IRS ISSUES DRAFT FORM 941 AND INSTRUCTIONS REFLECTING COVID-19-RELATED CHANGES

05 May 2020

Draft Form 941 for 2020: Employer’s QUARTERLY Federal Tax Return (Rev. April 2020)

Draft Instructions for Form 941 (Rev. April 2020)

The IRS has issued a draft version of 2020 Form 941 (Employer’s Quarterly Federal Tax Return) and its instructions. It will be used beginning with the second quarter return (April 1 to June 30). The form has been updated to reflect COVID-19-related credits and other tax changes.

Background-Form 941. Every person who

  1. Withholds income tax from wages or
  2. Pays wages subject to FICA tax, must file Form 941, Employer’s Quarterly Federal Tax Return, for the first calendar quarter in which he meets either (1) or (2), above, and for each subsequent calendar quarter, whether or not wages are paid in those quarters, until the person has filed a final return. (Reg § 31.6011(a)-1(a)(1); Reg § 31.6011(a)-4(a)(1))

One generally must report wages he pays during the second quarter-April through June-by July 31. However, if one makes timely deposits in full payment of his taxes for the quarter, he may file by the 10th day of the second month that follows the end of the quarter. Thus, a taxpayer may file Form 941 by August 10 if he made timely deposits in full payment of his taxes for the second quarter. (Instructions to Form 941)

Background-COVID-19-related changes affecting Form 941. Form 941 needs to be revised to take into account the refundable employment tax credits included in recent COVID-19 tax legislation. This includes the Families First Coronavirus Response Act (the “FFCRA,” P.L. 116-127), which provides small and midsize employers (businesses and tax-exempt organizations with fewer than 500 employees) with refundable tax credits from April 1, 2020, through December 31, 2020, that reimburse them, dollar-for-dollar, for the cost of providing paid sick and family leave wages (qualified leave wages) to their employees for leave related to COVID-19. Qualified leave wages aren’t subject to the employer share of Social Security tax. See IRS adds to FAQs on COVID-19 family, medical and sick leave credits

The form is also needs to be updated to take into account the employee retention credit. The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) provides certain employers that operate a business during 2020 and retain employees (despite experiencing economic hardship related to the COVID-19 crisis) with an employee retention credit. The refundable tax credit is equal to 50% of qualified wages (which include qualified health plan expenses) paid to employees after March 12, 2020, and before January 1, 2021. If employers paid any qualified wages between March 13, 2020, and March 31, 2020, inclusive, they will include 50% of those wages, together with 50% of any qualified wages paid during the second quarter of 2020, on their second quarter Form 941, 941-SS, or 941-PR to claim the credit. For more information about the employee retention credit, see IRS issues detailed employee retention credit FAQs ,Federal Tax Update(05/01/2020)

Eligible employers may claim the above credits on their federal employment tax returns (e.g., Form 941), but they can benefit more quickly by filing Form 7200 (Advance Payment of Employer Credits Due to COVID-19) to request an advance payment of the tax credits for qualified sick and qualified family leave wages and/or the employee retention credit. In addition, employers may file Form 7200 if there are insufficient federal employment taxes to cover the amount of the credits. See Tips for filing Form 7200, Advance Payment of Employer Credits Due to COVID-19 (04/28/2020).

Another reason for the form to be updated is to take into account Section 2302 of the Cares Act which allows employers to defer the deposit of the employer’s share of Social Security taxes. The deferral applies to deposits of the employer’s share of Social Security tax that would otherwise be required to be made during the period beginning on March 27, 2020 and ending December 31, 2020. The deferred deposits of the employer’s share of Social Security tax must be deposited by the following dates (referred to as the “applicable dates'”) to be treated as timely (and avoid a failure to deposit penalty):

  1. On December 31, 2021, 50% of the deferred amount; and
  2. On December 31, 2022, the remaining amount.

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If an employer receives a Paycheck Protection Program loan and the employer receives a decision from the lender that the loan is forgiven, then the employer may not defer the deposit of the employer’s share of Social Security tax that is otherwise due. See IRS issues guidance on CARES Act deferral of employment tax deposits (04/14/2020).

Analysis of draft Form 941. bottom of page 1 of the draft form notes that employers must complete all three pages of Form 941 and sign the form. In the upper right of page one of the form, employers check a box to indicate what quarter they are filing the form for. The first quarter 2020 box is grayed out because the new version of the form should not be filed for the first quarter.

The draft instructions include a worksheet (Worksheet 1) to help with the computations. Only certain steps of the worksheet will be completed depending on which type of qualified wages the employer paid during the quarter: Steps 1, 2, and 3 will be completed when an employer paid in the quarter qualified sick and family leave wages as well as qualified wages for purposes of the employee retention credit. Steps 1 and 2 will be completed if the employer paid qualified sick and family leave wages in the quarter but did not pay any qualified wages for purposes of the employee retention credit in the quarter. Steps 1 and 3 will be completed if the employer paid qualified wages for purposes of the employee retention credit in the quarter but did not pay any qualified sick and family leave wages. Employers that paid qualified employee retention credit wages/health plan expenses between March 13 and March 31, 2020 will complete Steps 3c and 3d.

Part 1, Line 5a (Taxable social security wages), of the form has been expanded. In the first quarter, employers only reported the taxable portion of Social Security wages and multiplied that amount by 12.4% (employer and employee tax rate on taxable Social Security wages). On the draft version of Form 941, there are also lines 5a(i) (Qualified sick leave wages) and 5a(ii) (Qualified family leave wages).

The draft instructions for lines 5a(i) and 5a(ii) note that qualified leave wages aren’t subject to the employer share of Social Security tax; therefore, the tax rate on these wages is 6.2%. Employers should stop paying Social Security tax on an employee’s wages when the employee’s taxable wages, including wages reported on lines 5a (Taxable Social Security wages), 5a(i), and 5a(ii), and tips reach $137,700 for the year. In addition, at that time, the employer should stop entering the employee’s wages on lines 5a(i) and 5a(ii). Line 5a should not include qualified sick leave wages reported on line 5a(i) or qualified family leave wages reported on line 5a(ii).

Part 1, Line 5c (Taxable Medicare wages and tips) should include all wages, including:

  1. Qualified sick leave wages
  2. Qualified family leave wages
  3. Qualified wages for the employee retention credit
  4. Tips
  5. Sick pay, and
  6. Taxable fringe benefits that are subject to Medicare tax.

Part 1, Line 11b (Nonrefundable portion of credit for qualified sick and family leave wages from Worksheet 1)has been added to the form.This is where employers will be able to claim a credit against their share of Social Security taxes for providing qualified leave wages. Employers complete Step 2 of Worksheet to determine the amount to enter on this line. The amount on Step 2j of Worksheet 1 is carried over to Part 1, line 11b.

The draft instructions point out that the credit for qualified leave wages consists of the qualified sick leave wages, the qualified family leave wages, the qualified health plan expenses, and the employer share of Medicare tax allocable to those wages. The nonrefundable portion of the credit is limited to the employer share of Social Security tax reported on Form 941, lines 5a and 5b, after that share is first reduced by any credits claimed on Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities) and/or Form 5884-C (Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans). Any credit in excess of the remaining amount of the employer share of Social Security tax is refundable and reported on Form 941, line 13c (see below).

Part 1, Line 11c (Nonrefundable portion of employee retention credit from Worksheet 1) is where employers claim the employee retention credit.Employers enter the nonrefundable portion of the employee retention credit from Worksheet 1, Step 3, line 3j. The employee retention credit is 50% of the qualified wages paid to employees in the quarter. For the second quarter only, the credit will include 50% of the qualified wages paid between March 13, 2020, and March 31, 2020. Qualified wages also include qualified health plan expenses allocable to the wages.

The nonrefundable portion of the credit is limited to the employer share of Social Security tax reported on Form 941, lines 5a and 5b, after that share is first reduced by any credits claimed on Form 8974, Form 5884-C, and/or for the nonrefundable portion of the credit for qualified sick and family leave wages. Any credit in excess of the remaining amount of the employer share of Social Security tax is refundable and reported on Form 941, line 13d (see below).

The draft instructions advise employers with respect to Part 1, line 13a (“Total deposits for the quarter”) that they shouldn’t include any amount that they didn’t deposit because they chose to defer the employer share of Social Security tax. They also shouldn’t include any amount they didn’t deposit because they reduced their deposits in anticipation of the credit for qualified sick and family leave wages or the employee retention credit. See Relief from failure to make employment tax deposits due to coronavirus credits(4/2/2020).

Part 1, line 13b, is where employers report the deferred amount of the employer share of Social Security tax. The draft instructions remind employers not to include the employee Social Security taxes reported on lines 5a(i) and 5a(ii). Employers shouldn’t reduce the amount reported on line 13b by any credits claimed on lines 11a, 11b, or 11c. However, employers can’t defer tax that they already paid; accordingly, the maximum amount that can be deferred each quarter is the employer share of Social Security tax, minus any excess of total deposits (line 13a) over the difference between total taxes after adjustments (line 10) and the employer share of Social Security tax (50% of column 2 of line 5a and line 5b).

Part 1, line 13c, is where employers report the refundable portion of credits for qualified sick and family leave wages from Worksheet 1, Step 2, line 2k. The credit for qualified sick and family leave wages consists of the qualified sick leave wages, the qualified family leave wages, and the qualified health plan expenses and employer share of Medicare tax allocable to those wages. The refundable portion of the credit is allowed after the employer share of Social Security tax reported on Form 941, lines 5a and 5b, is reduced to zero by nonrefundable credits.

Part 1, line 13d, is where employers report the refundable portion of the employee retention credit from Worksheet 1. The refundable portion of the credit is allowed after the employer share of Social Security tax reported on Form 941, lines 5a and 5b, is reduced to zero by nonrefundable credits.

Part 1, line 13f, is where employers report total advances received from filing Form(s) 7200 for the quarter. The IRS advises employers that filed a Form 7200 before the end of the quarter, but haven’t received the advance before filing Form 941, to not include the total advances received from filing Form(s) 7200 for the quarter. Employers were eligible to file Form 7200 for the quarter if they paid qualified sick and/or family leave wages or qualified wages eligible for the employee retention credit and the amount of employment tax deposits they retained wasn’t sufficient to cover the cost of qualified sick and family leave wages and the employee retention credit.

The draft version of the form does not contain any changes to Part 2 of the form. This is where employers provide information on their deposit schedule (monthly, semiweekly) and tax liability.

The IRS has substantially expanded Part 3 of the form (“Tell us about your business”) on the draft version of Form 941. There are now lines for:

  • Qualified health plan expenses allocable to qualified sick leave wages (line 19). This amount is also entered on Worksheet 1, Step 2, line 2b.
  • Qualified health plan expenses allocable to qualified family leave wages (line 20). This amount is also entered on Worksheet 1, Step 2, line 2f.
  • Qualified wages for the employee retention credit (line 21). Employers should exclude the amount of any qualified health plan expenses allocable to these wages. This amount is also entered on Worksheet 1, Step 3, line 3a.
  • Qualified health plan expenses allocable to wages reported on line 21 (line 22). This amount is also entered on Worksheet 1, Step 3, line 3b.
  • Credit from Form 5884-C (Work Opportunity Credit), line 11, for this quarter (line 23). Employers enter an amount here to notify the IRS that they will file Form 5884-C for the quarter and therefore reduce the amount of the employer share of Social Security tax that is available to be reduced by the nonrefundable portion of the credit for sick and family leave wages and the nonrefundable portion of the employee retention credit.
  • Qualified wages paid March 13 through March 31, 2020, for the employee retention credit (use this line only for the second quarter filing of Form 941) (line 24). This amount is also entered on Worksheet 1, Step 3, line 3c.
  • Qualified health plan expenses allocable to wages reported on line 24 (use this line only for the second quarter filing of Form 941) (line 25). This amount is also entered on Worksheet 1, Step 3, line 3d.

The IRS notes that it does not release draft forms until it believes it has incorporated all changes. However, unexpected issues occasionally arise, or legislation is passed. If changes are in fact needed, the IRS will post a new draft of the form to alert users that changes were made to the previously posted draft.

The draft form cannot be filed as it has not been finalized.