Payroll tax deferral: Deferred payments can lead to deferred tax deductions

Employers who took advantage of the option to defer payment of the employer portion of FICA taxes under the Coronavirus Aid, Relief and Economic Security (CARES) Act need to understand that the length of deferral may affect the timing of the deduction on their income tax returns. The CARES Act allowed employers the opportunity to defer payment of the employer portion of FICA taxes (6.2%) for any payroll paid between March 27, 2020 and Dec. 31, 2020. Eligible employers using this program will have until Dec. 31, 2021, to pay 50% of the deferred employer taxes, and the remaining 50% is due on Dec. 31, 2022.

Income tax effects of employer payroll tax deferral

Employers who have opted to defer payroll taxes have sometimes been surprised to learn that even though these deferred taxes may be accrued in their books for 2020, they may not be deductible from their taxable income until later. Accrual basis taxpayers who have adopted the recurring item exception will generally be permitted to deduct the portion of deferred taxes paid within eight-and-a-half months of year-end (September 15 for calendar year taxpayers). If employers choose to take advantage of the full deferral period, paying 50% in December 2021 and 50% in December 2022, the deferred taxes will be deductible in the tax year they are paid regardless of whether the employer uses the accrual method or cash method for tax purposes.

While employers are not required to submit their first payment of deferred taxes until December 2021, the CARES Act does not prohibit employers from early payment. Accrual basis taxpayers seeking to claim deductions on their 2020 returns for deferred payroll tax liabilities incurred prior to Dec. 31, 2020, may be able to do so if they pay their deferred payroll taxes by Sept. 15, 2021. This may be particularly appealing to taxpayers generating losses in 2020 that will be carried back to higher tax years.

Pros and cons of early repayment

In the absence of other considerations, taxpayers typically benefit from accelerating deductions where possible. Currently, there is no clear process for employers to pay and report the early payment of the deferred taxes on Form 941. That may create administrative challenges for employers who choose to submit early payment of any deferred taxes, but it’s possible the IRS could issue guidance to clarify this situation.

In addition, the election results have caused some concern around the possibility of future tax rate increases. If tax rate increases are on the horizon, taxpayers should consider the potential benefit of deferring the payment of taxes to gain a deduction at a higher tax rate, rather than accelerating deductions.

Plan ahead

Employers need to account for the timing of the income tax deduction for any CARES payroll tax deferral in year-end tax planning. For some employers, the cash flow benefit of utilizing the full deferral will outweigh the benefits of deducting in 2020 instead of 2021. Those who do opt for an early repayment should beware of potential administrative challenges that may ensue. Either way, the important thing is to make an informed choice before the passage of time forecloses any options.

To learn more about how the payroll tax deferral affects your business’s tax returns, please contact your Plante Moran advisor.