PAYROLL TAX HOLIDAY

Act §101 – Payroll Tax Forgiveness for Hiring Unemployed Workers. The HIRE Act amended IRC §3111(a) which assesses the 6.2% Old Age, Survivors, and Disability Insurance (OASDI). New §3111(d) provides a special exemption for Qualified Employers who pay wages to Qualified Individuals from the day after the date of enactment (March 19, 2010) through December 31, 2010.

Qualified Employer. The term “qualified employer” means any employer other than the United States, any State, or any political subdivision thereof, or any instrumentality of the foregoing. Postsecondary educational institutions are qualified employers regardless of their status as government institution.

Qualified Individual. To be a qualified individual the employee must meet four separate criteria. A qualified individual is an individual who –

1. Begins employment with a qualified employer after February 3, 2010, and before January 1, 2011, and

2. Certifies by signed affidavit, under penalties of perjury, that such individual has not been employed for more than 40 hours during the 60-day period ending on the date such individual begins such employment, and

3. Is not employed by the qualified employer to replace another employee of such employer unless such other employee separated from employment voluntarily or for cause, and

4. Is not a related individual.

a) Lineal ascendants or descendants, brother, sister, stepbrother, or stepsister, stepfather or stepmother, son or daughter of a brother or sister of the qualified employer, brother or sister of the father or mother of the qualified employer, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

b) Owns (directly or indirectly) more than 50% in value of the outstanding stock of the qualified employer’s corporation

c) Owns (directly or indirectly) more than 50% of the capital and profits interest in the qualified employer’s entity (partnership, LLC)

d) If the qualified employer is a trust or estate, grantor, beneficiary, or fiduciary of the trust or estate – individuals who have any of the relationships in subparagraph “a” above to the grantor, beneficiary, or fiduciary of the estate or trust. Qualifying employment and qualified wages are for different periods. An individual is a qualified individual if their employment begins after February 3, 2010. Qualified wages are only those wages paid after March 18, 2010 and before January 1, 2011. The date wages are paid is controlling for determining whether the exemption applies, not the date of work performed. For example, an employee who worked from February 15, 2010 through March 15, 2010 and was paid on March 19, 2010 would qualify. However, if the same employee was paid on March 17, 2010 the wages would not qualify.

Employee Affidavit. IRS issued Form W-11 – Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit in April 2010. Use of the form is not mandatory, an employer may use a statement that contains the information contained in paragraph 2 above under “Qualified Individual”, signed by the employee under penalty of perjury. The law does not mention how to treat a self-employed individual who becomes an employee. Paragraph 2 above is taken directly from the HIRE Act. Form W-11 certification states that the individual has “been unemployed or have not worked for anyone for more than 40 hours…” There is no discussion of self-employed individuals in the Joint Committee report (JCX-4-10). Employers must have a signed affidavit or W-11 by the date the employment tax return is filed to claim the exemption. If an affidavit or W-11 is received after the employment tax return is filed the employer can amend the payroll tax return by filing Form 941X.

No replacement employees. With certain exceptions, the qualified employee cannot be replacing a current employee. This provision is intended to avoid abuse of the credit by not allowing an employer to terminate an employee and rehire them when they become qualified (40 hours of employment within 60 days). An employee laid off due to lack of work and rehired when the employer staffing needs increase will be a qualified employee. The Joint Committee report used the example of an employer who closes a factory due to lack of work, reopens the factory and rehires the same employees.

The two exceptions provided in the HIRE Act are qualified individuals who replace former employees who voluntarily separated from employment or were terminated for cause.

The Other Requirement. Employees must be employed in the qualified employer’s trade or business (or for exempt organizations, in furtherance of the activities related to the purpose or function constituting the basis of the employer’s exemption).

Self employed individuals have not worked as an employee.

Coordination with Work Opportunity Tax Credit (WOTC). Any wages paid that are used in determining the WOTC are not eligible for the payroll tax forgiveness.

WOTC quick review. Employers are eligible for a 40% credit of the first $6,000 of wages paid to individual from targeted groups (AFDC recipients, qualified veterans, qualified ex-felons, designated community residents, vocational rehab referrals, qualified summer youth employee, qualified food stamp recipients, qualified SSI recipient and long-term family assistance recipients). Employees must work at least 120 hours to get a 25% credit, and at least 400 hours to get the 40% credit. The credit is not subject to the minimum tax limitation of the general business credit and can be carried back.

Mechanics of claiming the credit. No credit or exemption was allowed on the first quarter employment tax returns. The amount of credit earned during the first quarter is allowed as a credit on the second quarter payroll tax return. New Form 941 (revision April 2010) has been modified to include a credit below the calculated total tax liability after deposits and COBRA assistance payments for credits earned in the first quarter.

Electing out of the exemption or in to the exemption. Employers can elect out by not claiming the reduced social security tax on Form 941. The election out can be revoked by filing Form 941X. Updated Form 941 is on the IRS website now. Employers do not have to claim the exemption on every employee. The exemption may be applied to none, some, or all of the qualified employees. The HIRE Act left the election out procedures entirely up to the IRS’ discretion. The IRS was extremely liberal in their interpretation of the new law. The election can be made or revoked on amended returns. Amended returns are due within three years of the filing date of the original return. Because of the liberal interpretation and ability to amend a return within a three year period, employers will have 20/20 hindsight and the ability to claim the maximum credit available.

EMPLOYEE RETENTION CREDIT The HIRE Act also provided employers a tax credit for keeping the employees with payroll tax forgiveness for an entire year.

Employers who retain a qualified individual (defined above) for 52 weeks increase their general business credit by the lesser of (1) $1,000 or (2) 6.2% of the wages paid to qualified individual during the 52 week period.

Employers and qualified individuals. The definitions of “employer” and “qualified individual” are the same for the retention credit as the payroll forgiveness.

Retain. Retained workers must meet three criteria. They must be a qualified individual:

(1) who was employed by the taxpayer on any date during the taxable year,

(2) who was so employed by the taxpayer for a period of not less than 52 consecutive weeks, and

(3) whose wages (as defined in section 3401(a)) for such employment during the last 26 weeks of such period equaled at least 80 percent of such wages for the first 26 weeks of such period.

52 weeks. The 52-week period must be consecutive. There can be no lapse in the employment.

Wages. Wages are defined under IRC §3401(a) – effectively wages subject to income tax withholding.

Date credit becomes available. The credit is determined on the date when the qualified individual completes 52 weeks of consecutive employment. For calendar year employers this credit will not be available until 2011. Qualified individuals include only those individuals who began work after February 3, 2010.

Carryforward and carryback. The credit can be carried forward as a component of the general business credit but cannot be carried back to any taxable year beginning before the date of enactment.

Interaction with WOTC. Because a qualified individual is defined in terms of the payroll forgiveness and the employer has the option of electing out of the payroll forgiveness, the election out also elects out of the retention credit.

CALIFORNIA NEW JOBS CREDIT

California’s New Jobs Credit of up to $3,000 for each new qualified full-time employee hired by small employers is still available. A small employer is one who had 20 or fewer employees as of the last day of the previous taxable year. The credit is capped at $400 million statewide, but less than $40 million has been used as of January 2011. The credit is only allowed for a net increase in full-time employees. Each qualified full-time hourly employee must be paid wages for an average of at least 35 hours per week.

Salaried employees must be paid compensation during the year for full-time employment as defined by §515 of the Labor Code. The Labor Code defines full-time for salaried employees as those earning a monthly salary equivalent to no less than two times the state minimum wage for full-time employment.

For full-time employees that were not employed the entire year there are separate formulas for hourly employees and salaried employees. For hourly employees working less than 52 weeks during the year, total hours worked by such employees is divided by 2,000 to determine the full-time equivalent employees. For salaried employees working less than 52 weeks during the year, total weeks worked by such employees is divided by 52 to determine the full-time equivalent employees.

No credit is allowed for employees in an enterprise zone or targeted tax area; employees certified as qualified disadvantaged individuals in a manufacturing enhancement area or a targeted tax area; certified as a qualified disadvantaged individual or qualified displaced employee in a local agency military base recovery area; or an employee whose wages are included in calculating any other credit allowed.

The credit may be limited by current tax liability or tentative minimum tax. In these cases the credit may be carried forward for eight (8) years or until the credit is exhausted, whichever occurs first.