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In Notice 2020-22 the IRS provides penalty relief under IRC Section 6656 to employers that choose to defer their Social Security tax payments under Section 2302 of the CARES Act and to employers that opt to reduce their federal employment tax deposits in anticipation of tax credits that are available for qualified leave wages, qualified health plan expenses and the employee retention tax credit, rather than request an advance payment using new Form 7200, Advance Payment of Employer Credits Due to COVID-19.

The IRS is granting this relief because these tax credits are claimed on Form 941 that is filed quarterly (or other returns, such as Forms 943, 944 and CT-1, that are filed annually) while employers' federal employment tax deposits may be due daily, semiweekly or monthly. With penalties under IRC Section 6656 waived, employers can receive payment of their anticipated federal tax credits much sooner.

Limitations on penalty relief

1. Qualified leave wages. An employer will not be subject to a penalty under IRC Section 6656 if:
   • The employer paid qualified leave wages to its employees in the calendar quarter prior to the time of the required deposit.
   • The federal employment taxes the employer does not timely deposit are less than or equal to the amount of the employer's anticipated credits under sections 7001 and 7003 of the Families First Act for the calendar quarter as of the time of the required deposit.
   • The employer did not seek payment of an advance credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, for the anticipated credits that it relied upon to reduce its deposits. Thus, an employer may reduce, without incurring a penalty under IRC Section 6656, the federal employment taxes by the amount of qualified leave wages and qualified health plan expenses paid by the employer in the calendar quarter prior to the required deposit, plus the amount of the employer's share of Medicare tax on such qualified leave wages, as long as the employer does not also seek an advance credit with regard to the same amount.
   
   

   For purposes of this section, the total amount of any reduction in any required deposit may not exceed the total amount of qualified leave wages and qualified health plan expenses and the employer's share of Medicare tax on the qualified leave wages in the calendar quarter, minus any amount of qualified leave wages, qualified health plan expenses, and employer's share of Medicare tax that had been previously used (1) to reduce a prior required deposit in the calendar quarter and obtain the relief provided by this IRS notice or (2) to seek payment of an advance credit.

2. Employee retention tax credit. An eligible employer will not be subject to a penalty under IRC Section 6656 for failing to deposit federal employment taxes in connection with the employee retention tax credit if:
   • The employer paid qualified retention wages to its employees in the calendar quarter prior to the time of the required deposit.
   • The federal employment taxes the employer does not timely deposit, reduced by the amount of federal employment tax 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 of the Families First Act (see "1" above) is less than or equal to the amount of the employer's anticipated employee retention credit for the calendar quarter as of the time of the required deposit.
   • 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. Thus, after a reduction, if any, of a deposit of employment taxes by the amount of credits anticipated for qualified leave wages under 1 above, an employer may further reduce, without a penalty under IRC Section 6656 the amount of the federal employment tax deposit by the amount of the employee retention credit anticipated by the employer in the calendar quarter prior to the required deposit, as long as the employer does not also seek an advance credit with regard to the same amount.
   
   

   For purposes of this section, the total amount of any reduction in any required deposit may not exceed the total amount of the employee retention tax credit in the calendar quarter, minus any amount of employee retention tax credit that had been previously used (1) to reduce a prior required deposit in the calendar quarter and obtain the relief provided by this notice or (2) to seek payment of an advance credit.

Ernst & Young LLP insights

This IRS notice provides the legal framework to allow employers to reduce their federal employment tax deposits by the amount of anticipated COVID-19 tax credits. The precise mechanics of how employers and the IRS will reconcile their federal employment tax deposits to the actual tax credits they are entitled to will not be clear until the IRS has modified the Form 941 series to reflect the various tax credits available.

It is anticipated that the modified Form 941 will be available before the April 30, 2020 due date of the 2020 first quarter return.

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