September 3, 2020 | Payroll Software | Posted by Ascentis
Issues to Consider in Deciding Whether to Adopt the New Payroll Tax Deferral
On August 8, the President signed a series of Presidential Memoranda, one of which authorized the Secretary of the Treasury to develop regulations for a “payroll tax holiday” for American workers. Treasury issued Notice 2020-65 on August 28, and the rules become effective for pay dates beginning September 1.
This action was not a law passed by both Houses of Congress and signed by the President, which would have had the effect of binding all private sector employers by its terms. It was also not an Executive Order signed only by the President, which can usually legally bind, for example, federal employees or even federal contractor employers. As a Presidential Memorandum, its impact on all employers is advisory only, and every employer now faces a decision about whether to adopt the program or not.
First things first: the program is based on a Presidential commitment to fully work with Congress to forgive these taxes after the election if the President is re-elected. Employers should keep this in mind when making decisions about the program. To change tax law, and for the federal government to forfeit the up to $160 billion (estimated) in social security trust fund revenues over four months that this deferral represents, it is generally acknowledged to requires: (a.) re-election of the President, (b.) a filibuster-proof majority of at least 60 Republican Senators in January, increased from their current 53 seat majority, and (c.) turnover of the House 37-seat Democrat majority to Republican control. Even those experts who see the November Presidential race as a coin-toss right now would see this total changeover in Washington to be more akin to the odds of a coin tossed in the air and landing perfectly on its edge. So at this juncture, forgiveness of these taxes is not something organizations should rely on when making this decision. In fact, the IRS Notice makes no mention of the possibility of forgiveness, and employers should think of this as only a deferral of the employee taxes due.
The specific tax under consideration is the employee portion of OASDI – the 6.2% that employees have withheld during the year, up to the 2020 wage limit of $137,700. The employer “side” of OASDI has already been subject to optional deferral under the CARES Act since March 27. Neither “side” (employer or employee) of the Medicare tax of 1.45% is included in this new offer of deferral.
What Notice 2020-65 Tells Us
Given the brevity of Notice 2020-65 – just two and a half pages for this novel concept in tax administration – there are a substantial number of questions that employers do not have answered. Here’s what the Notice does tell us:
- The Notice affirms that participation in the deferral program is optional by employer, it is not mandatory for ANY employer.HCM Implications: This is historic; never in the history of payroll administration have service providers or in-house payroll programmers had to go into their payroll programs and install some form of “option switch” for whether certain taxes should be withheld or deferred from employee pay.
- The Notice re-affirms that the deferral applies only to employee paychecks for which gross pay (including all OASDI-taxable wages) totals less than the “threshold amount” of $4,000 on a bi-weekly basis. This equates to weekly pay of $2,000 or less, semi-monthly pay of $4,333 or less, or monthly pay of $8,666 or less. The threshold amount test is made independently each pay period; it is entirely possible that some variable pay employees may be eligible for the deferral in one period and not in the next.HCM Implications: More history being made.Never before have payroll systems had to develop and embed a “per-employee/per-pay-period” form of means-testing as to whether a payroll tax provision applies or not. Furthermore, many payroll systems are built in such a way that multiple paychecks issued to a single employee in a single pay period cannot be aggregated to measure the total against the new deferral threshold. For example, if a sales employee receives two paychecks in a single bi-weekly period, one for $3,000 gross for base pay, and another for $2,000 gross for commissions, the Notice indicates that employee would not be eligible for deferral. In recent conversations with IRS Chief Counsel’s Office, payroll service providers emphasized the need for clarification on this issue, and the Service has indicated they will have explanatory guidance forthcoming.
- The Notice makes NO reference to any employee option to participate or not, so employers’ previous assumption that this was a company-wide decision to be made by the employer still holds. So far, there is no indication of an upcoming Q-and-A release from Treasury that might address this issue explicitly, but that is certainly a possibility.
- The Notice clarifies that taxes deferred during the 4-month deferral period of September 1 through December 31, 2020, must be repaid during the 4-month period of January 1 through April 30, 2021. Unpaid deferrals will begin to accrue interest, penalties and additional taxes for the employer, as of May 1.
- The Notice re-affirms that responsibility for payment of the employee payroll tax deferral remains with the employer.
The “Risk vs. Reward” of Employee Payroll Tax Deferral
The benefit of this tax deferral to employees is obvious – more money in their paychecks to spend over the last four months of this year, which of course includes the holiday spending period. The downside is the high likelihood of a repayment requirement (i.e., no forgiveness), which will no doubt be seen by some employees as a “6.2% pay cut” for the first four months of 2021 – just when the holiday bills are coming due.
But that’s just scratching the surface of the “risks,” some of which are:
- Situations where the employee has tax withholdings deferred but terminates employment before April 30. This leaves the employer responsible for paying some portion of the employee’s deferred OASDI tax, if they cannot collect all deferred tax before the employee leaves.
- The worst case scenario here would be an employer who begins participating in the deferral immediately on September 1, and has an employee who quits at the end of December, maximizing the amount of deferred tax at ~ 50% of their regular paycheck (6.2% times 8 bi-weekly pay periods = 49.6% of a single regular gross pay amount).
- An employee might quit without notice and if the employer pays current (or close to current), the employer is left with little recourse to the employee for the money. The Notice is not terribly helpful on this point: “Affected Taxpayer may make arrangements to otherwise collect the total Applicable Taxes from the employee…” – the Notice includes no suggestions as to how that would be done.
- The Notice also offers no exceptions to some “age-old” payroll rules, which employers must keep in mind. For example, if an employer is unsuccessful at pursuing an ex-employee’s repayment of unwithheld OASDI taxes paid by the employer, this constitutes an “employer-pays-employee’s-tax-liability” situation, and the employer must impute the tax amount to the employee’s W-2 as additional income.
- Potential conflicts with collective bargaining agreements, and the lack of direction within the Notice about whether the withholding deferral can be implemented only for select portions of the workforce.
- Potential conflicts with state law. While this class of deduction from a final paycheck (deferred taxes) is a new phenomenon, state laws sometimes have restrictions on those deductions, without reference to their origin. From a Fisher Phillips blog on the subject (citing California law): “…But with regard to a final paycheck, a different rule is applied. In the same 2008 opinion, the Labor Commissioner wrote that deductions from an employee's final paycheck for debts owed to the employer are prohibited, even with prior written authorization. The Commissioner relied primarily on Barnhill v. Robert Saunders & Co. in which a state court ruled that deductions made by the employer from an employee's final paycheck for the balance owed on a debt constituted illegal self help.” The “illegal self help” doctrine may apply in other states as well and employers would be wise to check with their legal advisors on the rules in each state where they have employees, prior to making a decision about implementing the tax deferral program.
In a conference call with payroll service providers on September 3, IRS offered a key clarification about the options available to employers under this Notice. Specifically, employers can either: (a.) participate in the deferral program, stopping employee OASDI deductions and postponing the deduction and remittance to the IRS until January 1 through April 30, OR (b.) decline to participate in the deferral program, meaning that the employee deductions continue, as do the remittances, through end of this year. A third option – for the employer to continue to deduct the employee share of OASDI but hold it to remit next year (thus taking the benefit of “the float” on this money to benefit the employer), is NOT a permissible interpretation of the Notice, according to the IRS.
Bottom line for now: Employers should evaluate carefully whether the payroll tax deferral program is right for them and watch for explanatory Q-and-A releases coming from the IRS/Treasury in the near future.