Payroll in Practice: 12.6.2021

Question: If, for the second quarter of 2021, a company did not have sick leave, family leave, or employee retention credits, could the company rightfully compute the nonrefundable portion of the COBRA credit to be zero on Worksheet 5 of Form 941?

Answer: If there was an employer share of Medicare tax included on the second-quarter Form 941, Employer’s Quarterly Federal Tax Return, there should have been a nonrefundable portion of any eligible COBRA premium assistance credit that the employer was entitled to claim against those Medicare taxes.

The COBRA premium assistance Credit is claimed on Form 941 for the quarter in which the employer becomes eligible to claim the credit. If the employer did not pay qualifying sick leave, family leave, or employee retention wages for that quarter but was eligible to receive a COBRA credit, the employer would be entitled to both nonrefundable and refundable portions of the credit. The
nonrefundable portion of the credit could be up to the amount of the employer share of Medicare tax for the quarter and would be applied to those Medicare taxes. The refundable portion would be the amount of eligible COBRA credit exceeding the employer share of Medicare tax for that quarter and would be returned to the employer.

The COBRA Premium Assistance credit is separate from the sick leave, family leave, and employee retention credits. If there were credit-eligible COBRA costs, the nonrefundable portion of the COBRA credit would be limited by the amount of employer share of Medicare tax for the quarter. Credit-eligible COBRA costs are COBRA payments that were not paid by the COBRA-eligible individuals. That is, the employer paid the COBRA premiums but did not receive full payments from the employees.

Worksheets 1 and 2 in the Form 941 instructions are used to compute the refundable and nonrefundable amounts of credits that are applied against the employer share of Social Security tax. Since the Covid credit is applied against the employer share of Medicare tax, Worksheets 1 and 2 are not used when computing the COBRA credit.

Worksheets 1 and 2 include amounts applied to the employer share of Social Security tax for the Form 8974 credit for increasing research activities, the Form 5884-C work opportunity credit and the Form 5884-D credit for tax-exempt organizations affected by qualified disasters, in that order. These credits are nonrefundable but reduce the amount of employer share of Social Security tax available for the nonrefundable portions of the credits for sick and family leave taken during the first quarter of 2021 and the ERC wages paid during the first and second quarters of 2021.

Step 1 on Worksheets 3, 4, and 5 computes the amount of employer share of Medicare tax, including allowable additions, for that quarter to compute the nonrefundable portions of the Covid-related leave, employee retention, and COBRA credits for the quarter.

These nonrefundable credits reduce the employer share of Medicare tax for the quarter, but the tax is never reduced below zero. There are no other tax credits involved for these worksheets. First, the nonrefundable portion of the sick and family leave credits are applied. Then if any employer Medicare tax remains unapplied, the employee retention credit is applied. Finally, if any employer Medicate tax liability remains, the COBRA credit is applied. Any credit amount exceeding the nonrefundable amounts is claimed as a refundable credit.

On Worksheet 5, if sick and family leave credits and/or the employee retention credit were applied to the employer share of Medicare tax on Worksheets 3 or 4, the amount of employer Medicare tax available for the nonrefundable credits would have been computed in Step 1 of those worksheets. Any amount of employer Medicare tax remaining after computing the nonrefundable portions of those credits would be entered on Worksheet 5 Steps 1a and 2b.

If there were no sick and family leave credits or employee retention credit for the quarter, Step 1a of Worksheet 5 is left blank and the amount of employer Medicare tax available for the nonrefundable portion of the credit is computed using Steps 1b though 1g. The nonrefundable and refundable COBRA credits are computed in Step 2.

Question: An employer would like to take advantage of the employee retention credit for the first quarter of 2021 but is having difficulty because there does not seem to be a worksheet in the current Form 941 instructions for the first quarter. Is there a separate worksheet for the first quarter of 2021, or should the employer use the worksheet for the second quarter?

Answer: Do not use the second-quarter worksheet. There have been five versions of Form 941 since January 2020. The Form 941 instructions for the first quarter of 2021 had only one worksheet. The instructions for the version of Form 941 released for use for the second to fourth quarters of 2021 have five worksheets to accommodate changes to the credits made by the American Rescue Plan Act. These worksheets cannot be used for any quarters before April 1, 2021.

Further, when correcting prior quarters, do not use the worksheets from the Form 941 instructions. The Form 941-X instructions have worksheets that conform to the current Form 941-X and accommodate changes to prior versions of Form 941. Note that the line numbers on Form 941-X for changes to some items may not be the same as the line numbers on the Form 941 being corrected.

To make a correction to the first quarter 2021 Form 941 for a change in the employee retention credit, use Worksheet 2 from the instructions for the latest version of Form 941-X, which is dated July 2021. Worksheet 2 is used to make corrections to employee retention credits for wages paid after March 12, 2020, and before July 1, 2021.

If sick or family leave credits were claimed on the first quarter Form 941 and there is a change to any amount used to compute the sick and family leave credits being made on Form 941-X for that quarter, prepare Form 941-X Worksheet 1 and transfer the amount from Worksheet 1, Step 1, Line 1l (one L) onto Form 941-X Worksheet 2, Step 1, Line 1a. Then proceed to Step 2 to complete the employee retention credit computations.

If the first-quarter Form 941 claimed credits for qualified sick or family leave wages and none of the amounts, including the employer share of Social Security tax, needs to be corrected, the amount from Step 1, Line 1l of Form 941 Worksheet 1 may be used on Worksheet 2, Step 1, Line 1a.

If sick and family leave credits were not claimed or no Worksheet 1 amounts are being adjusted for that quarter, compute or document the employer share of Social Security tax available for the employee retention credit using Worksheet 2 of Form 941-X, Step 1, Lines 1b through 1n. Then proceed to Step 2 to compute the nonrefundable and refundable portions of the credit.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, N.C., and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.