The recent employee tax deferral, IRS Notice 2020-65, seems like a good deal, right? Defer employee social security taxes during this challenging time? Most business owners would jump at that little bit of relief right now. As with most IRS or other government-related changes, the details are a bit confusing and there is much left up to interpretation for your HR and Finance teams. Read on for a summary of the order and Fourth guidance on how to proceed.
In a nutshell, the August 28, 2020 Notice provides that the due date of the employer’s withholding, deposit, and payment obligations with respect to the 6.2% employee portion of Social Security payroll tax may be deferred for wages paid to certain employees. Although not stated explicitly, based on statements of Administration officials and a reasonable reading of the Notice and related IRS materials, it appears that an employer may decide whether or not to exercise this deferral option. Moreover, employees do not appear to have any right to require employers to defer these taxes.
The deferral applies to wages paid on a pay date from September 1, 2020, through December 31, 2020. The Notice provides that the deferral is only available with respect to employees receiving wages or compensation paid during a bi-weekly pay period of less than $4,000 (or the equivalent threshold amount with respect to other pay periods). This cap is applied on a pay period-by-pay period basis (e.g., an employee with $3,500 of wages in one bi-weekly pay period would be eligible for the deferral for that pay period, but if the employee had $4,000 or more of wages in another pay period, then he or she would not be eligible for that second pay period).
The Notice further provides that an employer must withhold and pay the total taxes deferred ratably from wages paid between January 1, 2021, and April 30, 2021. Otherwise, interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to unpaid deferred taxes.
What to Consider
Clear as mud, right? To date, the IRS has not provided any additional guidance. This leaves a lot of open questions for employers to deal with. Below we highlight some of the issues employers should consider and discuss with their trusted advisors.
Under the Internal Revenue Code (Code), Employers are liable for the employment tax obligations with respect to the wages paid to worksite employees. Penalties on employers for failure to meet employment tax obligations can be severe.
Absent further guidance, it appears that the Company may remain liable for any employee Social Security taxes deferred in accordance with Notice 2020-65. The Notice’s requirement to withhold the deferred taxes ratably during the first four months of 2021 would provide a mechanism for the employer to recoup the deferred taxes from the active employee.
Adding to the risk and uncertainty, the Notice does not indicate what the employer can do to protect itself if an employee leaves employment prior to May 1, 2021. The Notice only states that the employer must withhold and pay the total applicable taxes that the employer deferred and that interest, penalties, and “additions to tax” will begin to accrue on May 1, 2021, with respect to any unpaid taxes. The Notice further states that the employer “may make arrangements to otherwise collect” the deferred taxes from the employee. However, no guidance has been provided on what such arrangements might be or on how such arrangements may interact with federal and state wage garnishment laws.
Worksite Employee Liability
In addition to employer liability for the withholding, deposit, and payment of the employee’s share of Social Security taxes, the Code also provides that the employee remains liable for any taxes not withheld by the employer. Thus, the IRS retains the right to collect these amounts from individual employees. In any event, the employee Social Security taxes that are deferred will have to be repaid during the first four months of 2021. This will result in a substantial reduction in take-home pay early next year for affected workers.
Ability to Allow Employee Elections
Administration officials have made statements that they are working to implement mandatory employee Social Security tax deferral for all federal workers. If correct, it appears that an employer can force all employees to defer. However, many employers may not want to force this deferral upon their employees. The Notice does not address whether an employer may defer employment taxes for some of its eligible employees but not others. If employee-by-employee elections are allowed, it is not clear what types of educational materials would have to be provided to employees or what types of employee representations the employer might want to obtain in connection with any such election. Another issue that may need to be considered is whether nonresponding employees could be deemed to have made a default election in favor of or against deferral.
The decision on whether (and how) to proceed on the deferral of employee Social Security taxes is a complex one with a lot of unknowns. These rules are likely to continue to evolve in the weeks and months ahead and we will keep you posted as the situation evolves.
Attention Fourth HR & Payroll Customers
Should you decide to allow deferrals, please contact your payroll specialist. You will be required to sign an addendum that shows agreement that you will repay any deferred taxes on behalf of employees that are no longer with your company. Employees will also be required to sign an addendum as well. Payroll-only clients should also consider having employees sign an agreement to protect your tax liability.
Thanks to our partners Davis & Harman for this analysis.
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