IRS releases final instructions for Form 941, Schedule B and R

The IRS released final instructions for Form 941 (Employer’s Quarterly Federal Tax Return), Schedule B (Report of Tax Liability for Semiweekly Schedule Depositors), and Schedule R (Allocation Schedule for Aggregate Form 941 Filers). The second quarter Form 941 and its schedules, when applicable, are due July 31 (August 10, if all tax deposits were submitted timely for the second quarter).

Due to refundable employment tax credits, advance payment of employment tax credits, and permissible deferral of certain employment taxes provided in recent coronavirus (COVID-19) tax legislation, Form 941 and its related schedules, Schedule B and R required revisions to accommodate the reporting of these credits.

• Qualified leave wages. Refundable tax credits are available for paid sick leave and paid family leave (“qualified leave wages”) required under the Families First Coronavirus Response Act (the “FFCRA”). Qualified leave wages aren’t subject to the employer share of Social Security tax.
• Employee retention credit. Additionally, the form also includes the Employee Retention Credit (ERC) provided under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The ERC is equal to 50% of qualified wages paid to employees after March 12, 2020, and before Jan. 1, 2021. The ERC permits a credit of up to $5,000 per employee (a maximum of $10,000 in wages). The reporting of qualified wages for ERC was postponed for the first quarter and first quarter qualified wages for the ERC is reported on the new version of Form 941, 941-SS, or 941-PR for both both the first and second quarters. Form 941, 941-SS, or 941-PR to claim the credit.
• Advance payment of credits. Eligible employers file 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 the employee retention credit. Form 7200 may be filed if there are insufficient federal employment taxes to cover the amount of the credits.
• Deferred payment of employer tax. Section 2302 of the Cares Act allows employers to defer the deposit and payment of the employer’s share of Social Security taxes for deposits and payments 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 Dec. 31, 2020. 50% of the deferred amount is due Dec. 31, 2021 and the remaining 50% is due Dec. 31, 2022.

Instructions for Form 941

The updated Form 941 (Employer’s Quarterly Federal Tax Return) was released on June 19, 2020. The IRS released two drafts of the 941 instructions and released the final instructions on June 26. The instructions are 19 pages long. The prior version was 12 pages.

The 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 both qualified sick and family leave wages, and 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. Lines 1e through 1h are used by third-party sick providers and recipients of Code Sec 3121(q) Notice and Demand during the quarter to account for appropriate adjustments.

Section 3504 agents. The term “agent” has been replaced with “approved Section 3504 agents” throughout. Under Code Sec. 3504, the IRS may authorize a person who pays, controls, etc. the compensation of employees employed by one or more employers, to act as an agent. Both the agent and employer are liable for the employment taxes and penalties associated with the employer’s employment tax obligations undertaken by the agent.

CPEOs. Reflecting recent guidance provided by Notice 2020-35, 2020-25 IRB, the draft instructions now note that Certified Professional Employer Organizations (CPEOs) will be permitted to file a paper Form 941 and accompanying schedules for the second, third, and fourth quarters of the 2020 calendar year. Notice 2020-35 provides a temporary waiver of CPEO electronic filing requirements.

PEOs. Non-certified Professional Employer Organizations (PEOs) that must file aggregate Forms 941 must also complete and file Schedule R if any clients claimed the qualified small business payroll tax credit for increasing research activities, paid sick and family leave wages, or the employee retention credit. Schedule R must also be filed if clients deferred the employer share of Social Security tax.

Third-party payer of sick pay. Third-party sick pay providers who pay qualified sick leave wages for an employer would be considered an “agent” of the employer. The employer is required to report and pay employment taxes with regards to the qualified sick leave wages and claim the credit for qualified sick leave wages unless there is an agency agreement that requires the third-party payer to collect, report, and/or pay employment taxes for the qualified sick leave wages. Such third-party payers are required to include the qualified sick leave wages on the third-party’s aggregate Form 941, claim the credit on behalf of the employer, and separately report the credit allocable to the employers on Schedule R.

Government employers. The instructions now note that government employers are not eligible for the credit for qualified sick and family leave wages, however, government employers are not liable for the employer share of the social security tax on qualified sick leave wages paid to employees.

Qualified health plan expenses for qualified leave wages. The amount of qualified health plan expenses generally includes both the employer and employee portion paid but should not include any employee portion paid with after-tax contributions.

Qualified health plan expenses for employee retention credit. For the purposes of the employee retention credit, the qualified health expenses would include the amount paid by the employer to provide a group health plan but only to the extent these amounts are excluded from the employees’ income as coverage under an accident or health plan. This would include the employer cost and employee’s pre-tax contribution but would not include an employee’s after-tax contribution. Qualified health plan expenses include health plan expenses allocable for periods the employer is not paying qualified wages to the employee such as furloughed employees due to a full or partial shutdown due to a government order.

Line 2 (Wages, Tips and Other Compensation). This line would include ordinary sick pay wages and would not include qualified sick leave wages. Ordinary sick pay includes third-party sick pay provided by a non-agent such as an insurance company. Third-party payers should not include sick pay on line 2 if the policyholders received timely notice of the payments.

Line 3 (Federal Income Tax Withheld from Wages, Tips, and Other Compensation). Qualified health plan expenses should be excluded from qualified wages.

Line 5a (Taxable Social Security Wages). Line 5a 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). There are also lines 5a(i) (Qualified sick leave wages) and 5a(ii) (Qualified family leave wages). Qualified wages should be reported excluding qualified health plan expenses. Filers should see line 8 for an adjustment for sick pay.

The 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, and entering an employee’s wages on lines 5a(i) and 5a(ii), 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. Line 5a should not include qualified sick leave wages reported on line 5a(i), or qualified family leave wages reported on line 5a(ii).

Line 5c (Taxable Medicare wages and tips). Line 5c 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.

Line 5d (Taxable wages & tips subject to Additional Medicare Tax withholding). The final instructions note line 5d should include qualified sick leave wages, qualified family leave wages, and qualified wages for the employee retention credit; tips; sick pay; and taxable fringe benefits that are subject to Additional Medicare Tax withholding. The final instructions note that qualified health expenses should not be included on line 5d.

Line 8 (Current Quarter’s Adjustment for Sick Pay). The instructions clarify that if an employer’s third-party payer of sick pay transfers the liability for the employer share of Social Security and Medicare taxes to the employer, the employer must enter a negative adjustment on line 8 for the amount the third-party payer withheld and deposited. For third-party payers filing Form 941 that transferred the liability, a negative adjustment is made on line 8 for any employer share taxes paid by the employer. Sick pay should be reported on lines 5a and 5c and on line 5d if the withholding threshold is met. No adjustment is required if the third-party payer is an agent of the employer. Employers who use an agent must report the wages on lines 5a and 5c, and if the withholding threshold is met, line 5d unless the third-party payer is required to collect, report and remit employment taxes on the sick pay.

Line 11b (Nonrefundable Portion of Credit of Qualified Sick and Family Leave Wages). Line 11b is used 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 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).

Line 11c (Nonrefundable Portion of Employee Retention Credit). Employers claim the employee retention credit on line 11c. 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 instructions remind employers that Form 941-X should not be used claim the employee retention credit for the first quarter of 2020.

• Third-party payers of sick pay.Third-party payers of sick pay who are not agents (i.e., insurance company) who wish to claim the credit for qualified sick and family leave wages (line 11b) and/or employee retention credit (line 11c) for amounts paid to their own employees must report the employer share of Social Security tax on line 5a reduced by any adjustment made on line 8 for employer share of Social Security tax transferred to clients.
• Code Sec 3121(q)Notice and Demand.Employers who received a Code Sec 3121(q) Notice and Demand (Letter 3263 or Letter 4520) in regards to unreported tips during the quarter must report the employer share of Social Security and Medicare tax on line 5f. The Letter will indicate the employer share of Social Security tax. This amount can be reduced by the nonrefundable portion of the credit.

Line 13a (Total deposits for this quarter, including overpayment applied from a prior quarter and overpayments applied from Form 941-X, 941-X (PR), 944-X, or 944-X (SP) filed in the current quarter). The instructions advise employers  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 IRS Notice 2020-22).

Line 13b (Deferred amount of the employer share of social security tax). Because taxes that have been paid cannot be deferred, the maximum amount that may be deferred each quarter is the lesser of: (1) the employer share of social security tax, or (2) the excess of (a) line 10 (total taxes after adjustment) reduced by the amount reported on line 11a (Qualified small business payroll tax credit for increasing research activities) over line 13a (total deposits for the quarter).

Payments made before December 31, 2021 are first applied the payment due on December 31, 2021, and then applied against the payment due on December 31, 2022.

Example: If your employer share of social security tax for the second quarter of 2020 is $20,000 and you deposited $5,000 of the $20,000 during the second quarter of 2020 and defer $15,000 on line 13b, then you must pay $5,000 by December 31, 2021, and $10,000 by December 31, 2022. However, if your employer share of social security tax for the second quarter of 2020 was $20,000 and you deposited $15,000 of the $20,000 during the second quarter of 2020 and defer $5,000 on line 13b, then you don’t need to pay any deferred amount by December 31, 2021, because 50% of the amount that could have been deferred ($10,000) has already been paid and is first applied against your payment that would be due on December 31, 2021. Accordingly, you must repay the $5,000 deferral by December 31, 2022.

The instructions note employers who use EFTPS to deposit taxes are required to identify the amount deposited for each category of tax (for example, Social Security and Medicare). However, the entries are for informational purposes only and the IRS does not use this information to compare the reported liabilities on the employment tax return and the total deposits made.

Line 13c (Refundable portion of credit for qualified sick and family leave wages from Worksheet 1). 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.

Line 13d (Refundable portion of employee retention credit from Worksheet 1). Employers report the refundable portion of the employee retention credit from Worksheet 1 on line 13d. 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.

Line 13f (Total Advances Received from Filing Form(s) 7200 for the Quarter). Form 7200 is used to file for an advance of qualified leave wage credits and employee retention credit. The Instructions note if Form 7200 is filed after the end of the quarter, it may not be processed prior to the processing of the filed Form 941. Advance payment requests will not be paid until Form 941 is processed for that 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 that amount. 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 IRS will correct the amount reported on line 13f to match any advance payments issued and the IRS will contact the filer to reconcile the difference prior to completing the processing of Form 941.

There are no changes to Part 2 of the revised Form 941 so there are no changes in the instructions for this part. This is where employers provide information on their deposit schedule (monthly, semiweekly) and tax liability. Failure to complete this Part correctly may result in an employment tax deposit penalty.

Part 3 (Tell us about your business) was substantially expanded on Form 941. Lines 19 through 25 have been added.

• 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.

No changes were made to Part 4 (May we speak with your third-party designee?) and Part 5, the signature area.

Instructions for Schedule B

Schedule B (Report of Tax Liability for Semiweekly Schedule Depositors, Rev. January 2017) will not be revised, however, the IRS has revised the instructions for Schedule B to provide guidance on how to report adjustments for tax liability for qualified business payroll tax credit for increasing research activities, qualified sick and family leave wages, and the employee retention credit on Form 941 (Lines 11a, 11b, and 11c of Form 941 or Form 941-SS).

The total tax liability for the quarter must equal the amount reported on line 12 on Form 941 or Form 941-SS. Total liability reported on Schedule B should not be reduced by the deferred amount of the employer share of social security tax, the refundable portion of the credit for qualified sick and family leave wages, or the refundable portion of the employee retention credit. Failure to account for credits on Schedule B may result in an erroneous increase in total tax liability reported on line 12. Daily tax liability may not be below zero.

Qualified small business payroll tax credit for increasing research activities (line 11a) of Form 941 or Form 941-SS. A qualified small business may elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer’s share of Social Security tax on Form 941. The payroll tax credit is claimed on Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities). The form is used to determine the amount of the qualified small business payroll tax credit for increasing research activities that can be claimed on the employment tax return. This credit applies to the employer share of social security tax on wages paid in the quarter that begins after the income tax return electing the credit has been filed. When completing Schedule B, the credit is accounted against the liability for the employer share of social security tax beginning with the first payroll payment of the quarter and may be taken on the employer share of social security tax for each quarter until the credit is used. Any remaining credit may be carried forward to the succeeding quarter and may be claimed. The remaining credit may not be used against federal income tax withholding, Medicare tax, or the employee’s share of social security tax.

Nonrefundable portion of credit for qualified sick and family leave wages (line 11b) of Form 941 or Form 941-SS. The nonrefundable portion for the credit for qualified sick and family leave wages applied against the employer share of social security taxes paid in the quarter is reduced by credits claimed for a qualified small business payroll tax credit for increasing research activities and by the Work Opportunity Tax Credit (WOTC) for hiring veterans. Any credit that remains at the end of the quarter because it exceeds the employer share of social security tax for the quarter is claimed on Form 941, line 13c as a refundable credit. However, the refundable portion of the credit does not reduce the tax liability reported on Schedule B.

Nonrefundable portion of employee retention credit (line 11c) of Form 941 or Form 941-SS. The ERC is applied against the employer share of social security tax on wages paid in the quarter and is reduced by credits claimed for a qualified small business payroll tax credit for increasing research activities and by the Work Opportunity Tax Credit (WOTC) and/or any credit claimed on Form 941, line 11b, for the nonrefundable portion of the credit for qualified sick and family leave wages. Any ERC credit that is remaining at the end of the quarter because it exceeds the employer share of social security tax for the quarter is claimed on Form 941, line 13d as a refundable credit. The refundable portion of the credit doesn’t reduce the liability reported on Schedule B.

Instructions for Schedule R

Reporting agents, certified professional employer organizations (CPEOs), and other third-party payers must complete and submit Schedule R when filing an aggregate Form 941 for quarterly federal employment taxes. PEOs must report on Schedule R all COVID-19 related credits claimed by employers who use the PEO to report and pay their federal employment taxes. For purposes of Schedule R, a client is: (1) an employer or payer identified on Form 2678, Employer/Payer Appointment of Agent, (2) a customer who enters into a contract that meets the requirements under Code Sec. 7705(e)(2) (certified professional employer organizations), or (3) a client who enters into a service agreement described under Reg. § 31.3504-2(b)(2) with a certified professional employer organization (CPEO).

The IRS released a final version of Schedule R on June 23, 2020. The revised Schedule R expanded the number of columns on the schedule from 9 to 25 to allow for the reporting of qualified wages for paid leave and employee retention and qualified health plan expenses related to credits and deferred amount of the employer’s share of Social Security tax.

The final instructions for Schedule R advise taxpayers not to report qualified wages for the employee retention credit on the first quarter Form 941. These amounts are to be accounted for on the second quarter Form 941 and Schedule R. The instructions note columns x and y which report first quarter qualified wages are only completed for the Schedule R filed with the 2nd quarter 2020 Form 941. Columns x and y should be blank for the 3rd and 4th quarters of 2020.

Generally, CPEOs must file Form 941 and Schedule R electronically, however, the IRS is waiving the electronic filing requirement for the second, third, and fourth quarters of 2020.

Additional resources:

Form 941: https://www.irs.gov/pub/irs-pdf/f941.pdf
Form 941 Instructions: https://www.irs.gov/pub/irs-pdf/i941.pdf
Schedule B: https://www.irs.gov/pub/irs-pdf/f941sb.pdf
Schedule B Instructions: https://www.irs.gov/pub/irs-pdf/i941sb.pdf
Schedule R: https://www.irs.gov/pub/irs-pdf/f941sr.pdf
Schedule R Instructions: https://www.irs.gov/pub/irs-pdf/i941sr.pdf