Employee payroll tax deferral guidance
New guidance from the Treasury Department and IRS outlines an opportunity to defer employee social security taxes. With many questions remaining unanswered, employers are faced with deciding whether to participate. Here are a few things to consider.
Background on tax deferral
On March 13, 2020, President Trump issued a federal emergency declaration due to the COVID-19 pandemic. That action triggered Section 7508A of the Tax Code, which provides significant authority for the Treasury Secretary to defer tax filing and payment due dates. That authority may be familiar since it was utilized earlier this year to defer the April 15 tax filling and payment due date to July 15.
On Aug. 8, 2020, President Trump issued a memorandum directing the Treasury Secretary to defer the collection of the employee’s share of social security payroll taxes paid for the period beginning on September 1 and ending on December 31. This deferral was to be limited to employees whose biweekly pay was less than $4,000 on a pretax basis. That equates to annualized wages of less than $104,000. That memorandum also expressed a desire for the Treasury Secretary to work with Congress to forgive the amount of deferred tax liabilities.
Following issuance of the presidential memorandum, many questions were raised by the business community (for example, see the AICPA and Chamber of Commerce letters). Those largely centered on whether this deferral would be optional or mandatory and what mechanisms would be used to repay the deferred amounts. Treasury Secretary Mnuchin indicated that the deferral would be optional though the White House hoped that many businesses would participate.
Payroll taxes generally
Social security payroll taxes are imposed upon employees and employers. Employers are obligated to withhold the employee’s share and remit it to the government along with all other withholdings and payroll taxes. If the employer fails to withhold and remit, the employer continues to be liable for the amount that was required to be withheld. In addition, in some circumstances employers that fail to properly withhold can face criminal liability or be subject to court orders, which require closure of the business.
Employees remain responsible for the payment of these taxes, as well. While the IRS may collect the amounts from employees, the IRS generally finds it far more efficient to attempt to collect them from the employer who faces liability for failing to withhold rather than attempting to collect taxes from each of the individual employees. Still, there is joint and several liability for the amount between the employer and employee until the amounts are paid.
Notice 2020-65: What we know
On Aug. 28, 2020, the Treasury Department and IRS issued Notice 2020-65, which provided the first formal guidance on the employee payroll tax deferral since the presidential memorandum. This Notice doesn’t address all of the questions raised by businesses. However, it does include the following:
- Employee social security payroll tax deferral: Relying on Section 7508A, the notice permits employers to defer the withholding and deposit of employee social security taxes (e.g., the 6.2% payroll tax) and the railroad retirement tax equivalent. If the employer isn’t withholding this tax, then the employee’s paycheck will be increased by this amount and a deferred tax liability will accrue.
- Timing of payroll: These tax withholdings can only be deferred on compensation paid to an employee between Sept. 1 and Dec. 31, 2020. Under the Notice, it doesn’t appear to matter when compensation is earned, only when it’s paid.
- Applicable wages: Tax withholdings can only be deferred on compensation that’s less than $4,000 on a biweekly basis. The $4,000 threshold is applied to each pay period separately, so it’s possible for one paycheck to qualify and another to not qualify. The threshold is also a cliff where a paycheck of $3,999 can qualify for full payroll tax deferral while a check of $4,000 will not qualify for any deferral.The Notice indicates that an equivalent threshold amount will apply to pay periods that are not biweekly periods, but doesn’t elaborate on that topic. The equivalent calculation is easiest for weekly pay periods, where the threshold would be $2,000. This becomes more complicated for monthly or semimonthly payrolls. The Notice doesn’t provide details on this point but there appear to be two potential options depending on whether the $4,000 biweekly amount is treated as imputing a per-month amount or per-day amount.
- The biweekly amount equates to a monthly threshold average of $8,666.67 ($4,000 per two-week period * 26 2-week periods per year/12 months per year) or $4,333.33 per semimonthly period.
- A per-day threshold of $285.71 could be applied ($4,000 per two-week period/14 days). That would result in a $8,571.43 threshold for a 30-day month or a $8,857.14 threshold for a 31-day month. The semimonthly thresholds would be $4,285.71 for a 15-day semimonthly period or a $4,571.42 threshold for a 16-day semimonthly period.
- Payment of deferred applicable taxes: The Notice describes a structure whereby employers are required to withhold and deposit the deferred taxes ratably from compensation paid between Jan. 1, 2021 and April 30, 2021. Any portion of the deferred taxes that remain unpaid on May 1, 2021, will accrue interest and penalties to the employer starting on that date. The Notice indicates that an employer “may make arrangements to otherwise collect the total Applicable Taxes from the employee” instead of withholding from wages in 2021. Presumably, this is directed toward employees who are terminated or whom otherwise don’t have sufficient wages to cover the deferred tax liability.
- Maximum benefit of the deferral: Based on the rules provided in Notice 2020-65, the maximum benefit that an employee could obtain from this deferral is $247.94 per biweekly paycheck ($3,999 * 6.2%). The maximum number of paychecks includible in the deferral window is 9 so the maximum possible deferral is $2,231.44 ($247.94 * 9). Therefore, the employee would receive an extra $247.94 in each paycheck from September 1 through December 31 and then each paycheck from January 1 through April 30 would be reduced by an extra $247.94.
- Is this mandatory or voluntary?: Prior to the issuance of Notice 2020-65, Treasury Secretary Mnuchin indicated that this program would be voluntary. The Notice provides relief under Section 7508A, which permits Treasury and the IRS to defer the due date of certain actions during a disaster. However, the deferral of a due date doesn’t require that a taxpayer take advantage of the deferral. Rather it merely provides the taxpayer with extra time to perform an action if it so chooses. Therefore, it appears that this program is entirely voluntary, and an employer isn’t required to defer the withholding of employee payroll taxes if it chooses not to. The Notice doesn’t explicitly address the voluntary nature of this program, but the IRS has indicated in verbal comments after the notice was issued that the program is voluntary.
Notice 2020-65: What we don’t know
Employers are now faced with the decision of whether to participate in this program. This decision is complicated by the discrepancy between what we currently know and don’t know.
Can an employer require employees to opt-in or otherwise pick and choose which employees to apply the deferral to?
The Notice doesn’t provide any guidance on whether employers are permitted to require employees to opt in or whether employers are permitted to defer only portions of payroll taxes for a period. Consistent with the voluntary nature of any Section 7508A deferral, it might be possible for an employer to choose to defer certain employee’s payroll taxes while withholding and remitting other employee payroll taxes. If an employer is permitted to apply, this deferral to only some employees, requiring those employees to opt in may also be possible. It does clarify these actions, and the overlap with other laws is unclear given the unique nature of this application of Section 7508A. The IRS indicated in verbal comments that an employer can choose the degree to which the employee participates in the decision whether to participate in the deferral.
Can an employer change its mind about participation after September 1?
The Notice doesn’t address this topic. There is certainly a possibility that an employer may change its initial decision about whether to participate in the program. This would be consistent with the idea that the program provides permission to defer taxes on each paycheck but doesn’t require any upfront notification or election be provided to the government. A change in this decision may be especially likely if further guidance is issued that makes the program either more or less attractive. However, other payroll deferral programs have been implemented in a manner where payroll taxes that were not originally deferred could never be caught up. That is, if an employer doesn’t defer employee payroll taxes on the first paycheck after September 1, the employer isn’t permitted to try to make up that amount on the next paycheck by reducing withholding of other items by the amount not previously deferred. It’s very possible that the current program will be implemented in the same manner.
How is the repayment measured in 2021?
The Notice indicates that the repayment must happen “ratably” on each paycheck paid between Jan. 1 and April 30, 2021. Presumably, this means that each paycheck would have an equal amount withheld regardless of the dollar amount of the paycheck. However, the IRS has indicated in verbal comments that a “proportional” allocation of the deferred taxes to each paycheck would be appropriate. Either method would still require the employee to remain employed and to have received a paycheck in each pay period of an amount of net cash at least equal to the extra withholding required. There is no guarantee that this will occur, particularly in industries where there are part-time and/or hourly employees without predictable hours.
What should an employer do if an employee is terminated or has reduced wages in 2021?
The Notice offers a provision regarding repayment of deferred taxes in 2021 by providing that employers “may make arrangements to otherwise collect the total Applicable Taxes from the employee.” It doesn’t provide any limit or requirements on what these “arrangements” may consist of. Therefore, it isn’t clear if an employer can either withhold lump-sum amounts (for example, from a final paycheck) or require the employee to reimburse the employer in full for the deferred amounts. It’s also not clear how an employer would document such a policy or what would be necessary to ensure that employer maintained a legal right to take such actions. This may be problematic for employers with union contracts, where many employment agreements exist that cannot be easily amended en mass, or where state law may not otherwise permit an employer to withhold such an amount from an employee’s paycheck, among many other considerations. At a minimum, this type of question implicates employment law considerations that necessitate coordination with legal counsel.
To the extent that an employer ends up having no recourse to collect the amount from the employee and has to pay the liability itself, it’s likely that amount will be viewed as additional compensation to the employee which would then require a “gross up” to be made. For example, if a terminated employee had $1,000 of taxes deferred and the employer pays that amount without collecting it from the employee, then the employee would have an extra $1,000 of compensation since the employer satisfied the liability on behalf of the employee. However, that $1,000 of additional compensation would require additional withholdings of income and payroll taxes, which would require the employer to “gross up” that amount to cover those additional amounts. This “gross up” amount would also be viewed as additional compensation so a circular calculation results in order to determine the full amount of the amount required to be repaid.
How does deferral impact payroll tax and Form W-2 reporting?
The IRS has indicated that quarterly payroll tax forms and Form W-2 will be updated to reflect the deferral of employee payroll taxes. However, the specifics of how that reporting will operate is still being determined.
What should employers do now?
Employers will need to consider whether they are willing to incur the cost of implementing this deferral program taking into consideration payroll processing matters, communication of the implications to employees, and any legal steps necessary to protect the employer’s interest with respect to any future unpaid liabilities. As currently constructed, this program can provide no more than an approximately $2,200, four-month benefit to the employee, but raises significant administrative and legal consequences for employers. As such, employers may ultimately decide not to implement the program when weighing the perceived costs and benefits.
Employers also must be particularly cognizant of the repayment provisions in 2021. Since the employer remains liable for any deferred taxes, they should carefully consider any available options to collect deferred amounts from employees who terminate service or who have reduced wages in the repayment period. Appropriate legal counsel with employment law specialties should be consulted by employers given the potential overlap between state and federal rules.
An employer should also consider how its decision about whether to participate in this program will be viewed by employees. Depending on the awareness level of the employees, it may be hard to communicate the many complexities and morale could suffer if the program isn’t implemented. An employer also needs to consider the possibility that these deferrals could eventually be forgiven by Congress. Payroll tax holidays haven’t had widespread support in either the House or Senate during the COVID-19 pandemic. That view might also extend to the concept of forgiveness of payroll taxes that are deferred under Notice 2020-65 — although that situation could change, especially if a significant amount of deferred tax liabilities has been accrued. If a forgiveness provision is adopted, it’s possible that it may only apply to taxes that are currently in deferment and might not apply to any taxes that have already been remitted or repaid. While all of this may feel highly unlikely to an employer, it must at least be considered since an employee may feel that there is a much higher chance of forgiveness and want to take that chance.
On the other hand, if repayment is required in 2021, then employee paychecks will be decreased at that time to cover the additional withholding. Employee morale could also suffer if employees are struggling to make ends meet in early 2021 while their paychecks are reduced.