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The IRS has issued temporary (TD 9904) and proposed (REG-111879-20) regulations under IRC Sections 3111 (Social Security/Medicare tax) and 3221 (Railroad Retirement Tax Act or RRTA), confirming that the overpayment of employment tax credits under the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act will be treated as an underpayment of federal employment tax.

Background

FFCRA

The FFCRA requires employers with fewer than 500 employees to provide paid sick leave and paid expanded family and medical leave. The FFCRA also stipulates that employers subject to these requirements, and that comply with them, are entitled to fully refundable tax credits to cover the cost of the leave required to be paid from April 1, 2020, through December 31, 2020. (See the IRS website.)

Eligible employers may receive payment of the recoverable amount for leave paid during the period beginning April 1, 2020 and ending December 31, 2020. The recoverable amount is claimed against the employer portion of Social Security (6.2% of wages up to $137,700 for 2020) and for employers subject to the RRTA, against the employer portion of Social Security and Medicare tax (1.45% of all covered wages), owed on all wages and compensation paid to all employees.

CARES Act

The CARES Act allows for an employee retention tax credit (retention credit) for qualified wages paid from March 13, 2020, to December 31, 2020, by employers that are subject to closure or significant economic downturn due to COVID-19. The retention credit amount takes into account up to 50% of qualified wages, up to $10,000. Thus, the maximum retention credit amount is $5,000 per employee. (IRS website, FAQs: EmployeeRetention Credit under the CARES Act.)

The retention credit is claimed against the employer portion of Social Security taxes under

IRC Section 3111(a) and the portion of RRTA taxes imposed under IRC Section 3221(a) that corresponds to the employer portion of Social Security taxes under IRC Section 3111(a).

Claiming the credits

The employment tax credits under the FFCRA and the CARES Act are claimed on Form 941, Employer's QUARTERLY Tax Return (or its equivalent). The Form 941 was significantly revised, effective for the 2020 second quarter, to accommodate this process.

Alternatively, advance payment of these employment tax credits can be requested using Form 7200, Advance Payment of Employer Credits Due to COVID-19.

IRS recovery of employment tax credit overpayments

Under the authority of IRC Sections 6402(a) and 6413(b), the temporary regulations provide that that erroneous refunds of the FFCRA and/or CARES Act employment tax credits will be treated as underpayments of the taxes imposed under IRC Section 3111(a) or IRC Section 3221(a).

Accordingly, the IRS is authorized to assess any portion of the credits erroneously credited, paid, or refunded in excess of the amount allowed as if those amounts were tax liabilities under IRC Sections 3111(a) and 3221(a), subject to assessment and administrative collection procedures.

These assessment and administrative collection procedures will apply in the normal course of processing employment tax returns that report advances in excess of claimed credits and in examining returns for excess claimed credits.

The IRS explains that this process will allow it to efficiently recover any overpayments, while also preserving administrative protections afforded to taxpayers with respect to contesting their tax liabilities and avoiding unnecessary costs and burdens associated with litigation.

Penalties and interest for the underpayment of Form 941 taxes

In addition to interest, IRC Section 6651(a)(3) authorizes a penalty of 0.5% per month or fraction of month to be assessed on amounts that should have been shown on a return and are not paid within 21 calendar days from the date of the IRS notice and demand (10 business days if the amount on the notice equals or exceeds $100,000).

IRC Section 6651(d) provides that the 0.5% rate increases to 1.0% for any month following 10 days after the IRS gives notice of intent to levy under IRC Section 6331(d) or the day the IRS makes demand for immediate payment of a jeopardy assessment under IRC Section 6331(a). The maximum penalty is 25%.

Unlike the failure-to-file penalty, the failure-to-pay penalty is reduced by payments made after the due date of the return. A payment is taken into consideration for a month if it is made before the first day of the month.

Ernst & Young LLP insights

Under Reg. Section 31.6205-1 employers can correct federal employment tax errors by reporting them on Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund (or its equivalent) provided the correction is timely-filed based on the date the error was discovered or fully ascertained. (See T.D. 9405 and Revenue Ruling 2009-39, 2009-52 IRB 951.)

Note that the Form 941-X is being modified to accommodate the changes required for the COVID-19 federal employment tax credits. (See the draft Form 941-X and instructions.)

A Form 941-X can provide essential relief from penalties and interest for overstated FFCRA and CARES Act employment tax credits, provided the employer is regularly reconciling and reviewing the employment tax credits it claims and timely files the Form 941-X when an error is discovered.

As we previously reported (EY Tax Alert 2020-1812), the IRS announced that it is mailing letters to employers when there is a delay in processing advance payment requests of the FFCRA and CARES Act employment tax credits on Form 7200. Letter 6312 is sent if the IRS either rejected Form 7200 or made a change to the requested amount of advance payment due to a computation error. The letter explains the reason for the rejection or, if the amount is adjusted, the new payment amount.

It is important that businesses filing Forms 7200 have a process in place for being promptly made aware of letters the IRS may have sent concerning processing delays, and, if employers agree with any IRS adjustments to the Form 7200, that they quickly ascertain if a Form 941-X is necessary to correct any errors.

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