IRS Notice on Payroll Tax Deferral Still Leaves Many Questions Unanswered

(Parker Tax Publishing September 2020)

The IRS has issued guidance on the August 8 Presidential Memorandum, under which employers can defer withholding and payment of an employee's portion of the social security tax for the period September 1, 2020, through December 31, 2020, if the employee's wages are below a certain amount for a particular payroll period. Under this new guidance, the due date for an employer to withhold and pay over to the IRS the employee's social security taxes is postponed until the period beginning on January 1, 2021, and ending on April 30, 2021, thus allowing employers to double up on an employee's social security tax withholding for the first four months of 2021 to make up for the deferral of such taxes during the last four months of 2020. Notice 2020-65.

Background

On August 8, 2020, President Trump issued a Presidential Memorandum directing the Treasury Secretary to use his authority pursuant to Code Sec. 7508A to defer the withholding, deposit, and payment of certain payroll tax obligations (Payroll Tax Memorandum) during the period of September 1, 2020, through December 31, 2020. Under the Payroll Tax Memorandum, the deferral is only available with respect to any employee with wages or compensation, as applicable, payable during any bi-weekly pay period of less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods. This equates to wages of $104,000 per year. The Payroll Tax Memorandum provides that the amounts deferred are not subject to any penalties, interest, additional amounts, or additions to the tax. The Payroll Tax Memorandum also authorized Secretary Mnuchin to issue guidance to implement these orders and directed him to explore avenues, including legislation, to eliminate the obligation to repay the deferred taxes.

In an August 18 letter to Senate Majority Leader Mitch McConnell, Speaker of the House Nancy Pelosi, and Treasury Secretary Mnuchin, the U.S. Chamber of Commerce, along with over 30 industry trade groups, raised concerns regarding the uncertainty associated with the Payroll Tax Memorandum. The letter noted that the Payroll Tax Memorandum creates a substantial tax liability for employees at the end of the deferral period and that, without Congressional action to forgive this liability, serious hardships may be imposed on employees who will face a large tax bill as a result of the tax deferral. As a result, the letter stated that many employers were unlikely to implement the deferral.

Treasury Secretary Issues Guidance

On August 28, 2020, the IRS issued Notice 2020-65. In Notice 2020-65, Secretary Mnuchin determined that employers that are required to withhold and pay an employee's share of social security tax under Code Sec. 3102(a), or the railroad retirement tax equivalent under Code Sec. 3202(a), are affected by the COVID-19 emergency for purposes of the relief described in the Presidential Memorandum (Affected Taxpayers). For these Affected Taxpayers, Notice 2020-65 provides that the due date for the withholding and payment of the taxes eligible for deferral is postponed until the period beginning on January 1, 2021, and ending on April 30, 2021. This would thus allow employees to repay their social security taxes and railroad tax equivalent amounts that were deferred in 2020 ratably, through employer withholding, over the first four months of 2021 rather than in one lump sum at the end of the year. Interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid taxes. Notice 2020-65 states that, if necessary, the employer may make arrangements to otherwise collect the total taxes deferred from the employee.

Observation: Neither the Presidential Memorandum nor Notice 2020-65 require employers to allow deferral of these payroll taxes; instead, the deferral is voluntary. Employees cannot demand the deferral in the absence of an employer providing it.

Under Notice 2020-65, the deferral only applies to "Applicable Wages" which the notice defines as wages paid to an employee on a pay date during the period beginning on September 1, 2020, and ending on December 31, 2020, but only if the amount of such wages or compensation paid for a bi-weekly pay period is less than the threshold amount of $4,000, or the equivalent threshold amount with respect to other pay periods. The determination of Applicable Wages is made on a pay period-by-pay period basis. If the amount of wages or compensation payable to an employee for a pay period is less than the corresponding pay period threshold amount, then that amount is considered Applicable Wages for the pay period, and the relief provided under Notice 2020-65 applies to those wages or that compensation paid to that employee for that pay period, irrespective of the amount of wages or compensation paid to the employee for other pay periods. Thus, for example, if an employee's wages is generally under the applicable threshold, but the employee receives a bonus or overtime pay during a pay period that puts the employee over the threshold, deferral is not available for that pay period.

While Notice 2020-65 resolves the problem of employees being on the hook for a large repayment of deferred taxes at the end of the year by allowing the repayment of such amounts over the first four months of 2021, it does not resolve numerous other issues that employers are concerned about.

Unresolved Issues

The following are some of the unresolved issues facing employers who are considering offering employees the option of deferring their social security or railroad retirement taxes.

1. What happens if an employee, who has deferred taxes that have not been repaid, quits, retires, or is furloughed from a business?

While both employers and employees pay into the social security and railroad retirement programs, the liability for paying those amounts over to the government rests with the employer. Thus, it would behoove an employer who is offering this tax deferral to an employee, to have a written agreement or contract with the employee that spells out the employee's liability for repaying the employer for amounts deferred. If for some reason, the employee leaves and doesn't repay the amounts owed and the employer ends up having to pays such amounts, the agreement should clearly state that the employer will treat any such repayment by the employer as additional compensation to the employee in 2021 for which a Form W-2 will be issued.

2. What about a deferral for self-employment taxes?

For self-employed individuals, the flip side of the social security tax paid by employees is the self-employment tax paid by Schedule C individuals and others. Neither the Presidential Memorandum nor Notice 2020-65 provides for any deferral for self-employment taxes. Thus, none is available.

3. How does the payroll tax deferral affect employer tax credits allowed under the CARES Act and the Families First Act?

Under both the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Families First Coronavirus Response Act (Families First Act), employers are eligible for tax credits based on wages, sick leave, and family leave paid to employees. Included in such amounts are the employee's share of social security taxes. There is no guidance on whether, or if, the payroll tax deferral will affect such tax credits.

4. Can an employer's payroll system, or the payroll systems of third-party payroll providers, be revamped in time and in such a way as to efficiently provide for payroll tax deferrals and the proper payroll tax reporting to employees and the IRS?

Reworking a payroll system to effect the payroll tax deferral and the subsequent recouping of such amounts from employees will be a complicated endeavor for many businesses. Depending on the employer's financial state and/or the number of employees for which deferral might be offered, a business may conclude that the cost of revamping a system, the potential financial liability for unreimbursed tax deferrals, and the administrative cost outweigh any benefit.

5. How will the payroll tax deferral affect an employee's W-2 and the employer's Forms 941?

An employee's Form W-2 has a special box for reporting the amount of social security tax withheld. It appears the government will need to revise Form W-2 in some way to accommodate the reporting of the payroll tax deferral. A similar issue exists for Forms 941, with respect to the reporting deferred tax amounts for the last four months of 2020 and for reporting the tax repayments made during the first four months of 2021. It would appear that the IRS will need to revise those forms as well.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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