Tax Credits for Paid Leave Under the American Rescue Plan Act of 2021: Special Issues for Employers — Taxation and Deductibility of Tax Credits

 

Note: These FAQs address the tax credits available under the American Rescue Plan Act of 2021 (the "ARP") by employers with fewer than 500 employees and certain governmental employers without regard to the number of employees ("Eligible Employers") for qualified sick and family leave wages ("qualified leave wages") paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, as well as the equivalent credits available for certain self-employed individuals. For information about the tax credits that may be claimed for qualified leave wages paid with respect to leave taken by employees prior to April 1, 2021, under the Families First Coronavirus Response Act ("FFCRA") and the COVID-related Tax Relief Act (the "Relief Act"), see Tax Credits for Paid Leave Under the Families First Coronavirus Response Act for Leave Prior to April 1, 2021 FAQs.

Although the requirement that Eligible Employers provide leave under the Emergency Paid Sick Leave Act ("EPSLA") and Emergency Family and Medical Leave Expansion Act ("Expanded FMLA") under the FFCRA does not apply after December 31, 2020, the tax credits under sections 3131 through 3133 of the Internal Revenue Code ("the Code") are available for qualified leave wages an Eligible Employer provides with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, if the leave would have satisfied the requirements of the EPSLA and Expanded FMLA, as amended for purposes of the ARP.

Throughout these FAQs, the use of the word "work," unless otherwise noted, is inclusive of telework.

70. What amount does an Eligible Employer receiving tax credits for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) need to include in gross income? (added June 11, 2021)

An Eligible Employer must include the full amount of the credits received for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) in gross income.

71. What are the tax consequences of claiming the tax credits for a tax-exempt Eligible Employer? (added June 11, 2021)

An Eligible Employer that is exempt from federal income taxation under section 501(a) of the Code must allocate the credits for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) between activities substantially related to its exempt purposes and any unrelated trade or business activities, using the same allocation it uses in allocating the qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) for purposes of calculating its unrelated business taxable income for the year.

The portion (if any) of the tax credits that is allocable to an unrelated trade or business must be included in gross income from that unrelated trade or business for purposes of the tax imposed by section 511 of the Code. The portion (if any) of the tax credits that is allocable to the tax-exempt Eligible Employer's exempt activities is exempt from federal income taxation under section 501(a) of the Code.

A tax-exempt Eligible Employer may deduct from gross income from an unrelated trade or business the amounts paid to an employee for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) that are directly connected with carrying on that unrelated trade or business.

Note: Neither the Federal government nor any agency or instrumentality of the Federal government is an Eligible Employer entitled to receive tax credits for providing paid leave wages under sections 3131 or 3132 of the Code, except for an organization described in section 501(c)(1) of the Code. State or local governments and their agencies or instrumentalities and tribal governments that pay qualified leave wages under sections 3131 or 3132 of the Code are Eligible Employers entitled to claim the tax credits for qualified leave wages.

For more information, see "What is an Eligible Employer?"

Example: X, a tax-exempt Eligible Employer, derives gross income from the conduct of an unrelated trade or business. X employs Y who devotes 90 percent of her time to X's exempt activities and 10 percent of her time to X's unrelated business activity. X receives $2,000 in tax credits for qualified leave wages (plus allocable qualified health plan expenses and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) paid to Y.

X allocates $200 (10 percent of $2,000) of the tax credits to gross income from its unrelated trade or business. X may deduct $200 (10 percent of $2,000), the portion of Y's qualified leave wages (plus allocable qualified health plan expenses and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) that is allocable to X's unrelated business activity, from its gross income from the unrelated trade or business.

72. May an Eligible Employer deduct as a business expense an amount paid to an employee for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) for which it expects to claim the tax credits? (added June 11, 2021)

Generally, an Eligible Employer's payments of qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified wages) are deductible by the Eligible Employer as ordinary and necessary business expenses in the taxable year that these wages are paid or incurred. An Eligible Employer may deduct as a business expense the amounts paid to an employee for qualified leave wages (plus allocable qualified health plan expenses and certain contributions to collectively bargained programs paid by an Eligible Employer that are properly allocable to qualified leave wages and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) for which the Eligible Employer expects to claim the tax credits under sections 3131 or 3132 of the Code, if the Eligible Employer is otherwise eligible to take the deduction. However, to avoid a double benefit to an employer that receives the tax credit, the Eligible Employer's income is increased by the amount of the credit. See "What amount does an Eligible Employer receiving tax credits for qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages) need to include in gross income?"

73. Do the tax credits under sections 3131 and 3132 of the Code reduce the amount deductible as federal employment taxes on an Eligible Employer's income tax return? (added June 11, 2021)

Generally, an employer's payment of certain federal employment taxes is deductible by the employer as an ordinary and necessary business expense in the taxable year that these taxes are paid or incurred, and the amount deductible is generally reduced by credits allowed. Although the tax credits under sections 3131 and 3132 of the Code are allowed against the Eligible Employer's portion of the Medicare tax, the credits are treated as government payments to the Eligible Employer that must be included in the Eligible Employer's gross income. If the Eligible Employer is otherwise eligible to deduct its portion of the Medicare tax and social security tax on all wages, the proper amount deductible by the Eligible Employer is the amount of these taxes before reduction by the tax credits.

74. Does a governmental employer that is not entitled to receive a credit for qualified leave wages receive credits for the employer's share of social security and Medicare tax on paid leave wages it provides under the ARP? (added June 11, 2021)

No. A Federal government employer (or agency or instrumentality thereof) that is not an organization described in section 501(c)(1) of the Code is not an Eligible Employer and is not entitled to receive tax credits for providing qualified leave wages under sections 3131 and 3132, including for the employer's share of social security or Medicare tax paid on the leave wages.

75. Does a governmental employer entitled to the tax credit for providing qualified leave wages receive a credit for the health care expenses allocable to the qualified leave wages? (added June 11, 2021)

Yes. Governmental employers that are Eligible Employers may increase the tax credits they receive for providing qualified leave wages by any qualified health plan expenses that are allocable to the qualified leave wages that they provide.

Note: Tribal governments that provide paid sick and family leave that would have met the requirements of the EPSLA and Expanded FMLA, as amended for purposes of the ARP, are eligible to claim the tax credits for qualified leave wages, including for any qualified health plan expenses and collectively bargained contributions allocable to the qualified leave wages, assuming they are otherwise Eligible Employers.

For more information, see "What is an Eligible Employer?"

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