Tax Strategy: To defer or not to defer payroll taxes
President Trump issued a presidential memorandum on Aug. 8, 2020, directing the Secretary of the Treasury to permit employers to defer the employee portion of Social Security taxes between Sept. 1 and Dec. 31, 2020. On Aug. 28, 2020, the Treasury issued Notice 2020-65, providing a few details about how the deferral should work. The White House has announced that the deferral will be put into effect for all federal employees. Many private employers remain concerned about aspects of the deferral that may lead them to decide against implementation. While the deferral period has already begun, employers could still decide to start deferral later in the period.
The deferral memorandum
The deferral memorandum was issued under the authority to postpone tax obligations for up to one year during a national emergency. The authority does not extend to forgiving obligations.
The deferral is only for the 6.2 percent employee portion of Social Security taxes, not the employee portion of Medicare taxes, and is based on pay dates between Sept. 1 and Dec. 31, 2020, not wages accrued during that period.
Treasury Secretary Steven Mnuchin (pictured below) has stated that the deferral is optional to the employer and is not required.
The deferred taxes must be repaid ratably from wages paid between Jan. 1, 2021, and April 30, 2021. This appears to mean not only withheld from the employee paycheck by April 30, 2021, but also forwarded by the employer to the Internal Revenue Service by that date.
Starting May 1, 2021, interest and penalties or additions to tax may apply.
Since the repayment period is shorter than the deferral period by two days, it is possible that an additional payday will fall in the deferral period as compared to the repayment period, making the repayment amounts per pay period potentially larger than the deferral amounts per pay period.
The employer has the obligation to repay the deferred taxes even if the employer is unable to collect from the employee or former employee. The notice leaves it up to the employer to make arrangements to otherwise collect the taxes from the employee. An employer who pays the deferred taxes without receiving reimbursement from the employee may create additional employee compensation that is itself subject to additional FICA and withholding taxes.
The deferral is only available to employees who have wages of less than $4,000 per biweekly pay period. This is determined on a pay-period-by-pay-period basis. Therefore, an employee may qualify for deferral in one pay period even though they fail to qualify in other pay periods.
The $4,000 biweekly limit would translate to a $2,000 weekly limit or, assuming a 52-week year divided by 24 semimonthly pay periods, $4,333 per semimonthly pay period.
Remuneration excluded from the definition of wages for FICA purposes does not count toward the limit. Among exclusions from wages for FICA purposes are health coverage and health and dependent care flexible spending accounts.
Employees with more than one job would appear to be potentially eligible for deferral from each employer.
The deferral does not appear to apply to the self-employed or partners in partnerships.
The employer deposit obligation is not deferred by this action. If the employer defers the withholding, the deposit obligation is also correspondingly deferred. If the employer does not defer withholding, the deposit obligation is not deferred.
The presidential memorandum directed the Treasury to look at means of forgiveness of the deferred payroll taxes. Notice 2020-65 does not mention any possibility of forgiveness. Forgiveness probably requires congressional action.
To defer or not to defer
Many employers are questioning the benefit of the payroll tax deferral.
It may leave employees in a difficult position at the start of 2021 if they have not adequately planned for an additional paycheck reduction to repay the deferral.
It may expose employers to repay payroll taxes that they cannot then easily collect from departed employees.
It may be difficult for payroll systems to give the employees the option to defer or not to defer. It may also be difficult for payroll systems to withhold or not withhold for any given pay period depending upon whether the income limit has been exceeded for that pay period.
An employee would appear to have little right to force the employer to defer Social Security taxes that the employer withholds and then timely deposits with the IRS.
Some employers desiring to do deferrals may find that it takes some time to adjust their payroll systems to accommodate the deferrals, which were supposed to commence with the first pay period on or after Sept. 1, 2020. It appears, however, that employers could start the deferral at any time during the deferral period.
Some state employment laws require the written permission of the employee for the employer to withhold anything from an employee’s paycheck that they are not required to withhold by law. It may not be clear how this applies to a withholding obligation where the only issue is the timing of the withholding. Employers should verify that a decision not to defer is consistent with state law.
The likelihood that Congress will act to convert the deferral into a forgiveness seems far from certain. The payroll tax forgiveness was not a popular proposal with many Democrats and Republicans in Congress on the basis of the fact that it did not provide enough immediate benefit to help during the COVID-19 pandemic, and forgiveness was perceived as a
threat to the viability of the Social Security trust fund.
While federal employees will apparently be subject to payroll tax deferral for the remainder of the year, with a repayment obligation at the beginning of 2021, private employers remain concerned about how beneficial the deferral will be to their employees given the repayment obligation in the not-too-distant future, possible complexities in implementing a deferral that started Sept. 1, 2020, and possible additional risk to the employer through inability to collect from departed employees. Employers considering forgoing deferral should verify that the approach does not violate any state law.
Employers deciding to implement deferral should seek some written agreement with employees as to recouping deferred funds from departing employees as part of a final paycheck, making sure such arrangements are also consistent with state law. Such employers may also need to alter their standard procedures for depositing payroll taxes to ensure that deferred payroll taxes are
fully repaid to the government by April 30, 2021.