On August 8, President Trump signed a memorandum ordering Treasury Secretary Steven Mnuchin to defer the employee’s portion of payroll tax withholding from September 1, 2020 until December 31, 2020. The deferral is for the employee’s 6.2% portion of social security tax only, not the Medicare tax. It applies to employees whose bi-weekly, pre-tax compensation is less than $4,000, or $104,000 per year.
The order, which bypassed Congressional action, has caused concern and confusion among employers who are facing a tight deadline to make complicated payroll changes. Fortunately, those changes may not be necessary. Although no official guidance has come out of Treasury, Secretary Mnuchin has made statements on television indicating the deferral may be optional for employees –and for employers. In other words, employers may be able to decide whether they want to offer this benefit to their employees.
Chamber of Commerce and AICPA Comments
The U.S. Chamber of Commerce, representing thousands of businesses, and the AICPA both wrote to the Treasury asking for clarification of the deferral order, pointing out complications that could result from payroll tax deferral.
The Chamber’s letter said employers are uncertain how the deferral applies to various situations. Examples include employees who have fluctuating salaries or receive bonuses; short term employees such as seasonal workers; and employees who leave employment before the end of the deferral period. The Chamber also expressed concern about the substantial liability for employees at the end of the deferral period, absent Congressional action to forgive the deferred payroll taxes.
The AICPA included 10 issues in a request for guidance in its letter to Treasury, leading off with a request that employees must make an affirmative election to defer the payroll taxes and that Treasury provide a model notice to inform employees of the election. The AICPA also requested that the $4,000 limit be a cliff, and the limit should apply to each employer of an employee. With a cliff, if the wage amount for an applicable pay period is above $4,000, no deferral is permitted. The AICPA believes this type of limit would be the easiest way to implement the deferral. The letter goes on to ask the Treasury to set a payment due date and identify a mechanism to pay deferred taxes.
What’s an Employer to Do?
Although Secretary Mnuchin’s statements are encouraging, they are not official guidance published through normal channels. It seems unlikely the current Administration will make the payroll tax deferral mandatory for employers. However, this situation could set up a conflict between employers and their employees if employees request deferral, but the employer is unwilling or unable to do it. If employers allow employees to elect deferral, employers will be required to track each employee’s participation or nonparticipation, which could be complicated.
Furthermore, although deferred amounts do not incur any penalties, interest, or additions to tax, at this point, employees must pay it back, and employers are the ones that may be responsible for collecting it. The President has the power to defer taxes by executive order, but not to reduce them. The President’s order directs the Treasury Secretary to explore avenues, including legislation, to forgive the deferred taxes. However, only Congress can forgive the tax. The legislators who will be making that decision will likely be those still in office during the lame duck session after the election. So far, the Democrats have criticized Trump’s action as a power-grab to circumvent Congress, while Republican lawmakers have not said much. Senator Majority Leader Mitch McConnell (R-Ky) said he supports the President “exploring his options” to get relief to people who need it. Senator Marco Rubio (R-Fl) wrote that he and other Senators “appreciate the President’s most recent EOs,” but did not address the payroll deferral specifically. Still, it will be hard for members of Congress from either party to vote in favor of requiring repayment of deferred taxes.
If the taxes are forgiven, then employers that deferred taxes for their employees will not have to collect and remit the deferred taxes next year. If an employer opts out, or has employees that opted out, the situation may be different. If Congress acts to forgive the deferred taxes, the question is whether it will forgive taxes just for those who defer them or for all taxpayers who meet the income limits. It seems unlikely that Congress would only forgive taxes that were deferred. If Congress forgives payroll taxes for everyone, then employers who did not offer deferral the first time around may be called upon to implement any broader forgiveness mandate that Congress enacts. Looking forward it is hard to predict what will happen.
August 28th Clarifications
On August 28th, the IRS released Notice 2020-65 with further clarifications of the President’s employee payroll tax deferral order.
The notice indicates an employer may defer withholding and depositing the employee share of social security tax (for eligible employees and wages) starting 9/1/2020 through 12/31/2020. As of 1/1/2021, the tax will be ratably paid back by the employee from wages paid through 4/30/2021.
If necessary (e.g., if an employee leaves before paying back the deferred taxes), an employer “may make arrangements” to otherwise collect the tax.
Optional Deferral and Possible Forgiveness
While the notice postpones the due date to withhold and pay the relevant tax, the notice does not preclude earlier withholding and payment (a position confirmed by Treasury Secretary Mnuchin).
The previously issued memorandum also directs the Treasury to consider forgiveness elements of the deferred tax; however, forgiveness legislation is up to Congress.
House Ways & Means Committee member, Rep. Kevin Brady (R-TX), has noted he will introduce such legislation, although the likelihood of (timely) passing such legislation amid election and political uncertainty does not seem likely.
Consider the implementation costs, tracking, payroll re-programming (twice) and also the implications of employees who may leave before the deferred tax is repaid. The “responsible party” rules allow the IRS to collect unpaid taxes from corporate officers, partnership members, employees and other people responsible for collecting and depositing taxes withheld (and “Trust fund” taxes, such as these, are non-dischargeable in bankruptcy).
If the employer does not pay in the deferred amounts by April 30, 2021, they will be subject to interest and penalties, including a “trust fund recovery penalty.”
Employers should consider their short-term horizons and employee expectations before implementing any changes. Consider how to navigate retirements, parental leave or exiting employees.
Postponement now will give employees more take-home pay, but at the beginning of next year, an employee’s social security tax rate effectively doubles for the first four months (6.2% on current wages plus the 6.2% deferred from the prior 4 months). This may pose challenges for employees that cease employment at any time during the payback period. For employees that cease employment, the entire amount likely comes due immediately.
Employers remain on the front lines of this uncertainty, and they will need to examine the complexities of payroll tax deferral and decide on whether they can offer this benefit to electing employees.
Your tax advisors at Frazier & Deeter will continue to provide updates as any further clarifications or changes arise.
About the Author
Lucia Nasuti Smeal is a guest blogger on tax topics for Frazier & Deeter. Smeal is an attorney, a tax professor with Georgia State University’s J. Mack Robinson College of Business and with Franklin University, and former editor of Tax Notes Today, published by Tax Analysts. Smeal also worked as a legislative analyst for the Congressional Research Service and is a former member of the U.S. House Periodical Press Corps. She is a frequent speaker on current tax developments.