How Furloughs Impact Small Business Taxes
During an economic downturn, it's often a necessity for small businesses to search for ways to reduce their expenses. One option is to furlough your employees. This is different from firing or laying off. When you furlough, you stop paying your employee(s), but you maintain their employer-provided benefits. This typically includes items like healthcare and retirement benefits.
If you anticipate that the economic downturn will be short-lived, a furlough will allow you to bring back your most valuable employees without having to go through the entire hiring process. Employees who are furloughed also have the security of knowing that they have benefits and are likely to maintain their positions and seniority once the current economic climate improves. Furloughing employees also has unique implications when it's time to file your taxes.
The CARES Act
The Coronavirus Aid, Relief, and Economic Security Act (better known as the CARES Act) included a provision that provides an employee retention credit for eligible businesses. The credit is intended to help businesses impacted by COVID-19 continue to pay their employees.
This employee retention credit is a refundable tax credit that covers up to 50 percent of an employee's qualifying wages (up to $10,000). The IRS has since ruled that businesses may claim the employee retention credit to offset the cost of providing healthcare benefits for their employees.
This means that if you've had to furlough one or more employees, you can use this employee retention credit to offset the expenses associated with providing their health benefits. You can claim a credit of up to $5,000 for each eligible employee that you've retained between March 13th and December 31st of 2020.
To claim this tax credit, you will need to report your qualifying health insurance costs on your quarterly tax return. The credit will reduce the amount of your quarterly tax payments. Or, if the credit will exceed the amount of your quarterly tax deposits, take advantage of the tax credit now by submitting a Form 7200. A Form 7200 will allow you to receive an advance on your employee retention credit in the form of a payment from the IRS.