Payroll Tax Deferral – Boondoggle for Employees and Headache for Employers
On Friday, the IRS issued guidance for employers concerning the President’s executive order calling for the deferral of the employees’ portion of the payroll tax from September 1 through the end of 2020. The guidance is yet another headache for employers during the pandemic because it appears to not only require employers to collect the deferred taxes from employees in 2021 but potentially puts employers on the hook for uncollected taxes. If the guidance remains unchanged, this creates a whole host of problems for employers.
Currently, employers and employees share responsibility for a 12.4% levy that funds Social Security and a 2.9% tax to support Medicare. Employers are generally responsible for withholding and depositing the payroll tax.
The executive order applies specifically to the Social Security tax and would affect workers whose bi-weekly pay is less than $4,000 on a pretax basis. No deferral is available for any payment to an employee of taxable wages of $4,000 or above for a bi-weekly pay period. It’s not deferral “up to” that amount with no relief for the overages. Rather, the deferral only applies to workers under the income threshold.
So long as the participating employer is not withholding any tax on behalf of the employees, the employer is not required to make a deposit to the IRS (payroll taxes are typically deposited on a particular schedule) during the deferral period. The employer does not have to start making deposits until the deferral is no longer in place. Specifically, the Notice postpones those deposits “until the period beginning on January 1, 2021 and ending on April 30, 2021.”
Employers are not required to participate in the deferral program. Treasury Secretary Steven Mnuchin has said he “can’t force” companies to stop withholding the payroll levies, but that he hopes many companies will participate. For those employers willing to participate, the deferral appears to be at the employee’s option. If employees request to participate in the deferral, employers may be hard pressed to refuse because the benefits to employees can be significant.
For an employee with annual compensation of $35,000, the deferral would result in an additional $83.46 in their paychecks bi-weekly. For someone making $50,000 a year, that’s an additional $119.23 every other week. The idea behind the executive order is that employees could use that additional money to catch up on rent, mortgages or pay other bills incurred during the pandemic. There is a catch though.
The executive order does not enact a tax cut or reduction. It is simply a deferral on paying the tax otherwise due. The tax will be payable before April 15, 2021. For employees holding out hope that the deferred tax will eventually be forgiven, the hope is faint. The President does not have the authority to forgive the tax. It would require an act of Congress and in case you’ve not been paying attention lately, they’re not seeing eye to eye on much these days.
The executive order creates a substantial tax liability for employees at the end of the deferral period. It threatens to impose serious hardships on employees who will face a large tax bill as a result of deferral. For that employee making $35,000 a year, they’ll have a $751 tax bill due by April 15, 2021. The tax bill for someone making $50,000 will be $1,073. Those bills will not be payable in a lump sum or offset against a potential tax refund on 2020 taxes. Instead, employees will likely be paying it back between January and April 2021 through additional withholdings on their paychecks. In other words, employees who elect to participate in the deferral will have even smaller paychecks come January 2021 while their employers “claw back” the deferred taxes.
For employers, this executive order presents a whole lot of headaches. The new guidance makes it clear that employers must collect the deferred tax and remit it in 2021: “[employers] must withhold and pay the total [deferred taxes] that the [employer] deferred under this notice ratably from wages and compensation paid between January 1, 2021 and April 30, 2021. Here’s the kicker for employees: “or interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid Applicable Taxes.” Yikes! That seems to indicate that employers could be responsible for paying deferred tax that is otherwise uncollectible from employees. This is a real possibility.
What if the employee balks at the additional withholdings to collect the tax? Worse yet, what if the employee does not work enough hours to repay the deferred tax? There is a limit to the amount an employer can withhold from employee wages. The withholding cannot result in an employee being paid less than the applicable minimum wage. For some employees, that does not leave much room for the additional withholding, especially if there are other amounts withheld already. Some employees may quit before the deferred tax is recouped by the employer. Companies could potentially recoup the remaining taxes owed by withholding them all from employees’ final paycheck but the guidance doesn’t explicitly say if that’s permitted. The guidance gives zero reason for employers to believe that they are protected for this.
Guidance for Employers
If you are going to offer the deferral to your employees, we recommend that you have your employee’s opt-in to the deferral in writing. Agree in advance (and in writing) on the method of collecting the deferred tax once 2021 rolls around. Our business attorneys are here to answer any questions that you have about this executive order and how it impacts your business.