As part of addressing the economic impact of COVID-19, the Internal Revenue Service (IRS) issued a Notice that employers may suspend withholding and paying to the IRS the employees' portion of the Social Security payroll taxes. The payroll tax "holiday," or suspension period, runs from September 1 through December 31, 2020. The Notice leaves a number of unanswered questions that employers need to consider in deciding whether or not to suspend withholding the employees’ portion of payroll taxes.
Who is Eligible.
The suspension applies only to employees whose wages are less than $4,000 for a biweekly pay period ($2,000 weekly, $8,666 monthly or $104,000 annually). Wages include an employee's wages, bonuses, overtime, and portion of any health insurance benefits that the employer paid. The $4,000 limit is determined on a period-by-pay period basis. Employees whose pay fluctuates over and under the threshold during the Deferral Period will only be eligible for the deferral during the pay periods in which their pay is less than the threshold amount of $4,000. To illustrate, an employee who normally earns $3,500 every two weeks, would not be eligible if they worked 10 hours of overtime and earned over the $4,000 limit. Similarly, a bonus could push some employees over the limit for the payroll period that it is paid.
The IRS Notice does not require that the payroll taxes be suspended. Rather, employers have the option. The Notice gives the employer, not employees, control over the choice. The Notice does not address whether an employee can opt out of the suspension. It is also unclear if an employer can select which employees will have the tax suspended or whether it must suspend collection for all eligible employees if it decides to suspend collecting the taxes.
Given that the notice was released just days before the deferral period beginning on September 1, 2020, some employers may not be able to implement the deferral. The IRS notice is silent as to whether an employer must defer for the full four-month deferral period. It is also unclear whether an employer can apply the deferral retroactively if it cannot implement it for the first payroll periods.
The Tax Must Be Paid Back.
Employers that suspend collection of eligible employees' portion of the payroll taxes during the four-month suspension period must repay the deferred taxes to the IRS during the first four months of 2021 (January 1 to April 30, 2021). After April 30, 2021, penalties, interest and "additions to tax" will begin to accrue on employers for any tax amounts that have not been repaid. While the White House has suggested that employers should not be required to collect and pay back the tax amounts deferred, doing so would require new legislation. Accordingly, the employer may have to collect double payroll taxes for the beginning four months of 2021.
Risks of Not Collecting the Taxes.
Unless Congress takes action to forgive the deferrals, one of the most significant risks for an employer implementing the deferral is that the employer may be liable for deferrals that it is unable to collect from employees who are terminated, have resigned or are on leave during the repayment period. Employers are responsible for collecting the tax from their employees and paying it to the IRS, and the employer remains liable for the employee's share of Social Security taxes that were not able to collect from employees.
Employers can try to mitigate that risk by entering into written repayment arrangements with employees. For example, it could agree with its employees to take out of their final paycheck any amount of the deferral that remains unpaid. It is unclear whether such an arrangement would be enforceable. The IRS Notice mandates that the employer “must withhold and pay the … [payroll] deferred under this notice ratably from [the employee’s] wages and compensation.” The requirement that the deferred payroll taxes be withheld “ratably” may prevent an employer from accelerating the repayment or collecting a large, one-time payment in one pay period. Moreover, some states have strict rules about what an employer can deduct from final wages.
To Withhold or Not to Withhold.
Employers are faced with a difficult decision of whether to suspend withholding the employees’ portion of the payroll taxes. First are the administrative challenges and costs. The employer would need to adjust payroll to first not collect the taxes for eligible employees and then collect double the tax in the beginning of 2021. The system would also have to be able to adjust for employees whose pay fluctuates over and under the $4,000 biweekly threshold, so the proper amount is suspended and then repaid.
While an employer can opt to continue to collect the payroll taxes, this can also create problems. If Congress later takes legislative action to forgive the deferrals, employees may feel that they “lost” out on a benefit because their employers decided to continue to collect the taxes. Whether Congress will pass legislation to forgive the deferrals is uncertain in light of its impact on funding to Social Security.
An employer cannot take a wait-and-see approach by continue to withhold the tax but suspend the deposit of it until next year. The IRS prohibits such an approach. There are other options. For example, employers could consider providing a nominal bonus to compensate employees for the lost deferral. There may be cost savings available to employers by avoiding the administrative challenges with implementing the deferral which could be the basis for such a bonus.
Given the complex issues, employers should consult with tax and legal advisors. Employers should also work with vendors to assess the costs and problems with making changes to the payroll system that would be needed to implement the deferral of the payroll tax collection. It is also key that the employer stay abreast of any additional guidance from Treasury and the IRS and other developments, such as legislation that forgives the deferral. Finally, the employer should communicate its decision to employees. They are likely to be aware of the deferral, and keeping them aware of the of the decision may avoid problems.
Notice: The information contained in this update is abridged from legislation, court decisions, and administrative rulings, and should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.