IRS Issues Final Regs Allowing Assessments of Erroneous Refunds of COVID-19 Credits

(Parker Tax Publishing August 2023)

The IRS issued final regulations authorizing the assessment of any erroneous refund of the employment tax credits for paid sick and family leave provided under the Families First Coronavirus Response Act (Pub. L. 116-127) and the employee retention credit provided under Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (Pub. L. 116-136) and Code Sec. 3134. The final regulations clarify that the common law employer clients of third-party payors of employment taxes may be assessed for an erroneous refund of credits. T.D. 9978.

Background

In 2020, Congress enacted the Families First Coronavirus Response Act (Families First Act) (Pub. L. 116-127) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. 116-136) to provide relied to taxpayers impacted by the COVID-19 pandemic. This relief included paid sick and family leave credits to eligible employers with respect to qualified leave wages paid for a period of leave taken beginning April 1, 2020, and ending March 31, 2021, and an employee retention credit (ERC) with respect to qualified wages paid

after March 12, 2020, and before July 1, 2021, respectively.

These credits were amended and extended by the COVID-related Tax Relief Act of 2020 (Tax Relief Act) and the Taxpayer Certainty and Disaster Relief Tax Act of 2020 (Relief Act), both enacted as part of the Consolidated Appropriations Act, 2021 (Pub. L. 116-260), and the American Rescue Plan Act of 2021 (the ARP) (Pub. L. 117-2).

Paid Sick and Family Leave Credits

The Emergency Paid Sick Leave Act (EPSLA) and the Emergency Family and Medical Leave Expansion Act (EFMLEA), enacted by the Families First Act, generally require employers with fewer than 500 employees to provide paid leave due to certain circumstances related to COVID-19. The Families First Act generally provides that employers subject to the paid leave requirements under EPSLA and EFMLEA are entitled to fully refundable tax credits to cover the wages paid for leave taken for periods when employees are unable to work or telework for specified reasons related to COVID-19, plus allocable qualified health plan expenses. Although the paid leave requirement under EPSLA and EFMLEA expired December 31, 2020, the tax credits for qualified leave wages were extended by the Tax Relief Act through March 31, 2021, for paid leave that would have satisfied the requirements of EPSLA and EFMLEA.

The ARP added Code Secs. 3131, 3132, and 3133 which extend the refundable tax credits for paid leave to employers that provide paid sick and family leave for specified reasons related to COVID-19 with respect to periods of leave beginning on April 1, 2021, through September 30, 2021. The paid sick and family leave credits under Code Secs. 3131-3133 are available to eligible employers that provide employees with paid leave that would have satisfied the requirements of EPSLA and EFMLEA, with certain modifications made pursuant to the ARP. Under Code Secs. 3131 and 3132, qualified leave wages are subject to the taxes imposed on employers by Code Sec. 3111(a) (employer's share of social security tax) and Code Sec. 3111(b) (employer's share of Medicare tax), but Code Sec. 3133(a) provides that the paid sick and family leave credits under Code Secs. 3131 and 3132 are increased by the amount of the taxes imposed by Code Secs. 3111(a) and 3111(b) on qualified leave wages. The paid sick and family leave credits under Code Secs. 3131 and 3132 are allowed against the taxes imposed on employers under Code Sec. 3111(b) on all wages and compensation paid to all employees, and any credit amounts in excess of these taxes are treated as an overpayment to be refunded under Code Secs. 6402(a) and 6413(b).

Employee Retention Credit

Section 2301 of the CARES Act, as originally enacted, provided an employee retention credit for eligible employers, including tax-exempt organizations, that pay qualified wages, including certain health plan expenses, to employees after March 12, 2020, and before January 1, 2021. Section 206 of the Relief Act adopted amendments to Section 2301 of the CARES Act for qualified wages paid after March 12, 2020, and before January 1, 2021, primarily expanding eligibility for certain employers to claim the credit. Section 207 of the Relief Act, which is effective for calendar quarters beginning after December 31, 2020, further amended Section 2301 of the CARES Act to extend the employee retention credit to qualified wages paid after December 31, 2020, and before July 1, 2021, and to modify the calculation of the credit amount for qualified wages paid during that time.

The ARP enacted Code Sec. 3134, effective for calendar quarters beginning after June 30, 2021, to provide an employee retention credit for qualified wages paid after June 30, 2021, and before January 1, 2022. The employee retention credit is available to any employer carrying on a trade or business during a calendar quarter that meets the requirements to be an eligible employer under Code Sec. 3134. The employee retention credit under Code Sec. 3134 is equal to 70 percent of qualified wages paid. The credit is allowed against the taxes imposed on employers under Code Sec. 3111(b), first reduced by any tax credits allowed under Code Secs. 3131 and 3132, on all wages and compensation paid to all employees. Any credit amounts in excess of these taxes are treated as an overpayment that will be refunded under Code Secs. 6402(a) and 6413(b).

Refundability of Credits

Code Secs. 3131(b)(4)(A), 3132(b)(3)(A), and Code Sec. 3134(b)(3) provide that if the amount of the paid sick and family leave credits (which would include any increases in the credits under Code Sec. 3133(a)) and employee retention credit exceeds the taxes imposed under Code Sec. 3111(b) (employer's share of Medicare tax) for any calendar quarter, after application of the other credits previously applied, the excess is treated as an overpayment that is refunded under Code Secs. 6402(a) and 6413(b).

The IRS revised Form 941, Employer's Quarterly Federal Tax Return, Form 943, Employer's Annual Federal Tax Return for Agricultural Employees, and Form 944, Employer's Annual Federal Tax Return, so that employers may use these returns to claim the paid sick and family leave credits under Code Secs. 3131 through 3133 and the employee retention credit under Code Sec. 3134. The revised employment tax returns allow for any of these credits in excess of the taxes imposed under Code Sec. 3111(b) to be credited against other employment taxes and then for any remaining balance to be credited or refunded to the employer in accordance with Code Sec. 6402(a) or Code Sec. 6413(b).

Advance Payment of Credits and Erroneous Refunds

Code Secs. 3131(b)(4)(B) and 3132(b)(3)(B) provide that, in anticipation of the paid sick and family leave credits (which include any increases in the credits under Code Sec. 3133(a)), including any refundable portions, these credits are to be advanced up to the total allowable amount of the credits and subject to applicable limits for the calendar quarter. Code Sec. 3134(j)(2) provides that eligible employers for which the average number of full-time employees employed by the eligible employer during 2019 was not greater than 500 may elect for any calendar quarter to receive an advance payment of the employee retention credit for the quarter in an amount not to exceed 70 percent of the average quarterly wages paid in calendar year 2019. Eligible employers may use IRS Form 7200, Advance Payment of Employer Credits Due To COVID-19, to request an advance of the paid sick and family leave credits and the employee retention credit. Employers must reconcile any advance payments claimed on Form 7200 with total credits claimed and total taxes due on their employment tax returns. A refund or credit of any portion of these tax credits, regardless of whether they are advanced, to a taxpayer in excess of the amount to which the taxpayer is entitled is an erroneous refund that the employer must repay.

Temporary Regulations

On July 29, 2020, the IRS issued temporary and proposed regulations (T.D. 9904 and REG-111879-20) under Code Secs. 3111 and 3221 to provide for the recapture of erroneous refunds of the paid sick and family leave credits under the Families First Act and erroneous refunds of the employee retention credit under the CARES Act. On September 10, 2021, the IRS issued temporary and proposed regulations (T.D. 9953 and REG-109077-21) to provide for the recapture of erroneous refunds of the paid sick and family leave credits and the employee retention credit under the ARP.

On July 26, the IRS issued final regulations in T.D. 9978 that adopt the proposed regulations with a minor modification and remove the corresponding temporary regulations.

Final Regulations

The final regulations in T.D. 9978 provide that erroneous refunds of COVID-19 credits are treated as underpayments of the taxes imposed under Code Sec. 3111(a) or Code Sec. 3111(b), as applicable, and so much of the taxes imposed under Code Sec. 3221(a) as are attributable to the rate in effect under Code Sec. 3111(a) or Code Sec. 3111(b), as applicable, and are, therefore, subject to assessment and administrative collection procedures.

In certain circumstances, third-party payors claim tax credits on behalf of their common law employer clients. The final regulations clarify that employers against which an erroneous refund of credits may be assessed as an underpayment include persons treated as the employer under Code Secs. 3401(d), 3504, and Code Sec. 3511, consistent with their liability for the employment taxes against which the credits applied. In addition, the final regulations clarify the proposed regulations by expressly stating that the common law employer clients of these third-party payors may also be assessed for an erroneous refund of credits. According to the IRS this clarification makes clear to employers what had been implicit in the proposed regulations - that the existing rules in Code Secs. 3504 and 3511(c) concerning the liability of common law employer clients of third-party payors remain applicable in this situation.

Specifically, Code Sec. 3504 provides that where a fiduciary, agent, or other person is acting for an employer in performing acts required of the employer under the Code, "the employer for whom such fiduciary, agent, or other person acts shall remain subject to the provisions of law (including penalties) applicable in respect of employers." Similarly, Code Sec. 3511(c) and Reg. Sec. 31.3511-1(a)(3) provide that, for third-party payors that are Certified Professional Employer Organizations (CPEO), an employer client of a CPEO is treated as an employer (and therefore subject to all applicable provisions of law) for purposes of federal employment taxes imposed on remuneration paid by the CPEO to non-worksite employees. While Code Sec. 3504 and Code Sec. 3511 applied in the same manner as a matter of law under the proposed regulations, the final regulations expressly state these rules to avoid any confusion and help employers better understand their legal responsibilities stemming from Code Secs. 3504 and 3511.

For a discussion of the employer credits for paid sick and family leave, see Parker Tax ¶106,410 and ¶106,430. For a discussion of the employee retention credit, see Parker Tax ¶106,460.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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