The employee retention credit is one of the most effective forms of pay and tax planning. All employees should benefit from it. Its benefits apply to all employers, in all industries, at all levels. The Internal Revenue Service requires a three-year test to ensure that a credit has been paid, not just a one-year test for a bonus. A few hundred dollars saved is much better than a thousand dollars in the pockets of a new hire, or the thousands saved by an employee who is still with your company. Here’s a closer look at this wonderful tax law benefit.
Why a Retention Credit is a Good Idea for All Employers
Employees all want the best pay for their work. Most have a simple mindset that they will get the same paycheck or even more when they leave. The rewards are not just financial, but also psychological. New employees have many more years ahead of them. Most employees don’t realize that, even for the high-earning executives, the tax benefits of a retention credit are very significant. The retention credit allows employees to transfer a portion of their profit to themselves. Many economists, such as Jeffrey Pfeiffer and Thomas C. Howell, have been clear that this transferable tax treatment of retained earnings makes sense.
Employee Retention Credit is Nice, but Why Did Congress Give It?
The tax code allows individuals and families to take money from their Social Security accounts as a tax-free distribution, also known as a Roth conversion. This particular tax provision is unique. Normally, the IRS takes a distribution from an individual’s accounts when it exercises the audit discretion to demand an additional tax. Retained earnings are the funds remaining after the distribution is made. This is often referred to as an “exit tax”.
Now, this same rule applies to an employer-based retirement account. The IRS has made the policy decision to treat these distributions to employees the same as any distributions from an individual retirement account. In fact, it is given the same status as Social Security benefits, which are not taxed. It is not yet clear whether the IRS intends to treat this retirement account like a Roth IRA, or the way it treats personal retirement accounts, but we know that the IRS did not intend to treat this change as a gimmick.
So, what happens when you take a portion of an employee’s earnings in this way? To convert a traditional IRA to a Roth IRA, you are limited to contributing up to the first $5,500 of an employee’s wages in any year, or $6,500 if you are over age 50. If you have multiple employees, you would have to add up the total contributions each of them make in a year and add that to the total allowed to be contributed. This is the minimum amount you can give each of your employees.
To convert an employee-based traditional IRA to a Roth IRA, you are only limited to contributing the lesser of the first $10,000 of a worker’s wages in a year, or $11,000 if you are over age 50. If you have multiple employees, you would have to add up the total contributions each of them make in a year and add that to the total allowed to be contributed. The limit is on total contributions for the same year. For the same year, the Roth IRA contributions are lower. If you have multiple employees, you would have to add up the total contributions each of them make in a year and add that to the total allowed to be contributed.
Why Are the Amounts Different?
The amounts will be higher for your employees who had a lower amount at the beginning of the year. If an employee has a $5,000 salary, he or she can contribute a total of $11,500 in a year. If the employee earns $5,500 in the year, he or she can’t contribute the full $11,500. If a married couple has a $45,000 salary, the employee can’t contribute any more than $45,000 in a year. The employee can make the $45,000 contribution if he or she chooses, but the couple can’t. They must pay income taxes on all of the money they contribute.
To take that benefit away from them, you are limited to $6,000 in combined employer and employee contributions in any one year. If you convert an employee-based traditional IRA to a Roth IRA and don’t have a limit, you can contribute $10,000 to that account in a year. Even though you can contribute as much as $12,000 to a traditional IRA for yourself, your contributions are subject to the same limits as those you contribute to a Roth IRA. This means that you can make the $12,000 Roth contribution in a single year, but not the $10,000 one.
If you convert an employee-based traditional IRA to a Roth IRA, you are limited to contributing the lesser of the first $5,500 of a worker’s wages in a year, or $5,500 if you are over age 50. If you have multiple employees, you would have to add up the total contributions each of them make in a year and add that to the total allowed to be contributed.
Why Does the IRS Exempt Employee Loyalty Bonuses?
To start, any employee who is engaged in a willful fraud is subject to penalties. In order to allow those individuals to avoid penalties, the IRS has allowed only so-called “bonus-type” compensation for these types of frauds. In addition, the bonus type arrangement could make it difficult for the IRS to determine the relationship between the earnings of the bonus and the results of the fraud. The following will explain why you should even consider the retention credit with bonus payments.
How Much of an Earnings Transfer Will Be Tax Deductible?
The IRS requires a three-year test. This means that you must calculate and record an appropriate withholding and tax adjustment (Form W-4) for each employee and employer in your accounting system for the three-year period. This form should have the employee’s name as the first taxpayer and tax ID # as the second taxpayer. This amount is not necessarily income, but a retainer or “synthetic fee” if you want to use the term. In fact, you could even treat the fees for the purpose of this test as debt.
As a result, there could be other costs associated with preparing tax returns, including Form 1099s, withholding tax, and customer compliance. In my opinion, using the retention credit in addition to the “bonus fee” can save more in taxes. In many cases, the cost of any withholding of salaries by the employer and tax filing of withholding returns can be as much or even more than the actual taxable salary paid.
The IRS has allowed for a second option for entities that pay “bonus payments” or have other types of payment systems. This option allows “synthetic earnings,” where the “earnings” are properly recorded, but, unlike the retainer deduction, the employee would be able to claim the income from the taxes withheld from the payroll or other federal withholding systems (all employers have to do the withholding, I am referring to entities that have their own separate payroll systems).
When Will Retainer Compensation be Taxable?
When someone gets a retainer fee or synthetic fee, the amount of the retainer or bonus is the amount of the retainer or bonus. The federal income tax does not change when the fee is retainer or the bonus. This means that the salary you withhold must match the amount of the retainer or bonus.
Retaining more of the retainer or bonus income will typically reduce the annual tax withholding on the amount of the retainer or bonus and result in lower taxes. Also, if the retainer or bonus exceeds the IRS withholding requirements, the employee can continue to withhold the withholding from the payments.
If Retainer Compensation Is Controversial
If the payment is retainer, it is generally received as a payment for services. Therefore, it is only available to employees who have a professional relationship with the employer. The IRS allows the “retainer fee” for more than one year in some cases. In other words, if your organization is not in the habit of requiring the payment of a retainer fee, you might want to use a retainer instead of the “bonus fee.” Also, many entities who hire professional staff as consultants will pay these consultants a retainer fee or as a commission. Again, if your organization is not in the habit of requiring this type of payment, you might want to use a retainer instead of the “bonus.”
Frequently Asked Questions
I was told that I will be taxed on the entire retainer if I use it for the CEO’s work. What does the IRS say?
The IRS says that if the employee gets a cash payment and does work on your behalf, then the employee will be required to report the cash payment on a Schedule C (Schedule C-EZ) if the payment is greater than $600. The IRS does not require reporting if the payment is less than $600. When reporting income, you must use the “multiplier” or multiple-purpose factor when reporting a Schedule C (Schedule C-EZ). This is the percentage of the amount of the payment that was for services (as opposed to the cash amount). The multiplier is different for individuals and corporations.
A typical multiplier will be approximately 35% (Schedule C-EZ). If the employee is paid as a retainer, and the payment is less than $600, then you will need to use the 10% factor. When calculating the Schedule C (Schedule C-EZ), use the “multiplier” and “and-fraction” factors. The difference between using a “multiplier” and a “and-fraction” is that a multiplier can be reduced by only one half of the amount over $600, while an and-fraction has no limitation. For example, if the payment was for $600, and the employee had to be paid $375 to get the remainder of the retainer paid in cash, you could reduce the $375 to $200. You would then include that $200 on the Schedule C (Schedule C-EZ).
Does Retainer Compensation Count as Paid Travel Expenses?
If you deduct travel expenses when you file Form 1040, you are generally required to make a special report for Schedule E (Schedule E-EZ). If you don’t make a special report, you will be subject to an audit and could be subject to penalties and interest if the travel report is inaccurate. As discussed above, the IRS allows you to use a Section 168(k) adjustment to make the reporting of expenses more manageable.
If the travel is paid on the basis of time and was done in connection with the duties of your employment, then the portion of travel expense for which you are deducting the cost in computing income will generally be treated as “normal business expense.” If the travel is paid on the basis of customer relations or meetings, then you will need to use a “standard deduction.” If you decide to use this provision, the first step is to determine how many days and hours you worked. The part of the business trip that is for personal reasons or business meals will not be deductible.
What if I assign a consultant to do my work and they are paid by check? What do I do with the check?
Generally, all of the money that is received on a personal check is your personal income. You will need to report all of the income and file the appropriate tax return. If you are a freelancer, you will need to make a note on your W-2 of the amount of payment in the freelance column and use the W-2 to compute your tax. The same rules apply as described above for filing a Schedule C (Schedule C-EZ) and other tax returns.
What about receiving checks from a corporation that don’t have a “bank check?” What do I do with those?
Typically, you have to deposit those checks into your bank account, but you don’t have to report them as income on your tax return. The IRS has also instituted regulations (10 IRC 90-206(1)(f)) that are designed to make it easier for corporations to receive the compensation paid to them on a check and then make the payment themselves on a bank draft to the employee who is paid by check. For example, an employer may pay its employee using a check or other check (such as a personal check or wire transfer), but the employee may not be paid using a personal check. Therefore, the employee should not receive a check and need to deposit the check into their personal account. After they have deposited the check, they can then send the corporate check to the corporation.
If you receive a check from a corporation but wish to make the payment to the employee, then you would need to file Form 6562 and provide the payment to the corporation and the employee. This form allows you to calculate what you are supposed to pay and then deduct the appropriate amount as a business expense. Form 6562 is generally used to determine the amount of money that is due to the employee, and the form is generally filed with the Form 1040. However, if you are a freelancer, you will need to attach a Form 6562 to Form 1040 as a Schedule C (Schedule C-EZ).
If an employer issues you a check that you would not normally receive, you can record the check as a personal check to yourself. Generally, the person who issues you a check is considered the payee. The payee can generally write the check out to themselves. The payee will then record the check as a personal check to themselves. The payee will use the check to make a payment to themselves, and will then record the payment as a personal check to themselves. There may be an exception to this rule for some of the checks that are issued, but this exception is not commonly used. Usually, you will only have to file the additional payee, or personal income, tax forms if you received a personal check for a business purpose. For example, if you received a check from a stockbroker for stock that you bought from the stock broker on his or her personal check account.
Conclusion
If you are planning to maximize your employee retention credit, then you may be wondering what to do with the large number of checks that you are likely to receive over the course of the year. Simply depositing them into a personal bank account may be a quick way to avoid reporting them as income, but it isn’t the best way to maximize the credit. For more information on this topic, visit the IRS website.
We hope that you are able to maximize your employee retention credit. It is easy to do, and can have a positive impact on your business. This information is not legal advice. It is provided as general information only. You should obtain professional advice from an attorney if you have questions about the matters described in this article.