Payroll in Practice 7.26.2021

Question: Is it better to enter retention credits in the payroll monthly so it will reduce our liability or is it better to calculate all the credits once the quarter is over and complete Form 941-X?

Answer: The nonrefundable portion of the employee retention credit should be calculated after the end of the quarter. The nonrefundable portion of the ERC is computed using the worksheets provided with the Form 941 instructions. The filing due date for Form 941, Employer’s Quarterly Federal Tax Return, for a particular quarter is the last day of the month after the end of the quarter.

This should leave plenty of time to compute the nonrefundable portion of the credit so that monthly deposit schedule depositors can use it to determine the monthly amounts to report on Line 16 of Form 941 and semiweekly schedule depositors can use it to determine the daily liability amounts to report on Schedule B, Form 941. If done correctly, there should be no need to file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.

For the calendar quarters ending before July 1, 2021, the nonrefundable portion of the ERC is limited to the amount of the employer share of the Social Security taxes remaining after applying other credits that are limited by the amount of employer Social Security taxes for the quarter. These tax credits are the Qualified Small Business Payroll Tax Credit for Increasing Research Activities (Form 8974), the Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans (Form 5884-C), and the Employee Retention Credit for Certain Tax-Exempt Organizations Affected by Qualified Disasters (Form 5884-D).

These credits do not have a refundable portion. Instead, any credits exceeding the employer share of Social Security tax for a particular quarter are carried forward to future quarters. The ERC is also limited by the amount of employer Social Security tax applied to the nonrefundable portion of the sick and family leave credits. For calendar quarters after June 30, 2021, the ERC credit is applied to the employer share of Medicare taxes instead of the employer share of Social Security tax. With this change, the other credits cease to be limiting factors regarding the nonrefundable portion of the ERC.

The purpose of the credits is to generate current cash flow for businesses that have suffered a decline in revenue from corresponding pre-Covid periods. That is, the cash flow from revenue has declined, so the reduction in tax deposits makes cash available for the business to stay in operation and continue to pay employees.

This question may be about required tax deposits rather than tax liability. The amount of a tax deposit for a particular deposit period can be affected by various factors. For example, a Form 941-X adjustment of overpaid tax will reduce the amount of tax required to be deposited in future deposit periods. Also, both the refundable and nonrefundable portions of the ERC, as well as the other Covid-19 tax credits applicable to wages paid during a particular pay period, can be used to reduce the deposit requirement for that pay period. However, if the employer has received a Form 7200 advance credit payment, that payment offsets the credits for the purpose of reducing deposits.

The amount of retention credit is limited at the employee level, so it may be good practice to identify the qualified employees and wages each pay period. Doing so would allow the employer to take full advantage of the reduction in tax deposits afforded by the credits. With respect to the retention credit, the split between the nonrefundable and refundable portions of the credit does not matter with respect to tax deposit relief since both reduce the amount of tax the employer is required to deposit. At the same time, tracking the qualified wages and total allowable credit each pay period will reduce the chances that the employer will deposit less than the required amount and incur penalties.

The nonrefundable portion of the credit is identified after the end of the quarter using the worksheet and the additional qualified costs, health care costs, employer taxes, and other allocable costs, are then allocated to the wages.

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.

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