Late Friday, the IRS released guidance that implements President Trump’s executive order permitting employers to defer certain employee payroll taxes. The IRS guidance provides key details on employee eligibility, the repayment period, and employer responsibilities. But the IRS guidance leaves some questions unanswered, even as the optional deferral period takes effect September 1. Importantly, the IRS guidance could cause an economic hardship for many employees while exposing employers to a new contingent liability.
Specifics of the Employee Payroll Tax Deferral
The IRS specified that any employer required to withhold and pay the employee share of Social Security tax is an “affected taxpayer” for purposes of specified disaster relief. The relief provided is for the employer’s requirement to withhold, deposit, and pay the employee’s share of social security tax on eligible wages during the period Sep. 1, 2020 through Dec. 31, 2020.
Consistent with President Trump’s executive order, an employee’s “eligible wages” in the IRS guidance means wages or compensation paid for a bi-weekly pay period that are less than the threshold amount of $4,000, or the equivalent threshold amount with respect to other pay periods. Further, the IRS guidance clarifies that this determination is made on a pay period-by-pay period basis. Thus, if an employee’s bi-weekly pay during a given period is less than $4,000, then the employee has eligible wages for that pay period. If in a later pay period the employee’s pay is greater than $4,000, then the employee has no eligible wages for that pay period. Each pay period is considered separately, and an employee’s amount of eligible wages in a prior or succeeding pay period has no effect on eligibility.
Repayment of the Deferred Employee Payroll Taxes
Beginning Jan. 1, 2021, employers are responsible to initiate a repayment schedule for the deferred amounts of employee payroll taxes. Specifically, employers must withhold and pay back each employee’s deferred payroll taxes ratably from the employee’s wages over the four-month period that spans Jan. 1, 2021 to April 30, 2021. This means, assuming the employer includes the deferred amounts in an employee’s wages that the employee’s wages will drop correspondingly during the first quarter of 2021. If the employer fails to repay any amount of deferred payroll taxes by May 1, 2021, then interest, penalties, and any applicable additions to tax begin to accrue. Further, the IRS guidance provides that “if necessary, the [employer] may make arrangements to otherwise collect the total [deferred taxes] from the employee.”
CBIZ Observations on IRS Guidance
Consistent with Treasury Secretary Steven Mnuchin’s previous comments, employers can choose whether they want to offer the payroll tax deferral to employees. However, the IRS guidance does not specify whether individual employees can opt out. From a practical standpoint and in light of the program’s timing, employers that choose to implement the program may need to cover all of its employees in any case.
Unless Congress enacts legislation to forgive the deferred payroll taxes, the repayment schedule essentially requires doubled-up social security withholding from employee wages during the period Jan. 1, 2021 through April 30, 2021. This could cause an economic hardship for many employees, especially if employee wages fluctuate over each pay period.
Employers that participate in the program also risk exposure to contingent liabilities concerning the repayment of deferred payroll taxes. The IRS guidance provides that employers may “make arrangements” with employees to collect deferred payroll taxes, which likely pertains to situations where employees separate from service or otherwise no longer earn sufficient wages during the repayment period. Additionally, this may incentivize employees to quit or change jobs after year-end in order to avoid the imminent drop in their wages. Employers must realize that there is no IRS safe harbor for these arrangements; the employer is obligated to repay the deferred taxes whether or not these arrangements are effective. Legal measures to collect the tax from each employee would likely be too expensive or time consuming to meet the May 1 repayment deadline. Employers must carefully evaluate risk tolerance for these potential liabilities.
In sum, the IRS guidance provides important clarifications on the payroll tax executive order, but it does not answer all of the outstanding questions. Employers must carefully evaluate whether the program would be beneficial to employees and whether the risks associated with repayment are acceptable. For more information on the employee payroll tax deferral executive order, please contact your local CBIZ tax professional.
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