Employers electing to defer the deposit of the employer share of Social Security taxes on wages, as permitted under section 2302 of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, are challenged with how to take the deferral in conjunction with the COVID-19 payroll tax credits—the employee retention credit authorized by section 2301 of the CARES Act and, if applicable, the two payroll tax credits applicable to employers employers of 500 or fewer employees that are required to provide paid leave under the Families First Coronavirus Relief Act (“FFCRA”).

The benefit of electing to defer the deposit of the employer share of Social Security taxes or claiming payroll tax credits may be realized in real time when the employer runs its payroll providing a near-immediate cash injection into the employer’s business to help defray the cost of employee wages.  In other words, the employer does not have to wait to enjoy the benefit until it files its quarterly employment tax return (Form 941).  The IRS is in the process of revising that return so that the reporting of the deferral and credits are reconciled with the payroll taxes (e.g., employer share of FICA taxes, the employee share of FICA taxes and federal income tax withholding) paid and withheld on payments made to employees during the calendar quarter.

Over the last month, the IRS issued informal guidance, including three sets of FAQs—“COVID-19-Related Tax Credits for Required Paid Leave Provided by Small and Midsize Businesses FAQs,” “Deferral of employment tax deposits and payments through December 31, 2020,” and “Employee Retention Credit under the CARES Act.”  Many unanswered questions remain, but this guidance, along with the release of the new Form 7200, “Advance Payment of Employer Credits Due to COVID-19,” and the accompanying form instructions, provides employers with clues on how to apply the various adjustments to their payroll tax liabilities and obtain advance refunds of any amounts that cannot be retained from the employer deposit liability amounts at the time of payroll.  Although the IRS’s position on the interaction of these provisions is still somewhat uncertain and may change, this article explains our understanding based on the available guidance and our conversations with IRS personnel.

UPDATE: On April 29, 2020, the IRS released new FAQs providing significant guidance on the employee retention credit.  Q&A-74 specifically confirms our analysis of the earlier guidance and is consistent with the methodology described in this post.

How does the deferral of the deposit of the employer Social Security taxes work? 

An employer is only allowed to defer the deposit of the employer’s share of Social Security taxes, which is the amount of tax calculated at 6.2% based on an employer’s wages up the Social Security wage base ($137,700) that is paid by the employer.  (See our earlier coverage.)  The employer is not allowed to defer the employer’s share of Medicare taxes (1.45% of wages) or the employee’s share of Social Security or Medicare taxes.  The employer can defer the deposit of the employer’s share of Social Security taxes that were “required to be made” (i.e., deposited) on or after Friday, March 27, 2020, and through the “payroll tax deferral period” ending on December 31, 2020.  In other words, the employer can defer its share of Social Security taxes required to be deposited on wages paid in the last few days of the first calendar quarter and can continue to defer throughout 2020, including the last date in December on which it is required to make a deposit of those taxes on wages paid to employees.

If an employer defers the deposit of the employer’s share of Social Security taxes during the 2020 payroll tax deferral period, it must deposit 50% of the deferred taxes by December 31, 2021 and the remaining 50% by December 31, 2022.

How does the employee retention credit work?

An employer can take the employee retention credit when it meets certain conditions for retaining employees during the COVID-19 crisis.  (See our earlier coverage for a more detailed discussion of how this credit is determined.)  The tax credit is equal to 50% of “qualified wages” that “eligible employers” pay their employees. The maximum credit that an employer can claim for qualified wages paid to any individual employee is $5,000.  An eligible employer is one that carried on a trade or business during calendar year 2020 and that 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 experiences a significant decline in gross receipts during the calendar quarter.  Unlike the paid leave credits under the Families First Coronavirus Relief Act (“FFCRA”), the employee retention credit is available to employers of all sizes if they otherwise satisfy the eligibility requirements.  The calculation of qualified wages, however, differs for employers with 100 or fewer employees and for larger employers.

When calculating how much an employer should deposit each payroll period, how do the deposit deferral of the employer Social Security taxes and the employee retention credit interface?

An employer is permitted to defer the deposit of the employer’s share of Social Security taxes before it applies the employee retention credit.  In other words, the paid leave credits and the employee retention credit, if applicable, are applied after taking into consideration the deferred employer share of Social Security taxes.  This approach determines how much of the other employment tax deposits (employer’s share of Medicare taxes, employees’ shares of Social Security and Medicare taxes, and federal income tax withholdings) may be retained by the employer in satisfaction of the credits.  In a case where the total payroll tax credits exceed that payroll period’s tax liability, the employer can use the Form 7200 to request a refund of the excess credit amount without having to wait until the Form 941 for the calendar quarter is filed.

A Step-by-Step Guide to Determining Payroll Tax Deposit Liabilities

Step 1: Calculate what your total payroll tax deposit would be for the payroll period, without regard to the application of the deferral or the COVID-19 payroll tax credits.

Step 2: Determine what portion of the total deposit is attributable to the employer share of Social Security taxes and reduce your required deposit by that amount, understanding that 50% of this amount must be deposited by December 31, 2021, and the remaining 50% must be deposited by December 31, 2022.

Step 3: Based on the qualified wages paid to employees during the quarter for which the employer has not yet claimed a credit, determine the amount of the paid leave credits and retention credit and reduce the remaining payroll tax deposit by those amounts, respectively.  If there is a remaining payroll tax deposit due, timely deposit those taxes based on your usual deposit schedule.

Step 4: If you have an employee retention credit (or other COVID-19 payroll tax credits) remaining after reducing your required payroll tax deposit liability for the pay period to zero, you may either (1) fax Form 7200 to the IRS to get an advance payment of the amount you could not retain by reducing your deposit; (2) roll the remaining credit forward to reduce your next payroll tax deposit; or (3) wait for the refund of the payroll taxes through the reconciliation procedure of the Form 941.

The following examples help illustrate this process:

Example 1.  Total payroll tax deposit exceeds the deferred taxes and the COVID-19 payroll tax credits.

For the payroll period, assume that you are required to make a deposit of $90,000, including $20,000 for the employer share of Social Security taxes and $70,000 for other employment taxes.  Assume that you are also entitled to COVID-19 payroll tax credits of $20,000.  First, defer the deposit of $20,000 in employer Social Security taxes, which leaves a remaining deposit liability of $70,000.  Second, reduce the $70,000 deposit liability by $20,000 for the COVID-19 payroll tax credits.  Third, deposit the remaining $50,000 of employment taxes as required by your standard deposit schedule.  Of the $20,000 attributable to the deferred employer’s share of Social Security taxes, $10,000 must be deposited by December 31, 2021, and the remaining $10,000 must be deposited by December 31, 2022.

Example 2.  Total payroll tax deposit is less than the deferred taxes and the COVID-19 payroll tax credits.

Assume that you are required to make a deposit of $90,000, including $20,000 for the employer share of Social Security taxes and $70,000 for other employment taxes.  Assume that you are also entitled to COVID-19 payroll tax credits of $80,000.   As in the prior example, you will first defer the deposit of $20,000 in employer Social Security taxes, which leaves a remaining deposit liability of $70,000.  Second, reduce the $70,000 remaining deposit liability to zero to claim $70,000 of the $80,000 in total COVID-19 payroll tax credits.   To claim the excess $10,000 in COVID-19 payroll tax credits, you may fax Form 7200 to the IRS to request an advance payment of that amount.  Alternatively, you may use the excess credit to reduce the deposit liability for your next payroll tax deposit by $10,000 or wait for the $10,000 to be refunded when you file your Form 941, which reconciles for the calendar quarter the deposits, liabilities, election to defer the employer share of Social Security taxes, and claims of payroll tax credits.  Of the $20,000 in deferred employer’s share of Social Security taxes, $10,000 must be deposited by December 31, 2021, and the remaining $10,000 must be deposited by December 31, 2022.

Employers should consult with their payroll providers to ensure that the deferral and credits are being applied in the most advantageous manner.