On August 8, 2020, the White House issued a Presidential Memorandum on deferring payroll tax obligations in light of the ongoing COVID-19 crisis. The Memorandum directed the Secretary of the Treasury to permit the deferral of the employee portion of Social Security taxes on compensation paid during the four-month period beginning September 1, 2020, and ending December 31, 2020.
This order applies only to the employee share of Social Security taxes and not the additional 6.2 percent of Social Security tax paid by the employer. Furthermore, it allows the deferral of payroll tax obligations only with respect to employees whose bi-weekly compensation is less than $4,000.
The Internal Revenue Service acted under the authority delegated to the Department of Treasury and published implementing guidance under Notice 2020-65 on August 28, 2020, to provide guidance on deferring payroll tax obligations.
The intent of the Presidential Memorandum is to provide economic relief in response to the coronavirus (COVID-19) pandemic. However, it did not provide details regarding what wages are eligible for deferral, when the deferred Social Security taxes have to be paid, or whether employers or employees are responsible for remitting the deferred Social Security taxes. Consequently, Notice 2020-65 attempts to address these issues.
Employers considering whether to defer payroll tax obligations should pay attention to the following components of the Notice:
- Employers remain liable to collect from employees and pay the full amount of the employee Social Security taxes deferred to the IRS after December 31, 2020,
- Employers are required to withhold the total taxes deferred for an employee from the employee’s wages for the four-month period from January 1 – April 30, 2021,
- If an employee is not employed with the employer for the full four-month period, the employer is still obliged to pay the total deferred taxes to the IRS. Interest, penalties, and additions to tax will begin to accrue on May 1, 2021,
- Employers are permitted, if necessary, to make arrangements to otherwise collect the total taxes due from the employee. However, the guidance does not describe what those arrangements might be.
Also, it is important to note that the deferral of the payroll tax obligations is not equivalent to a tax cut. It extends the employer’s withholding and payment deadlines, but it does not forgive the tax obligations. Therefore, employers need to pay close attention to payment requirements and the pitfalls they may face in case they decide to postpone their payroll tax obligations.
Eligibility for Deferral of Payroll Tax Obligations
An employee is eligible for deferral of payroll tax obligations for any payment of Social Security taxable wages paid from September 1 through December 31, 2020, that is less than $4,000 for a biweekly pay period. Each pay period is considered separately as Notice 2020-65 provides that the deferral is determined based on the specific payroll period and does not look to the amount of wages in prior payroll periods.
The applicable wages are determined on a pay-period-by-pay-period basis. If the amount of wages is less than the threshold amount, then the employee portion of social security on these wages may be deferred. If the amount of wages is equal to or greater than the threshold, the deferral is not available for that pay period. Therefore, for an employee whose wages fluctuate, an employer may defer collecting the tax in one pay period but be required to collect it for the next pay period.Find out how to stay compliant when collecting and filing payroll taxes with this detailed guide, and stay on top of different state and federal tax laws.
Unanswered Questions on the Implementation of the Deferral
Despite the issuance of Notice 2020-65, there are many unresolved issues when it comes to the implementation of payroll tax obligations deferral. Apart from numerous technical and practical inquiries, the Notice does not explicitly define if the deferral is optional. While the Notice does not oblige employers to defer payroll tax obligations, it is unclear whether they need to obtain employees’ confirmation before deferring taxes.
Another confusing issue is the liability imposed on the employer when the employee takes an unpaid leave of absence, quits, or is terminated before the deferred tax balance is recovered. Employers remain responsible for ensuring that the deferred taxes are paid as the deferral of payroll tax obligations is just an extension of time. Therefore, if an employee quits after deferring payroll taxes but before the deferred amount has been withheld, the employer will be responsible for the uncollected deferred tax amounts. This happens unless there is another arrangement to collect the sums from the employee.
Finally, there is no guidance regarding the reporting requirements associated with the program. The IRS may release additional guidance or publish revised forms to simplify reporting and paying of the deferred taxes. Employers can use revised Form 941 to report deferred employee payroll taxes. Still, it is anticipated that the Form 941 will have to be updated for the third and fourth quarters of 2020, as well as the first and second quarters of 2021 in order to properly report deferrals and repayments.
Factors to Consider before Deferring Payroll Tax Obligations
While the Notice 2020-65 provides answers to some important questions, it leaves many others unanswered. Since this program is a deferral of payroll tax obligations lasting only a few months, many employees may prefer that taxes not be deferred. Also, many companies may not participate in the deferral because of the difficulties of administering it and the burden it will place on employees in 2021.
However, if employers want to offer this option to their employees, they need to provide them with a detailed explanation of the deferral and repayment processes and obtain written consent from each employee in regard to the repayment of deferred taxes. It is important to manage employee expectations and keep them informed of their obligations prior to making the decision to defer. Furthermore, there are state law matters that employers need to consider if implementing payroll tax obligations deferral.
In order to properly handle the deferral of payroll tax obligations, there are also many practical considerations related to payroll systems. Employers will probably have to adjust their payroll systems to provide for the deferrals and repayments. Managing taxes in combination with constantly evolving regulations can be complex and time-consuming as it is, but outsourcing payroll tax processing leaves little or no possibilities for errors. This allows employers to minimize tax and payment compliance risks, implement the current legislation updates, reduce expenses, and remain IRS compliant.Outsource payroll tax management to ensure meeting tax obligations accurately and timely while keeping your organizations’ confidential information well-protected.