this communication is to analyze in greater detail some of the key provisions of the Act that relate to small businesses so that you may gain a greater understanding of how they may impact you and your business interests.
There are four major provisions that are likely to have an immediate economic impact on small business. The CARES Act aims to afford small businesses with welcomed cash flow assistance in four primary ways:
- The Paycheck Protection Program (“PPP”) as part of the Small Business Administration (“SBA”) loan program,
- Emergency Economic Injury Disaster Loan (“EIDL”) grants as part of the existing SBA loan program,
- Delay of payment of employer payroll taxes, and
- Employee Retention Credit for employers subject to closure due to COVID-19
This communication will cover numbers 3 and 4 above. Additionally, an analysis of the employer tax credits and related expansion of family medical and sick leave contained in the Families First Coronavirus Response Act (“FFCRA Act”) effective March 18, 2020 is warranted given those provisions closely tie in with the payroll tax deferral and credits in the CARES Act.
FFCRA Act Paid Leave and Employer Credits
The FFCRA Act signed into law on March 18, 2020 contained a multitude of appropriations designed to address the impact on families related to the interruption imposed by the coronavirus on regular business and educational activity. The FFCRA Act created a federal paid sick leave requirement for coronavirus-related needs and expanded the Family and Medical Leave Act of 1993 to include a paid leave component for employees caring for an individual subject to quarantine or children whose schools or child care facilities were closed because of the virus outbreak. Individuals employed by the employer for at least 30 calendar days qualify for paid sick and family leave. More specifically, the reasons an employee may qualify for leave under the FFCRA Act are:
- The employee is under a Federal, State or local quarantine or isolation order related to COVID-19,
- The employee has been advised by a health care provider to self-quarantine due to concerns related to COVID-19,
- The employee is experiencing symptoms of COVID-19 and seeking a medical diagnosis,
- The employee is caring for an individual who is subject to a Federal, State, or local quarantine or isolation order related to COVID-19, or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19,
- The employee is caring for the child of such employee if the school or place of care of the child has been closed, or the child care provider of such child is unavailable, due to COVID-19 precautions, or
- The employee is experiencing any other substantially similar condition specified by the U.S. Department of Health and Human Services.
Employees requesting sick leave qualify for paid leave starting with the first day of leave. Employees requesting family leave are placed on unpaid leave for the first 10 days before they begin to qualify for the paid leave benefit. However, there is overlap between the paid sick leave and paid family leave provisions whereby an employee taking family leave may qualify for the sick leave benefit for the first 10 days. Thereafter, the family leave benefit would kick in to cover additional days. An employee may opt to apply accrued vacation or other accrued leave days to the initial 10-day period.
The paid sick leave benefit is capped at 80 hours for full-time employees. Part-time employees are capped at the average number of hours they work over a 2-week period. Sick leave is paid at the employee’s regular hourly rate for those individuals directly impacted by COVID-19 and is paid at 2/3 of the employee’s regular hourly rate for those employees caring for another individual impacted by COVID-19. Sick leave is capped at $511 per day and $5,110 in total for those employees directly impacted by COVID-19 or $200 per day and $2,000 for those employees caring for another individual impacted by COVID-19.
The paid family leave benefit is 2/3 of an employee’s regular rate of pay multiplied by the number of hours the employee would otherwise be normally scheduled to work. In no event can the benefit exceed $200 per day and is capped at $10,000 in the aggregate.
In cases where the viability of the business would be threatened if the leave is provided, employers with fewer than 50 employees are eligible for an exemption from the requirement to provide the leave described above.
IRS issued a news release IR-2020-57 on March 20, 2020 outlining the implementation of the paid leave and employer credits.
Paid Sick Leave Credit
Employers are eligible for payroll tax credits in connection with providing paid leave from April 1, 2020 to December 31, 2020. Division G of the FFCRA Act provides for a credit against the employer portion of payroll taxes. The credit is equal to 100 percent of the qualified sick leave wages paid by the employer during each respective calendar quarter for which payroll taxes are due.
Employers receive 100% reimbursement for paid leave pursuant to the Act via the payroll tax credit. As outlined above, the paid leave required under the FFCRA Act is a maximum of $200 per day or $511 per day depending on whether an individual is caring for another or is directly affected by COVID-19. An employer is also allowed to increase the credit amount for the portion of qualified health plan expenses properly allocable to the employee receiving sick leave wages.
The credit is refundable to the employer such that if the qualified sick leave wages paid by the employer during a calendar quarter exceeds the total payroll tax obligation of the employer, a refund of the excess credit will be issued.
Those employers who claim the credit must include in gross income an amount equal to the credit so claimed. Congress included this provision to ensure an employer did not receive a double benefit for the funds paid. An employer will have a deduction for wages paid and a deduction for payroll taxes but will only have paid cash for the wages. Being refundable, the credit amount may exceed the total payroll taxes such that a gross income item was chosen to eliminate the possibility of creating a negative expense.
The credit above is also made available to eligible self-employed individuals. Those individuals are defined as an individual that (1) regularly carries on any trade or business within the meaning of section 1402, and (2) would be entitled to receive paid leave if they were an employee of an employer. A self-employed individual may claim up to 10 days of sick leave. The maximum allowable amount that can be taken into consideration by self-employed individuals are the same limits ($200 per day / $511 per day) allowed for employers. However, the limitation may be decreased if the self-employed individual’s average daily self-employment income falls below the $200/$511 thresholds.
The FFCRA Act does not explicitly indicate the manner in which a self-employed individual would reflect this credit nor does it provide for an advanced credit in the manner in which an employer would obtain that credit. The IRS FAQs linked below address these issues in questions 65 and 66. A self-employed individual is to claim the credit on their Form 1040 filed for the 2020 tax year. No further specifics have been offered at this time on the exact methodology or form on which the credit will be claimed with Form 1040. A self-employed individual may fund the sick leave and family leave equivalents by reducing the estimated payment they otherwise would be required to make by the amount of the credit benefit being claimed.
Although it is not obvious, the legislation may be drafted in such a way that partners who pay self-employment tax on their distributive share of earnings from a partnership who do not also actively participate in the trade or business of the partnership may not qualify as an eligible self-employed individual. The construction of section 1402 defines net earnings from self-employment as income derived by an individual from any trade or business carried on by such individual, plus an individual’s distributive share of income from any trade or business carried on by a partnership. Section 1402 does not deem the partner to be engaged in the partnership’s trade or business.
Family Leave Wage Credit
Similarly, employers are eligible for a credit of 100% of the qualified family leave wages paid. The daily limit of $200 and the maximum limit of $10,000 applicable to the required benefit is mirrored in the credit computation provision. The amount of the allowable credit is also increased for the share of qualified health plan expenses properly allocable to the employee.
As with the paid sick leave credit, the family leave wage credit is also refundable to the extent the total claimed exceeds the employer’s payroll tax liability for all employees for the quarter in question.
The amount claimed as a credit must be included in the gross income of the employer.
Self-employed individuals qualify to claim the family leave wage credit in the same manner as with the sick leave credit. Self-employed individuals are specifically limited to a number of days not to exceed 50. Similar limitations to the self-employed individual’s average daily self-employment income are applied.
As with the sick leave benefit, the family leave benefit provisions do not explicity state the manner in which a self-employed person may obtain the credit amount. However, see questions 65 and 66 of the IRS FAQs linked below.
Full details for both paid leave programs can be found on the IRS website under COVID-19 Related Tax Credits for Required Paid Leave Provided by Small and Midsize Business FAQs.
Delay of Payment of Employer Payroll Taxes
The CARES Act allows employers to defer the payment of the employer’s share of payroll tax attributable to wages paid from March 27 through December 31, 2020. The payments will be considered timely made provided the employer remits 50 percent of the tax on or before December 31, 2021 and the remaining 50 percent on or before December 31, 2022.
Employers who have debt forgiven related to a PPP or equivalent loan are not eligible to defer the payment of payroll tax. It is not yet known how an employer who has deferred payments under this provision and later has a PPP loan forgiven will remedy the deferral. Any business that receives a PPP loan and anticipates that debt being forgiven may choose not to defer the payment of payroll tax given the unknown outcome. If a business ultimately chooses to defer under that fact pattern so they have additional current cash flow should anticipate a provision whereby the payment of the deferred tax may need to be made shortly after the forgiveness of PPP debt.
Employee Retention Credit
The CARES Act also makes available an Employee Retention Credit. This device has been commonly used by Congress over the years to provide cash flow relief to employers who are affected by disasters. Under the statute employers are eligible for a quarterly payroll tax credit equal to 50 percent of qualified wages paid (including allocable qualified health plan expenses) to an employee. Only qualified wages paid after March 12, 2020 and before January 1, 2021 may be considered for the credit. Only a total of $10,000 of wages per employee may be considered such that the maximum credit available to an employer for any one employee is $5,000.
An eligible employer is a an employer that is carrying on a trade or business that (a) either fully or partially suspends operation during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19, or (b) experiences a significant decline in gross receipts during the calendar quarter. Neither of these qualifiers has an obvious answer on its face. What does it mean to be partially suspended? Does a business need to be directly affected by a government order or is an indirect impact sufficient? What constitutes a significant decline in gross receipts? To address these types of questions, the IRS posted FAQs: Employee Retention Credit under the CARES Act.
With respect to partial or full suspension of business operations, IRS provides an example. In the example, a state governor issues an executive order closing all restaurants, bars and similar establishments in the state in order to reduce the spread of COVID-19. However, the executive order allows those establishments to continue food or beverage sales to the public on a carry-out, drive-through, or delivery basis. The example concludes that with respect to any restaurants, bars, and similar establishments in the state that provided full sit-down service, a dining room, or other on-site eating facilities for customers prior to the executive order, the order results in a partial suspension of the business operations. The example may be implying that any restaurant that did not have on-site eating facilities would not have had its operations partially suspended; perhaps because the executive order does not directly impact their operations. The example fails to address a broader stay at home order whereby all businesses are indirectly impacted and may ultimately partially or fully suspend their normal business operations. Would those businesses qualify to claim the credit? The answer is currently not clear, but we remain hopeful that additional guidance may be issued to address this less direct impact of an executive order.
Another FAQ seeks to define a significant decline in gross receipts. An employer must demonstrate a 50 percent decline in gross receipts in a quarter relative to the same quarter in a prior year to establish a significant decline. For example, an employer that had $1,000,000 of gross receipts in the first calendar quarter of 2019, would have a significant decline if its gross receipts in the first calendar quarter of 2020 where less than $500,000. The significant decline ends, and thus the employer’s ability to qualify for the credit ends, in the first calendar quarter following the quarter in which the employer’s gross receipts are restored to greater than 80 percent of gross receipts in the same calendar quarter for the prior year. The FAQ contains a comprehensive multi-quarter example illustrating the concept.
The credit provision is particularly impactful for small employers whom averaged less than 100 full-time employees in 2019. For those employers, wages paid to all employees are considered qualified wages. This is true without regard to whether those employees are actually providing services to customers. For those employers whom averaged more than 100 employees in 2019, only those wages paid to employees who are not providing services are considered qualified wages. In other words, only wages paid to those employees who are being kept on the payroll but whom are not required to come to work count for the credit for larger employers. The provision is clearly designed to encourage larger employers to retain individuals on their payroll even if their services are not currently required due to a reduction in business operations.
An employer need not wait to claim the credit on a timely-filed Form 941, Employer’s Quarterly Federal Tax Return. An employer may either fund qualified wages by accessing federal employment taxes required to be deposited with the IRS or by requesting an advance of the credit from the IRS using Form 7200, Advance Payment of Employer Credits Due to COVID-19.
It should be noted that any employer that receives a Small Business Interruption Loan under the PPP is not eligible to claim the Employee Retention Credit. The Employee Retention Credit represents an alternative methodology to the loan program to assist employers with cash flow needed to retain employees. Employers who apply for or receive an EIDL have not been precluded from claiming the Employee Retention Credit. It is not clear whether an EIDL grant would cause an employer to be ineligible for the credit.
The IRS issued Notice 2020-22 as a compliment to each of the sections of the CARES and Families First Acts by ensuring that employers are able to make payments to employees with funds they otherwise would have been required to deposit for payroll taxes without the application of penalty provisions. The notice provides penalty relief for deposits of federal employment taxes which are not deposited under any of the three provisions above. Specifically, Section 3 of the notice clarifies that an employer may reduce the deposit by the amount of anticipated credits provided the employer does not also seek an advance credit with regard to the same amount.
As you consider the application of these provisions to your business, please consult with your tax advisor to ensure the rules are applied properly. If you have any questions about this or any other topic, please call any member of your TFO Phoenix engagement team.
Director of Tax Strategy
TFO Phoenix, Inc.