Payroll processors await IRS guidance on tax deferral
Payroll-processing companies are eagerly anticipating guidelines from the Internal Revenue Service and the Treasury Department on how to handle the payroll tax deferral that President Trump included in his executive orders over the weekend in an effort to spur the economy during the novel coronavirus pandemic. Payroll services need the rules, which are expected to arrive as soon as this week, before they can start processing paychecks next month.
Trump’s executive order calls for a payroll tax deferral from Sept. 1 to Dec. 31, 2020. The order only addresses the 6.2 percent employee’s share of Social Security taxes but doesn’t apply to the 1.45 percent employee’s share of Medicare taxes, according to a briefing released Tuesday by Wolters Kluwer. The payroll tax deferral only applies to employees with biweekly pre-tax income of less than $4,000. The Treasury Department is expected to issue guidance on how the deferral will work and address a number of uncertainties.
Employers that defer the payroll taxes would need to start collecting those taxes from payroll starting next January, unless Congress passes legislation waiving the taxes, which would mean the shortfall in the Social Security and Medicare trust funds would need to be made up for with money from the Treasury’s general funds or some other source. The outcome of the election in November may ultimately determine that question, but until then it’s up to the IRS and the Treasury to provide some immediate guidance on the payroll tax deferral before the end of this month.
“They're under the gun,” said Pete Isberg, head of government relations at payroll giant ADP. “This is effective September 1, which is a few days away, and of course, we can't start programming until we get the guidance. We’re not sure when to expect it.”
Another big payroll processor, Paychex, has been planning what to do when the guidance comes out. “We have a very active dialogue internally,” said Paychex director of compliance Mike Trabold. “We really stay on top of all this stuff, and then we have a really active and very fluid dialogue with all of our internal partners — our technology team, which is obviously very large and obviously prioritizes all these types of things with our product team that's very sensitive to how we might go in and have to update or amend program terms. And our service team that is charged with face-to-face dialogue with our clients directly and all the other teams, like legal and so forth. So we watch this very closely."
"In fact, I was on a couple of calls today where we say we don't know definitively what this is going to look like, but here's what we've been able to cobble together through our analysis and the work we do in D.C., and we can provide a framework," Trabold continued. "Oftentimes that's enough for some of our internal partners to start crafting what we do from a technology standpoint and so forth, as well as starting to cobble together some of the fundamental education we'd be able to provide to some of our clients who, as you can imagine, are very interested in how all this stuff is going to play out. And once we set that framework out, it's that much easier once we get the definitive guidance to then just act on that, because we've already got a foundation.”
ADP is waiting for the guidance to be released before making programming changes. “We really can't start programming until we see some guidance, to let us know, for example, what reporting is going to be required,” said Isberg. “We're pretty sure there's going to have to be something on the W-2, for example, to separately state what were the wages paid during this deferral period, maybe what Social Security tax was deferred, things like that. But there's a lot of details that we don't know yet. We can't really start doing programming until we see the details.”
Both ADP and Paychex had some experience with earlier payroll tax cuts and deferrals, such as one during the Obama administration that cut payroll taxes for employees from 6.2 to 4.2 percent for 2011 and 2012. Earlier this year, the CARES Act included a deferral of the payroll tax for employers, which lets most employers defer payment of their portion of Social Security taxes without interest or penalties. Fifty percent of the deferred amounts will be due by Dec. 31, 2021, and the rest by Dec. 31, 2022.
“There's a lot of interest in that, especially from larger companies that got shut out of some of the benefits of FFCRA [Families First Coronavirus Response Act], for example, where they could get a tax credit for employers with 500 or fewer [employees], but the larger employers didn't get much out of those bills,” said Isberg. “The Social Security tax deferral is one that really did apply, so for the larger clients, most of them are doing that.”
The Obama administration’s payroll tax cut was relatively easy to handle in comparison to the new payroll tax deferral that’s suddenly coming with Trump’s executive order. “That was a full year one,” said Isberg. “Full year anything is so much easier to do. You could do a change and make it full year. I could do that today and have it take effect back to Jan. 1. That's the way these systems are programmed. But this is not full year. It’s part year. In fact, it’s smack in the middle of a quarter. Normally you store wages and taxes quarter by quarter, but now we've got to establish brand new buckets to store wages paid after September 1. That's not a small thing.”
Both ADP and Paychex have been talking with officials in the IRS trying to get a sense of what the guidance will say, but the administration’s on-and-off talks with Democrats in Congress only seem to have resulted in an impasse so far.
“Normally these negotiations in Congress with the White House will have a bit of a rhythm to them where they seem really far apart, and then there's a deadline, and more times than not they're able to come together in some kind of package,” said Paychex government relations manager Thad Inge. “And last week, I think that was our hope. We knew that they were extremely far apart, but we were hoping that with a little time they'd be able to bridge those gaps. And some of the things we were looking at really closely were the PPP second round and extending some of the new tax credits. And then this really was a curveball because Trump had sort of threatened to do this a little bit, but it changed the dynamics a lot, and put some of these new issues on the table. Unemployment and evictions and stuff were part of the negotiations. In Congress, payroll had kind of fallen off and was not really on the table anymore. So this put it back front and center. It had the potential to force negotiations and bring people back to the table or make it harder to get the deal done."
"It's hard to say how it's going to play out," Inge continued. "The last few days, it has definitely not brought people back to the table. It seems like Congress is not anywhere close to doing a deal. And then I think if they were to come back to the table, there'd be a question of does this put payroll tax in the mix, or is that a bridge too far for folks that weren't in favor of it? And if that's the case, does this still hang out there? Obviously there’s lots of uncertainty. These things are always hard to predict. But I think this one's particularly hard. And I think that without more guidance from IRS and Treasury, it's also hard to know exactly how this payroll tax cut plays out.”
The IRS is under pressure from not only payroll processors, but from businesses as well to get the guidance out as soon as possible. “We're very sympathetic to their plight,” said Trabold. “We know how difficult it is for them to react to this as well. We have an idea of what might play out and are able to at least begin preparatory conversations internally. But until you get that definitive guidance from the IRS, then this is really tough for us to do anything substantive. It's going to be really, really important and challenging, given the truncated time frame, but we really need to get that from them, which they're very aware of.”
In turn, the payroll processors are under pressure to deliver the right paychecks to their customers. “I think everybody's reading the paper and wondering how this is going to work,” said Isberg. “Typically our clients assume that we’re going to do whatever’s necessary to keep up with the tax law, and this is just one example of something changing, and they're going to wonder what it's going to look like. I think what will happen is that our clients and their employees will automatically default to deferring. Starting September 1, or sometime shortly thereafter, paychecks will be coming out. Their pay will be 6.2 percent higher, which will be nice, and it’ll just be automatic. They will potentially be responding to some employees that will be coming back and saying, ‘You know what? Please don't apply this deferral to me. I’m not too comfortable with it, or I don't want to have this prospect of owing a great deal of money on my annual 1040 at the end of the year.’ So we may see some employees who actually prefer not to do it as well.”
Most employees are likely to allow the payroll tax deferral to go through, if they are even aware of it. The prospect of a big tax bill for taxpayers next year is likely to induce Congress to pass legislation forgiving the deferred taxes, but that will depend on who’s in control of Congress and the White House next year.
“It does put a lot of pressure on Congress to forgive the amounts deferred,” said Isberg. “Otherwise, the actual employees are going to be unhappy in April, or whenever they have to file their returns and pay that tax back. It really will be a deferral, which is not doing anybody any great favors. But we noticed early on in the [Democrats’] HEROES Act and the [Republicans’] HEALS Act, there's nothing in there about a payroll tax holiday for employees. So, even if Congress does get together and says, ‘OK, we're going to come to an agreement,’ they may not even touch the employee Social Security deferral. We’ll just have to see what they do.”
Until then, expect uncertainty to be the order of the day, but guidance from the IRS and the Treasury will provide a little bit of clarity for the short term. “There’s obviously a lot of uncertainty whether Congress would ever pass legislation down the road to forgive the deferred amounts,” said Trabold. “Given that, it’s certainly the cause of some anxiety and some questions we have gotten from employers about how that would work out. What ability would they have to go and claw some of that money back from employees that may have left or no longer have the wherewithal to pay? The mechanics around that, I think, will be one of the key things we are waiting for some guidance from the IRS on.”