Payroll Tax Deferral – What the Treasury Guidance Did and Did Not Make Clear
September 8, 2020
By Soheila Shahidi
To assist employees with the economic hardships resulting from COVID-19, recent guidance provides relief in the form of a payroll tax deferral (Deferral Program). Internal Revenue Service Notice 2020-65 (Notice)1 provides that, with respect to certain wages paid during the period beginning on September 1, 2020 and ending on December 31, 2020 (Deferral Period), employers are allowed to defer the withholding and payment of an employee’s portion of the Social Security tax if the employee’s wages are below a certain amount. Below is a summary of the Notice, which leaves many important questions unanswered.
I. Is the Deferral Mandatory or Optional?
An IRS representative recently stated that the decision to participate in the Deferral Program is made by the employer and the employer’s decision is binding on its employees, meaning that if an employer decides not to participate in the Deferral Program, then an employee cannot require the employer to do so. The IRS representative further clarified that an employer can decide the level of its employees’ participation in the employer’s decision. However, it is still unclear how an employer can apply a bifurcated approach (e.g., can an employer choose to defer withholding only for those employees who wish to participate in the program), or whether the employer can participate in the program during some pay periods, but not others.
The Deferral Program is available for wages paid to an employee during the Deferral Period if such wages, before tax, are less than $4,000 during any applicable biweekly pay period. The determination for this threshold amount is made on a pay-period-by-pay-period basis, meaning that if an employee’s wages are below this threshold in one pay period during the Deferral Period, then those wages qualify for deferral regardless of the employee’s wages in another pay period during the Deferral Period. For example, if an employee’s gross wages during the first pay period of the Deferral Period are $3,900 and such employee’s gross wages during the second pay period of the Deferral Period are $4,200, then the employee’s wages paid during the first pay period qualify for deferral, but the wages paid during the second pay period do not.
Despite what many had hoped, the Notice does not forgive the obligation to pay the Social Security taxes deferred during the Deferral Period (such taxes referred to as the Deferred Taxes). In general, the Deferred Taxes must be repaid ratably during the period beginning on January 1, 2021, and ending on April 30, 2021 (the Catch-Up Period).
For example, assume (i) an eligible employee is employed by the same employer during all of 2020 and all of 2021, (ii) the employee’s gross wages during each biweekly pay period are $3,000, and (iii) withholding of the employee’s Social Security taxes during the Deferral Period is properly deferred in accordance with the Notice. As a result:
- during each biweekly pay period of the Deferral Period, the employee would take home an extra $1862, and
- during each biweekly pay period of the Catch-Up Period, the employee’s wages will be reduced by both (i) the employee’s portion of Social Security taxes that are generally withheld during a typical pay period (in this example, $186), and (ii) a ratable portion of the Deferred Taxes not withheld during the Deferral Period (in this example, an additional $186).
This leaves open the question, discussed below, of what happens if an employee’s employment is terminated at any time after Social Security taxes have been properly deferred under the Notice.
III. Termination of Employment After Participating in the Deferral Program
In general, an employer is liable for payroll taxes, including but not limited to the employee’s share of Social Security taxes. Significantly, an employer who participates in the Deferral Program remains liable for all Deferred Taxes.3
In this respect, the Notice falls short of providing any meaningful guidance or assistance for many of the practical situations that employers are forced to consider. For example, what happens if an employee’s employment is terminated at any time after participating in the Deferral Program, but before all of the Deferred Taxes have been collected from the employee’s wages during the Catch-up Period? In such a case, can an employer choose to withhold all Deferred Taxes from the employee’s final paycheck? If so, what if the amount payable in the final paycheck is insufficient to cover all of the applicable withholdings, including the Deferred Taxes?
If, for whatever reason, an employer fails to pay the Deferred Taxes, then the employer will be liable for such amounts, together with interest and penalties.4 An employer forced into this situation may choose to avoid the imposition of interest and penalties by paying the Deferred Taxes out of the employer’s own pocket. However, by doing so, the employer’s payment will be treated as additional compensation to the employee, which itself results in additional withholding and information reporting requirements. Although the Notice states that an employer may make arrangements to collect Deferred Taxes from an employee, it provides no further insight on the matter. The IRS is aware of these issues and may be providing additional guidance in this regard.
While certainly well intentioned, the Deferral Program may create more problems than solutions. Employers are strongly encouraged to speak with their tax, accounting and payroll advisors in determining whether to participate in the Deferral Program.
- President Trump signed a memorandum on August 8, 2020 authorizing the IRS to implement rules respecting a payroll tax deferral program. That memorandum was followed by the IRS’ publication of Notice 2020-65, which was clarified by remarks made on September 3, 2020 by an IRS representative during the IRS’ monthly payroll industry teleconference – the memorandum, IRS Notice, and clarifying comments are collectively referred to in this article as the Notice.
- This amount is calculated as the product of $3,000, multiplied by 6.2 percent, and represents the employee’s portion of Social Security taxes that would generally be withheld during each applicable pay period.
- Additionally, certain “responsible persons” (e.g., executives and officers of the employer) may be personally liable if these taxes are never paid to the IRS. See, Code Sections 6672 and 7202.
- Respecting the imposition of interest and penalties, the Notice only contemplates a very straight forward situation in which (i) the employee is employed by the same employer from September 1, 2020 through April 30, 2021, (ii) Deferred Taxes are not withheld during the Deferral Period, and (iii) Deferred Taxes are withheld, ratably, from wages paid during the Catch-up Period. In such a case, failure to timely pay Deferred Taxes will be subject to interest, penalties, and additions to tax, each of which begin to accrue on May 1, 2021 on any unpaid Deferred Taxes. However, the Notice does not address whether interest or penalties will commence earlier on unpaid Deferred Taxes if, for example, the employee’s employment is terminated before the end of the Catch-up Period. For example, if employment is terminated on December 31, 2020, does the employer still have until April 30, 2021 to avoid the imposition of interest and penalties on the Deferred Taxes?
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