The Employee Retention Credit (ERC) is inherently complex. For example, determining ERC eligibility under either gross receipts or partial suspension can be daunting for even the most seasoned tax professional. Additionally, there are several rules that make accurately calculating the ERC very difficult (e.g., 30-day limitation, ownership family restriction, PPP overlap, etc.). However, many employers find the most difficulty when it comes to reporting the credit on the Form 941 or Form 941-X and ultimately monetizing the ERC. Below are six common mistakes, misunderstandings, and complexities related to the Form 941, outlined to help any employer that has or will claim the ERC.
Nonrefundable v. Refundable Portion of ERC
The Form 941 (or Form 941-X, if applicable) require that the ERC be allocated between the “Nonrefundable Portion of Employee Retention Credit” (line 11c) and, if necessary, the “Refundable Portion of Employee Retention Credit” (line 13d). It is important to understand the difference between both portions to properly claim the ERC. The portion of the ERC that is used to offset the employer’s share of Social Security tax (for claims prior to third quarter of 2021) or the employer’s share of Medicare tax (for claims beginning with third quarter of 2021) is considered the “Nonrefundable portion of Employee Retention Credit.” Whereas the portion of the ERC (if any) that exceeds such offset is considered the “Refundable Portion of Employee Retention Credit.” Additional information regarding this allocation is provided below for reference.
- The IRS published a series of worksheets to help employers allocate the ERC between the “Nonrefundable Portion of Employee Retention Credit” and the “Refundable Portion of the Employee Retention Credit” properly. It is very difficult to accurately allocate the ERC and, in turn, complete the Form 941 without first completing these worksheets. All the necessary worksheets can be found in the most recent IRS Form 941 Instructions. Worksheet 2 should be used to prepare Form 941 for an ERC claimed on wages paid before July 1, 2021 and Worksheet 4 should be used to prepare Form 941 for an ERC claimed on wages paid after June 30, 2021.
- The nonrefundable vs refundable naming convention can be highly misleading because in most cases the “Nonrefundable Portion of Employee Retention Credit” will ultimately be refunded to the employer. This is especially true for employers that did not utilize any ERC acceleration strategies (i.e., Form 7200, deposit short pays, etc.).
Form 7200 Advance Payments
Congress understood that many employers would be in desperate need of cash and, in an effort to help, implemented several processes to quickly monetize the ERC and other related stimulus programs. One such process is to request an ERC advancement by filing the newly created Form 7200. While the idea of advanced payment was great in theory, it occasionally proved difficult in practice. There are issues that should be understood by any employer that has or will file a Form 7200, including the following:
- The IRS made it clear that the Form 7200 for each applicable quarter must be filed on or before the last day of the month following quarter close. For example, the last day to file a Form 7200 to request an advanced payment for the third quarter of 2021 is November 1, 2021. This means that the Form 7200 acceleration strategy can only be used for current quarter credits and not for prior quarter credits.
- Many employers fail to realize that the Form 7200 is connected to, reported on, and reconciled with the Form 941. For example, all advanced payments received for a particular quarter must be reported on line 13h of the Form 941. Failure to do so can delay an ERC refund and create subsequent reporting and processing errors. Another part of the Form 941 instructions that is often overlooked is the following: “If you filed a Form 7200 for the quarter but you haven’t received the advance before filing Form 941, don’t include on line 13h the amount of the advance requested.” Essentially one should only include advancements “received”, not “claimed”, on line 13h of Form 941. Again, failure to adhere to this guidance can delay an ERC refund and create subsequent reporting and processing errors.
- Employers can be limited by their payroll vendor’s technology and processes when attempting to carry out an accelerated monetization strategy such as filing a Form 7200. An employer should always ask their payroll vendor whether there are system limitations that would prevent them from fully implementing their desired strategies.
Short Pay Deposits
Another acceleration strategy implemented by Congress allows employers to short pay federal payroll tax deposits in anticipation of an ERC. This strategy also is great in theory but can be difficult in practice. There are issues that should be understood by any employer that has or will short pay deposits, including the following:
- Employers can be limited by their payroll vendor’s technology and processes when attempting to carry out an accelerated monetization strategy such as short paying federal payroll tax deposits. An employer should always ask their payroll vendor whether there are system limitations that would prevent them from fully implementing their desired strategies.
- The IRS requires the ERC to be reported in the proper quarter, meaning the quarter in which the underlying qualified wages were paid. Therefore, qualified wages paid in the first quarter of 2021 must be reported on the first quarter Form 941 or Form 941-X. This requirement essentially means that, like the Form 7200, the strategy to short pay deposits can only be used in the current quarter and not for prior quarter credits.
As expected, the IRS is currently experiencing significant processing delays for all employment tax filings. Such delays are seemingly attributable to both a surge in filing activity and an overall staffing shortage. An employer that files an ERC refund claim on an original Form 941 electronically can currently expect to receive an ERC refund check in approximately four to eight weeks. On the other hand, an employer that files either an original Form 941 via paper or an amended Form 941-X may not receive an ERC refund check for up to ten months.
Part 3 of Form 941
Many employers overlook a few line items on Form 941 that relate to the ERC, including the following:
- Line 21, Qualified wages for the employee retention credit (Line 30 on 941-X)
- Line 22, Qualified health plan expenses for the employee retention credit (Line 31a on 941-X)
Although these specific line items do not affect the ultimate tax calculation on the Form 941, the lines do provide the IRS with the necessary background to assess the completeness and accuracy of the employer’s ERC. We expect that leaving these specific lines blank may significantly increase the likelihood of an IRS review or examination.
Relief from Failure to Deposit Penalties
IRC § 6656 generally imposes a penalty in the event an employer fails to deposit a tax liability amount required by law. However, in accordance with Notice 2020-22, an employer that is eligible for the ERC will not be subject to such penalty if all the following conditions are satisfied:
- The employer paid Qualified Retention Wages to its employees in the calendar quarter prior to the time of the required deposit,
- The amount of Employment Taxes that the employer does not timely deposit, reduced by the amount of Employment Taxes not deposited in anticipation of the credits claimed for Qualified Leave Wages, Qualified Health Plan Expenses, and the employer’s share of Medicare tax on the Qualified Leave Wages under sections 7001 and 7003 (as described in section 3.a of this notice), is less than or equal to the amount of the employer’s anticipated credits under section 2301 of the CARES Act for the calendar quarter as of the time of the required deposit, and
- The employer did not seek payment of an advance credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, with respect to the anticipated credits it relied upon to reduce its deposits.
This penalty relief should make employers more comfortable short paying payroll tax deposits in anticipation of an ERC.
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