IRS payroll tax deferral started September 1, but is it right for your small business?
In response to President Donald Trump’s executive order on deferring employees’ share of Social Security tax, the Department of Treasury and the IRS have released much-awaited guidance for employers.
Before we get into the guidance, let’s look at what Trump’s executive order calls for in terms of deferring Social Security tax.
What the executive order requires
Trump’s order directs the Secretary of the Treasury to use his authority to defer the withholding, deposit, and payment of employees’ share of Social Security tax owed on wages paid between September 1, 2020 and December 31, 2020. The order aims to deliver temporary relief to employees facing financial hardships because of the COVID-19 pandemic.
Under the order, only eligible employees’ Social Security tax can be deferred. For 2020, the Social Security tax withholding rate is 6.2% of the employee’s taxable wages, up to the annual wage limit of $137,700. The order does not apply to employees’ share of Medicare tax.
To qualify for the deferral, employees must earn less than $4,000 biweekly (pretax), or the equivalent for other payroll periods (such as $2,000 weekly or $4,333 semimonthly).
Trump issued the order on August 8, 2020, and with the order’s effective date being September 1, 2020, employers waited anxiously for guidance from the Treasury department.
On August 28, 2020, guidance arrived in the form of IRS Notice 2020-65.
What Notice 2020-65 says
The notice — which consists of 3 pages — states that:
- The deadline for withholding and paying employees’ deferred Social Security taxes “is postponed until the period beginning on January 1, 2021, and ending on April 30, 2021.” In other words, employers can start withholding employees’ deferred Social Security taxes as early as January 1, 2021, and amounts owed must be paid to the IRS by April 30, 2021.
- “Applicable Wages” (for purposes of the deferral) are wages paid between September 1, 2020 and December 31, 2020, up to the threshold — that is, less than $4,000 biweekly, or the equivalent for other payroll periods. These wages must also meet the definition of “wages” under sections 3121(a) and 3231(e) of the U.S. Code.
- Amounts excluded from wages under sections 3121(a) and 3231(e) do not count toward Applicable Wages.
- The determination as to whether an employee qualifies for the deferral must be made on a pay-period-by-pay-period basis. This means that the deferral applies only if the employee earns less than the threshold for the pay period. For example, a biweekly-paid employee who earns less than $4,000 in the current pay period is eligible for the tax deferral. But if they earn more than $4,000 in the following pay period, then they are not eligible for the deferral.
- If the deferred taxes are not paid by April 30, 2021, “interest, penalties, and additions to tax will begin to accrue on May 1, 2021.”
- “The employer may make arrangements to otherwise collect the total Applicable Taxes from the employee.”
When Trump issued the executive order, employers and industry experts had many questions, which they hoped the forthcoming guidance would clear up. But now that the guidance has been released, it leaves some questions unanswered while raising new ones.
One of employers’ biggest concerns was whether the deferral program is mandatory for employers.
On August 12, 2020, Treasury Secretary Steven Mnuchin said in an interview that he can’t force employers to participate in the program. But since the Treasury department did not issue an official statement on this, employers were expecting the forthcoming guidance to unequivocally say whether the program is mandatory or voluntary for employers. However, Notice 2020-65 falls short of this expectation.
The notice does not require employers to defer employees’ Social Security tax — thereby strongly suggesting the program is not mandatory for employers. But it also does not directly state that the program is voluntary.
Despite the lack of clarification, the general consensus seems to be that the program is voluntary for employers.
Additionally, the notice raises the following questions:
- What happens if the employee leaves their employer prior to paying off their deferred taxes? Who will be responsible for the balance then? Although the notice says that employers can “make arrangements to otherwise collect the total Applicable Taxes from the employee,” this isn’t always feasible when employees no longer work for the company.
- What happens if the employee does not earn enough during the repayment period to cover the deferred taxes owed?
- What happens if the employee wants to defer their taxes but their employer has chosen not to participate in the deferral program? Can the employer refuse the employee’s request?
Employers and employees should tread carefully
With the IRS’ guidance coming only a few days before the program’s start date of September 1, and with the program running for only 4 months, employers are strapped for time.
Note: It takes considerable time to properly implement this type of payroll change, as adequate information must be gathered and impacts on employees and the business must be properly assessed beforehand. Further, employers must:
- Determine payroll (and associated) system changes
- Collaborate with payroll vendors as needed
- Create low-risk standardized practices to facilitate the change
- Analyze and update related policies and procedures
- Develop strategies for communicating the change to employees
Adding to that, employers are concerned that the IRS’ notice does not explicitly release them from liability if they cannot recover all of the deferred taxes from employees. Small businesses, in particular, are already grappling with the financial fallout from the COVID-19 crisis and cannot afford to be saddled with employees’ share of unpaid taxes. For this reason — and given the scarcity of answers from the Treasury department — employers should obtain legal and financial counsel before adopting the IRS’ guidance.
Employees, as well, should weigh the pros and cons of participating in the deferral program. While participation is likely to boost their take-home pay for several months, they will be subject to double (Social Security) withholding when it’s time to pay the deferred taxes — unless Congress passes legislation forgiving the deferred amounts.
What are the odds that employers will participate in the program?
Per an article published by Iowa State University, Center for Agricultural Law and Taxation, “Based upon the risk this new [deferral] program would impose upon employer and employee alike, it appears likely that many employers will not take advantage of this new option.”
But if you’re interested in participating, be sure to seek legal and financial advice.