Payroll Tax Deferral Won't Help Employees or Employers
President Donald Trump recently issued a memorandum directing the secretary of the U.S. Department of the Treasury to defer the withholding and payment of the employee share of certain Social Security taxes for the period Sept. 1 through Dec. 31, and permit employers to pay the deferred taxes during the period beginning Jan. 1, 2021, and ending April 30, 2021.
On Aug. 28, the Treasury secretary did so by issuing IRS Notice 2020-65. The notice fails to provide guidance on key issues, such as the treatment of withholdings from employees who leave service prior to April 30, or relief for employees that face hardship when employers double the same withholdings between Jan. 1 and April 30.
What the IRS Notice Does and Doesn't Say
According to the notice, taxes imposed by Internal Revenue Code Section 3102(a) on taxable wages paid — not earned — between Sept. 1 and Dec. 31 may be deferred. Importantly, though not explicitly stated, the notice does not require an employer to defer the withholding and payment of the taxes. It simply extends the deadline for such withholding and payment.
The deferral only applies to the employee share of Social Security taxes, and only with respect to employees whose wages are less than $4,000 during a biweekly pay period, or a comparable amount if the employer uses a different pay period.
Note that this dollar threshold is calculated separately for each pay period, without regard to what an employee may have earned in a different pay period. Consider the potential administrative burden for automated payroll processes already in place.
The deferral only applies to the 6.2% old-age survivor and disability insurance tax, imposed on the first $137,700 of wages received in 2020. It does not apply to the 1.45% hospital insurance tax, which is not subject to an annual dollar limitation.
The deferral is not available to sole proprietors and other individuals who pay self-employment taxes.
The notice confirms that, having not withheld and paid the employee's Social Security taxes between Sept. 1 and Dec. 31, employers should withhold and pay an employee's deferred Social Security taxes from wages paid to the employee from Jan. 1, 2021 through April 30, 2021.
In apparent recognition of the fact that an employee's termination of employment prior to April 30, 2021, would prevent this from happening, the notice states "if necessary [the employer] may make arrangements to otherwise collect" the taxes. But no further guidance is provided as to what exactly that means.
Employers Should Think Twice Before Deferring the Taxes
Although an employee is individually liable for the deferred Social Security taxes, the employer is liable as well, and the IRS will almost assuredly be looking to the employer, and not to the employer's employees, if the deferred taxes are not paid.
The IRS's so-called arrangement suggestion notwithstanding, if an employee terminates employment before or during 2021, but before the deferred taxes have been fully withheld from the employee's first quarter 2021 wages, the employer should expect to have to make up the shortfall.
The notice states that deferred taxes are to be withheld ratably from wages paid during the first quarter of 2021, but provides no direction as to how employers are to apply this in operation.
What happens, for example, if an employee is furloughed during the first quarter of 2021 and stops receiving paychecks? Can the employer, assuming the employer is comfortable doing so, withhold additional amounts from paychecks if the employee returns before April 30, 2021 or withhold amounts from post-April 30, 2021 paychecks?
The notice's reference to making arrangements does not provide assistance in evaluating how to handle this situation. The answers are anything but clear.
Employers who desire to defer employee Social Security taxes are well advised to provide employees with a notice that lays out how the deferral and payback process works. It is recommended that employers have employees agree to the deferral and repayment in writing. Given the variety of circumstances that could affect repayment — furloughs and pay reductions, among others — this presents some obvious drafting challenges.
Employers should also consider having employees who agree to the deferral 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. Such potential deductions are subject to state laws, which should be consulted before using this approach.
The deferral is for the benefit of employees, something along the lines of an interest-free loan. But the loan will have to be repaid next year in the form of increased tax withholding, which may create a hardship for many employees as it essentially doubles the amount of Social Security tax withholding during the first four months of 2021. One can easily foresee cash-strapped employees seeking an advance or loan from their employer to make up for the reduction in their 2021 paychecks.
Employees will be asking about this new program, but employers should proceed cautiously when assessing potential deferral. In light of these concerns and uncertainties, it is difficult to envision why an employer would conclude that deferring employee Social Security taxes is something the employer should be doing.
“Payroll Tax Deferral Won't Help Employees or Employers,” by Daniel L. Morgan was published in Law360 on September 4, 2020.
This extended article was first published in Blank Rome Workplace on September 2, 2020.