Uncertainties Remain Regarding Payroll Tax Deferral
Tax Law Alert 09/10/20 Patricia A. Hintz, Christie R. Galinski
On August 8th, President Trump announced a deferral of the employee portion of Social Security Taxes for the period of September 1, 2020 through December 31, 2020 (the "Deferral").
The original declaration provided few specifics to employers about how to implement this new policy and many feared that the deferred taxes would be due in a lump sum on January 1st. Many also wondered whether it would be the employee or the employer who would ultimately be responsible for the payment of the deferred taxes.
In an attempt to provide clarity, the IRS issued Notice 2020-65 at the end of August. Unfortunately, the new guidance does not provide the details or certainty that most employers will need to actually defer collection of the tax.
Note that this Deferral refers only to the employee portion of Social Security taxes. A separate deferral for the employer portion was provided in the CARES Act and allows employers to defer the employer portion of Social Security taxes otherwise due in 2020 -- half to the end of 2021 and the other half to the end of 2022.
The Current Government Guidance on the Deferral
Usually, employees pay 6.2% Social Security tax or Railroad Retirement tax on their wages, in addition to 1.45% for the employees' share of Medicare taxes. Social Security and Medicare taxes are withheld from the employee's paycheck by the employer who then remits the amounts to the federal government. The Social Security tax is only withheld until an employee reaches their wage base income, which is $137,700 in 2020.
On August 8th, President Trump issued an order directing the Treasury Secretary to use his authority pursuant to Section 7508A of the Internal Revenue Code to defer the withholding, deposit and payment of Social Security taxes on wages for the last four months of 2020. Section 7508A allows the Secretary to defer tax collection during a federally declared disaster. It does not allow the Treasury Secretary to forgive, eliminate or reduce the total tax that is due -- only to "postpone certain deadlines." Although the President has stated he would like to reduce or eliminate payroll taxes, such an action would require Congressional approval.
On August 28th, the IRS issued Notice 2020-65, with limited additional guidance.
Based on the original memorandum and the Notice, these are the basic rules of the Deferral:
- The Deferral applies to the employee's (not the employer's) portion of payroll taxes, specifically Social Security Taxes.
- The Deferral does not include Medicare Taxes.
- The Deferral applies to individual employees who earn less than $4,000 gross pay in a bi-weekly pay period or the equivalent amount with respect to other pay periods.
- The $4,000 calculation is made on a pay-period-by-pay-period basis.
- The Deferral applies to wages paid during the period of September 1, 2020 through December 31, 2020. Previous musings by the President that he could backdate the Deferral to an earlier month have not materialized.
- The due date of the deferred taxes is postponed until the period beginning on January 1, 2021 and ending on April 30, 2021.
- Employers, not employees, are responsible for paying the deferred taxes.
- Employers must withhold and pay the deferred taxes ratably from wages and compensation paid between January 1, 2021 and April 30, 2021.
- If the deferred taxes are not paid by April 30, 2021, the employer will be liable for interest, penalties and additions to tax, starting on May 1, 2021.
- Employers "may make arrangements to otherwise collect the total" deferred taxes from the employee.
The President's memorandum stated that this "modest, targeted action will put money directly in the pockets of American workers and generate additional incentives for work and employment, right when the money is needed most."
Unanswered Questions, Uncertain Future and Other Difficulties
The Deferral is optional, the IRS confirmed Sept. 3, resolving ambiguity that had persisted since President Donald Trump’s announcement of the relief measure last month. “Employers may, but are not required, to utilize the relief,” Kelly Morrison-Lee, an attorney with the Internal Revenue Service, said during the agency’s monthly payroll industry teleconference.
It is unclear how the deferred taxes can be paid back if an employee quits, retires or passes away. Will employers have to pay the bill or will they be able to withhold the total amount of deferred taxes from the last paycheck? The Notice states that the deferred taxes should be collected ratably over the first four months of 2021. Therefore, it is not clear whether an employer can collect the deferred taxes from an employee who quits in December. It is also not clear whether the employer can collect a lump sum.
The Deferral may cause difficulties for employees who will have double withholding (12.4%) in the first four months of 2021. Many employees will not expect this and will not appreciate the sudden large tax bill.
The Notice stated that the calculation of whether an employee qualified for the Deferral will be made on a pay-period-by-pay-period basis. The employee will only be eligible during each two-week pay period in which he or she earns less than $4,000. This will be administratively difficult for employers and payroll companies who might find that some employees are eligible during certain pay period and ineligible in others.
Ultimately, the liability for these deferred taxes, as well as interest and penalties, will rest on employers. And since this appears to be a voluntary deferral, it is likely that employers will choose to collect and remit Social Security Taxes as normal. Employers who desire to defer employee Social Security taxes should provide employees with a written notice that describes how the deferral and payback process will be implemented. In addition, employers should have employees agree to the deferral and repayment in writing and should consider having employees consent to allowing the employer to withhold, to the maximum extent legally permissible, from the employee's final paycheck any deferred taxes that have not been repaid. Employers should note, however, that such deductions are subject to state laws, which should be consulted before using this approach and which ultimately determine whether such approach can be used.
Adding to the uncertainty regarding the Deferral, the White House and Treasury could release additional guidance at any point, changing or adding to these rules. Although it is less likely, it is also possible that Congress could pass legislation to forgive the deferred taxes or cancel the Deferral. Congressional Republicans are pushing for a legislative fix, but Congressional Democrats have indicated they are not on board. In fact, Senate Democrats have begun an attempt to withdraw the memorandum, by requesting the Government Accountability Office to determine whether the Notice can be defined as a "rule" subject to the Congressional Review Act.
At this point, other than federal employees, the Deferral will probably not have any effect. The Deferral is currently optional and employers should confer closely with their tax advisors before opting in. Regardless, employers should keep informed on developments to make sure the Deferral does not become mandatory and that they do not become subject to any penalties.
For more information on this update or additional guidance on the new Deferral, contact your Quarles & Brady attorney or: