On August 8, 2020, President Donald J. Trump signed an executive memorandum directing the U.S. Department of the Treasury (Treasury) to allow deferral of the withholding, deposit, and payment of the employee portion of the 6.2 percent Social Security tax (but not the 1.45 percent Medicare tax) for the period of September 1, 2020, through December 31, 2020, for workers earning less than $100,000 annually. Previously, in March 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) included a provision allowing employers to defer the deposit and payment of the employer’s share of 2020 Social Security tax until December 31, 2021, and December 31, 2022.
Specifically, this deferral is available to employees whose biweekly compensation is less than $4,000, calculated on a pretax basis. The amounts are deferred without any penalties, interest, additional amount, or addition to the tax.
The goal is to free up money for workers as the U.S. economy recovers. However, the president doesn’t have the authority to enact a true payroll tax holiday via an executive order, meaning this deferral is temporary, and employees will eventually have to pay any deferred payroll tax at some point in 2021 unless Congress enacts legislation to permanently eliminate the deferred obligation.
Last Friday, on August 28th, the IRS issued guidance (Notice 2020-65) indicating how it will administer this memorandum. Here is our analysis and thoughts about the key points in the IRS guidance:
- AS DISCUSSED BELOW, WE ARE ADVISING MOST BUSINESSES AND NOT-FOR-PROFIT CLIENTS NOT TO OFFER WITHHOLDING DEFERRAL TO THEIR EMPLOYEES. AN EXCEPTION MIGHT BE A SMALL BUSINESS IN WHICH ALL THE EMPLOYEES ARE OWNERS.
- The memorandum does not give employees the right to demand deferral of withholding. It simply gives the employer the right to withhold and deposit at dates later than those prescribed by law. This is consistent with sec. 5(c) of the Memorandum.
- The employer is on the hook for the amount not withheld no matter what. There had been speculation that employees might owe the unwithheld tax with their returns in April 2021. The IRS set up no such system to accomplish that.
- An employee can move in and out of the status of qualifying for withholding deferral from one paycheck to the next. This was unclear in the memorandum, since the phrase “generally is less than $4,000” was used. The determination of whether a particular paycheck qualifies is made taking into account only what is being paid on that particular pay date.
- The amount deferred must be tracked. The total at the end of 2020 is then divided by the number of pay periods the employer expects to have between January and April 2021, and the pro rata amount is withheld from the employee’s paychecks during the first four months of 2021. The Notice indicates that if necessary, the employer may make other arrangements to collect the unwithheld taxes from the employee. This indicates that if the employee’s employment terminates, the IRS expects the employer to collect the unpaid tax and deposit it.
- Since the act of withholding or an obligation to withhold triggers a requirement to deposit the taxes, even if an employer cannot collect the unwithheld tax, it will remain obligated to deposit those taxes.
- The Notice indicates that interest, penalties and additions to tax on remittances of the deferred payroll taxes will begin to accrue on May 1, 2021. This indicates that all 2020 unwithheld social security tax must be deposited by the employer no later than April 30, 2021. This is true even if the employer begins recovering the unwithheld taxes in early January. So, some float on the money is available to the employer. However, many may find it easier to simply include this in the deposit of all the other taxes arising on the same pay date. It’s a pretty good bet the payroll processing services will take advantage of this float where available.
- The Notice does not mention changes that will presumably be made to Forms W-2 and 941 to account for deferred social security taxes and social security wages on which withholding is deferred.
- Individual clients seeking advice regarding a deferral option offered by an employer should be advised that any amounts deferred will be repaid in early 2021. Many may not wish to swap larger paychecks now for smaller ones in the future.
- Sec. 4 of the President’s memorandum directs the Secretary of Treasury to explore avenues to permanently eliminate the obligation to pay the deferred withholding taxes. Presumably, if this comes to fruition, those who opted not to defer or were not given a choice to do so by their employer will get some sort of tax credit. If that happens, we can’t be certain that the W-2 will contain the information needed to compute the credit. This means that those who sometimes earn more and sometimes earn less than $4,000 biweekly should keep their paystubs for September to December 2020, until we are certain there will be no refundable credit for taxes withheld on wages eligible for withholding deferral under the Memorandum.
- An employer who chooses to defer social security withholding is ultimately the one making the decision. The Notice doesn’t confer any rights on the employees. That being the case, the employer could decide to apply this uniformly and not withhold from any employees under the threshold or decide to give the employees the option to either defer or have current withholding. So, an employer could actually impose deferral on the employees without the employees being able to opt out.
- If an employer has two employees, one of whom is an owner, it isn’t obvious whether the employer can choose deferral on the owner’s wages and withhold currently on the non-owner without giving the non-owner a choice. However, with nothing in the Notice forbidding that and no rights conferred on the employee by the Notice, it appears that is permissible.
We think very few employers are going to participate in this given that they assume all the risk, if they are unable to collect from the employees next year.
It just seems like the effort to track all this outweighs the benefit of deferring a maximum of about $2,000 per person for a few months.