Payroll Tax Deferral Guidance

Payroll Tax Deferral Guidance

On Friday evening, August 28th, 2020, the IRS and Department of the Treasury released Notice 2020-65 providing brief guidance as it relates to the August 8th, 2020 executive order allowing for a potential employee payroll tax deferral.

Executive Order Deferring Payroll Tax Obligations

After failing to come to an agreement on a new stimulus package, President Trump issued an executive order on August 8th, 2020 calling for the treasury to implement a deferral of employee payroll tax withholdings.

The deferral was targeted specifically at the employee portion of Old-Age, Survivor and Disability Insurance (OASDI), more commonly known as Social Security. This tax is 6.2% of employee wages up to a limit of $137,700 for 2020. The deferral did not include the 1.45% employee portion of Medicare tax.

The taxes are paid by the employee via payroll withholdings with employers having an obligation under IRS law to withhold & deposit these taxes when wages are paid and to be deposited shortly thereafter; the exact time for deposit can vary but for most employers is usually within a few days of payroll.

The executive order calls for the treasury to delay the deadline for the withholding & deposit (similar to how the April 15th, 2020 tax deadline was delayed) of these taxes, and to issue guidance on the process.

Notice 2020-65 Guidance

After nearly 3 weeks of silence, Notice 2020-65 was released on August 28th, 2020, a mere 3 days prior to the start of the deferral period. The notice was brief and lacks key information on several questions and scenarios for employers, however, it does provide as follows:

  • The guidance appears to allow for the option, but not the obligation, for employers to defer the withholding of employee OASDI taxes for payroll amounts below a certain threshold.While there is no explicit statement that this is optional, Secretary Mnuchin stated during an interview that the treasury could not force employers to participate. Functionally, the deferral acts as the movement of a deadline to withhold and deposit, and nothing should stop taxpayers from being able to complete the action prior to the deadline.
  • The ability to defer withholding is determined on a payroll-by-payroll period. The deferral can happen for payrolls below the following amounts:

    There is no phase-out, but rather a cliff, with the limitation determined per period.
  • The deferral of withholding is for wages paid during the period of September 1, 2020 – December 31, 2020, regardless of when the wages were earned.
  • The Notice calls for a “ratable” repayment of deferred amounts from the period of January 1, 2021 – April 30, 2021. The notice allows an Affected Taxpayer to “withhold and pay the applicable taxes,” thereby allowing for the withholding from employees payroll under IRS law. Amounts not paid by May 1, 2021 will begin to incur interest and penalties.The Notice also provides a vague sentence allowing for the “Affected Taxpayer [to] make arrangements to otherwise collect the total Applicable Taxes from the employee,” which conceptually allows a mechanism to collect from separated employees.
  • Interestingly, the notice itself covers that the employer is the “Affected Taxpayer.” As noted above, the employer has an obligation under IRS law to withhold and deposit from employees and the Notice allows for the employer to defer the timeframe from which to withhold. As a result, it is important to note that the employer is still ultimately responsible for the tax.

The notice itself is a little over 3 pages and does not provide any other guidance, leaving employers with still many unanswered questions and risks.

Observations and Analysis

  • This action is a deferral of a tax obligation, not an elimination. Employees will still have to pay the tax due in 2021 and employers will still be ultimately responsible for the tax due.As a deferral, this will for a short period increase net income for employees. However, the benefit may be short lived, as employees will then have to begin to repay in 2021, resulting in higher tax withholding for which they may not be prepared.
  • While not explicitly stated, it is believed and understood that this deferral is optional for employers. Nothing in the Notice states if this is optional from an employee perspective should an employer choose to participate. Employees generally do not have an independent right to defer withholding or an ability to force employers to participate.Given the potential for a future liability for employees, any employer that opts to participate may also wish to give an employee an option on deferral. Such “opt-in” may also assist with compliance with state law. This is not required under the notice but may be a best practice.
  • Employers that participate may wish to get agreements with employees prior to deferring the withholding to have a preemptive “arrangements to otherwise collect” in the event of a separation or termination. This too is not required under the notice but a potential best practice. The Notice did not give any indication as to how an employer should handle an employee that separates other than the one vague statement.
  • There could be potential collective bargaining and/or state employment law issues that could potentially be incongruent with this deferral, particularly regarding final or separation payments and collection of tax. New York State Labor Law Part 195 generally allows for the deduction “made in accordance with any law, rule or regulation issued by a government agency,” however, this only applies to New York.While the tax is based on Federal law, many employment laws are controlled on the state level and may need to be considered.
  • In the event an employer ultimately must repay deferred tax for an employee it may be considered additional compensation subject to withholding; that is, it may need to be grossed up.
  • The notice fails to address any relief or indemnification of the Trust Fund Recovery Penalty. Under IRS Law, a “responsible person” can be found to be personally liable for underpaid payroll taxes. This is typically the business owner, senior executives and financial executives (it is not mutually exclusive and more than 1 person can be found responsible) and is normally imposed when taxes are withheld but not paid. It is possible that executives who defer could be personally liable for any repayments due between January and April of 2021. Absent guidance to the contrary the best approach is to assume that this penalty could be imposed for any failure to remit the deferred taxes.
  • Practically speaking, many payroll processors may not be able to implement this deferral right away given the late guidance. The systems will need to be updated for both the new calculation, any potential “opt-in”, and calculation of the running deferred amount. Employers should be on the lookout for guidance from their payroll processors. It is unknown is there will be any “retroactive” deferrals or remedies available.
  • Employers should consider the best practices for messaging and managing employee expectations. Employers should never give employees tax advice however, employers should communicate to employees if they will be participating in the deferral and remind them that this only defers but does not eliminate the tax. Setting expectations will be crucial.
  • The future reporting of this deferral will be something to watch out for. It is likely there will need to be another update to Form 941 and this will likely alter the 2020 Form W-2 reporting and could, theoretically, delay the filing of 2020 Form W-2.
  • The Notice and Executive Order do not address Self-Employment taxes, which are imposed under a different IRS Code section. As such, there is currently no additional deferral under this guidance. Remember that part of self-employment tax could be deferred under the CARES Act.

Given the legal uncertainties above with state employment law, employers may also wish to contact their legal counsel regarding this program.

While each employer should make their own decision, given the remaining uncertainty, risk exposure and administrative burden, we feel at this time nearly all employers should continue to withhold tax with payroll practices in effect from time-to-time. The benefit is currently only short term for employees and offers high exposure for employers as they are ultimately responsible for the payment and further could be found personally liable for any repayment.

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Edward McWilliams, CPA

Edward McWilliams, CPA

Director, Tax

Ed is a Director in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.