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IRS Issues Regulations on Recapture of Excess Pandemic-Related Employment Tax Credits

July 29, 2020

By: Kasia A. Parecki

On July 27, 2020, the IRS issued temporary and proposed regulations (“Regulations”), providing guidance on the recapture of excess employment tax credits that are claimed under the Families First Coronavirus Response Act (“Families First Act”) and the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). The text of the temporary and proposed provisions is the same.  Because of the interplay between various provisions of the Families First Act and the CARES Act, including the Paycheck Protection Program (“PPP”), taxpayers may have inadvertently claimed or computed tax credits in excess of what they are eligible to receive.  The Regulations clarify how taxpayers may correct and the IRS may recover excess credit amounts received by taxpayers.

The Families First Act authorized employment tax credits for employers with fewer than 500 employees who provide up to 80 hours of paid sick and family leave to individuals unable to work due to coronavirus-related reasons (“FFTC”).  The CARES Act authorized an additional employee retention tax credit which is available to employers who continue to pay wages to their employees while suffering an economic hardship due to the coronavirus outbreak (“ERTC”).  Employers can claim both of these credits on their quarterly or annual employment tax filings on IRS Forms 941, 943, 944, or CT-1.  Both tax credits apply against the employer-share of Social Security taxes that employers would otherwise have to pay under IRC § 3111(a), or IRC § 3221(a) for railroad employers.  Both tax credits are also fully refundable if an employer’s employment tax liability is less than the amount of tax credits they are eligible to receive. Employers eligible for a refund can request an advance payment of the refund, prior to filing their Form 941, by completing Form 7200, Advance Payment of Employer Credits Due to COVID-19.  Employers are required to reconcile the advance payments claimed on Form 7200 with any tax credits claimed on their quarterly or annual employment tax returns.

The CARES Act also authorized the PPP to provide small businesses with forgivable loan funds to cover payroll and operational expenses and authorized employers to defer the deposit and payment of the employer’s share of Social Security taxes due between March 27, 2020 and December 31, 2020.  The first half of deferred Social Security taxes are due by December 31, 2021, and the remaining portion is due by December 31, 2022.  Employers borrowing a PPP loan are permitted to claim FFTC credits and defer their employment taxes, but they are not permitted to claim ERTC.  Additionally, the FFTC and ERTC cannot be claimed for the same wages, and cannot be claimed for wages for which the existing Work Opportunity Tax Credit or existing paid FMLA leave tax credit is taken.  Proposed stimulus legislation currently being negotiated by Congress may make PPP loan recipients eligible for the ERTC, so employers should keep an eye on upcoming legislation.

The Regulations address what happens if an employer requests an advance payment of a refund or files an employment tax return claiming tax credits in excess of what it was entitled to claim.  Any refund, credit, or advance that exceeds the amount the employer is actually entitled to receive is considered an “Erroneous Refund.”  Under the Regulations, Erroneous Refunds will be treated as an underpayment of the social security taxes the employer pays under IRC § 3111(a) which the IRS is authorized to collect and assess in the same manner as it currently collects underpaid social security taxes.  The Regulations also authorize the assessment and collection of Erroneous Refunds as part of processing of the applicable quarterly employment tax return. Employers will need to repay any Erroneous Refunds at the same time, and in the same manner, as they pay their quarterly employment tax liabilities.  If an employer is requesting a subsequent advance payment using Form 7200, any Erroneous Refunds can also be deducted from the advance payment the employer is eligible to receive. 

Employers should be diligent in their record keeping so that they can support any credits claimed or payments received in the event the IRS challenges the claimed credits or advances.  Further, if an employer discovers an error in the amount of credits claimed on a quarterly return, the employer can file a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, to amend the return.  Filing a timely Form 941-X can mitigate or abate penalties and interest if the employer did not knowingly make the underpayment or, here, claim an excess credit or Erroneous Refund, and filed Form 941-X by the due date of the quarter in which the error was discovered.

If you have any question about FFTC or ERTC employment tax credits, please contact your Hall Estill attorney today.