On August 8, President Donald Trump signed four Executive Orders, one of which addresses a federal payroll tax holiday that he has sought to have included in any new coronavirus pandemic relief legislation. The President’s order is in response to the absence of movement by Congress on an additional stimulus package. The new order defers the withholding, deposit and payment of the employee’s share of federal OASDI (Social Security) payroll taxes (6.2%) from Sept. 1, 2020 through Dec. 31, 2020, on wages of employees whose annualized income is “generally” less than $100,000. While some have questioned President Trump’s legal authority to take this action, employers are placed in a precarious and potentially costly situation regardless of the legal outcome.
The Executive Order
The executive order accomplishes the payroll tax holiday through the exercise of the President’s disaster declaration authority under Internal Revenue Code Section 7508A. This law allows the Secretary of the Treasury to defer tax filing and payment due dates for up to one year. Importantly, this law does not authorize the outright waiver of tax filing or payment obligations. As the withholding obligations of employers will eventually come due, the impending burden of such obligations may compel Congress to forgive the deferred payroll taxes. The order specifically directs the “Secretary of the Treasury [to] explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.” To date, neither Democratic nor Republican members of Congress have embraced President Trump’s desire for a payroll tax holiday, which leaves the prospects uncertain for the eventual forgiveness of these payroll taxes.
Potential Legal Hurdles for the Executive Order
There also is some uncertainty about the legal basis to order a payroll tax holiday in this manner. Section 7508A grants the Treasury Secretary the authority to, among other things, defer “payment of any income, estate, gift, employment, or excise tax or any installment thereof or of any other liability to the United States in respect thereof” (emphasis added). This provision has rarely been interpreted as broadly as it would need to be in order to invoke a payroll tax holiday. Section 7508A has been invoked nationwide only once, to delay the tax filing and payment deadline this year to July 15, 2020. The Treasury Secretary did not institute the payroll tax holiday using Code Section 7508A on that occasion, but instead delayed income, estate, trust, and gift tax filing and payment obligations.
The potential legal challenge with the type of payroll tax holiday in the executive order is that it pertains to the withholding obligation of an employer, and therefore does not directly apply to the amounts remitted to employees. If an employer passes the “savings” from not withholding the employee’s share of payroll taxes to its employees, it will not be possible to subsequently withhold the tax on those wages. As a result, this could be seen as rendering the putative deferral as effectively being a waiver — something that is not authorized under Section 7508A.
And of course, with the election right around the corner, the legality of the executive order is becoming a political hot topic.
Employer Options in Response to the Executive Order
The Coronavirus Aid, Relief, and Economic Security (CARES) Act previously established a payroll tax holiday for the employer’s share of Social Security taxes through Dec. 31, 2020. It is the deferral of employee’s share of Social Security payroll taxes under the executive order that places employers in a precarious situation. If we assume that the intent of the executive order is to put more money into the hands of employees immediately, then employers have to make difficult choices with little certainty as to the outcome. In order for employers to implement the intent of the payroll tax deferral and still ultimately be free of adverse consequences, employers must gamble that Congress will eventually act to forgive the deferred payroll taxes. Trying to divine the future in this manner is a no-win situation. Consider an employer’s choices in these circumstances:
- The employer assumes that Congress will eventually act by waiving the deferred payroll taxes, and implements the payroll tax holiday by passing the benefits on to employees. If Congress later fails to act, then the employer would either have to claw back money from employees or use its own money to pay the employee’s share of payroll taxes (on top of the gross pay already remitted). And because this would be compensation, as well, the employer would have to gross-up the amount and withhold more payroll taxes on that payment.
- The employer could withhold the tax but not pay it to the government, instead using it as an interest-free loan. This would defeat the purpose of the executive order as it would deny any benefit to employees, and could have potential negative public relations consequences because the employer effectively retains its “employee’s money.”
- The employer could withhold the tax and remit it to the government, effectively ignoring the executive order altogether. Not only would this deny any benefit to employees, it would position the employer itself in potential noncompliance with a presidential executive order.
Furthermore, in the event the potential executive order is found to lack legal authority, the IRS could assess a Trust Fund Recovery Penalty (TFRP) for a failure to withhold. The TFRP imposes a 100% penalty on persons responsible for withholding certain taxes, including employment taxes. This could be particularly harsh on businesses that are forced to shut down between the time the executive order is in effect and the time it is determined to be illegal. “Responsible persons” who tried to comply with the executive order could then find themselves subject to the TFRP, even though they tried to comply with the law while their now-defunct business was operating. The executive order directs that the deferred amounts shall be “deferred without any penalties, interest, additional amount, or addition to the tax,” which could diffuse the penalty concern if this part of the executive order is found to be legal.
Employers must proceed with caution and carefully evaluate options concerning any payroll tax holiday implemented via executive order. Each of the various options comes with its own risk and potential consequences. The only option that comes with no potential adverse consequences requires an employer to assume that Congress will enact future legislation. For more information concerning the potential executive order and its impact on your business, please contact us.
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