IRS Issues Guidance on Payroll Tax Deferral

Millions of workers could see smaller paychecks in the first few months of 2021 after the Treasury Department on Friday told employers they would be on the hook for the payroll taxes deferred under President Trump’s recent order.

The new guidance paints a sharply different picture from what White House officials have said for several weeks in response to Trump’s directive, which set in motion a plan to defer payroll taxes starting in September through the end of the year.

Trump has said he hopes to “terminate” the tax, which funds Social Security and Medicare, so workers see a boost to their weekly checks and aren’t required to pay it back later. But absolving Americans of these debts requires an act of Congress, something lawmakers from both parties have been reluctant to do.

Absent that, the Treasury Department’s guidance instead paves the way for employers to recoup the taxes deferred under Trump’s order from their employees’ pay, though it’s unclear what would happen if workers left their jobs or the firm no longer had the ability to deduct money out of their wages. The administration’s guidance perplexed tax experts, who said it could frustrate workers and add to the burden facing businesses, which may be deterred from implementing Trump’s order at all. Last week, automakers, restaurateurs, retailers, and a torrent of top employers signaled that possibility, when they joined with the U.S. Chamber of Commerce in calling the president’s plan “unworkable.” Their opposition means that many workers may see no change to their pay — and the economy may see a few of the gains Trump has touted.“While the Chamber appreciates the promulgation of guidance confirming the optionality previously suggested by Secretary [Steven] Mnuchin, we are concerned that many critical questions remain unanswered, making implementation a continuing challenge,” Caroline Harris, the vice president of tax policy at the Chamber, said in a statement Friday

The Internal Revenue Service, which issued the guidance, did not immediately respond to a request for comment. The Treasury Department and the White House declined to comment. The administration’s guidance came days after a payroll processor for one of the country’s largest employers — the federal government — announced that it could defer payroll taxes on the part of its employees.

Trump signed his payroll tax order earlier this month as congressional negotiations over a new coronavirus aid package broke down, promising at the time that it would result in larger paychecks for Americans. But his directive triggered widespread controversy as soon as it was signed, as tax experts, in particular, feared it would be impractical to implement.

Businesses fretted about the difficulties they’d face updating their payroll systems on a short time frame, and tax experts felt workers might struggle to repay the sums they owe, which could reach into the thousands of dollars depending on their incomes. Many, however, feared the future effects on Social Security and Medicare, particularly as Trump vowed to “terminate” the tax. AARP, the powerful senior’s lobby, sharply rebuked the White House earlier this month out of concern that the president’s plan could threaten future benefits, even as senior administration officials promised to protect retirees.

The Trump administration’s guidance Friday further added to the confusion. Companies that take advantage of the deferral program beginning Sept. 1 are tasked with collecting what their workers owe beginning next year. But it is unclear whether a worker — someone who perhaps doesn’t want to have to deal with repaying the amount they owe next year — can opt-out of the system, said Adam Cohen, a tax lawyer, and partner at Eversheds Sutherland.

“There’s still going to be a huge amount of uncertainty about how this could be implemented, which I think is going to lead most employers not to participate,” added Seth Hanlon, a senior fellow at the left-leaning Center for American Progress.

Others pointed to the fact that the Trump administration offered little word about what would happen if an employee was laid off, fired or changed jobs, said Garrett Watson, a senior tax policy analyst at the Tax Foundation. Already, there were fears that Trump’s order might result in billions of dollars in losses, as the government struggled to collect back-due tax balances. But Watson said the problems could be particularly pronounced depending on how the president’s order is implemented.

“It’s fair to say the more complex and uncertain it is … the longer it will take to get that repayment and the more likely there will be a remaining gap in collections going forward,” he said.

 The Treasury Department has issued its official guidance on the 2020 payroll tax relief that President Trump put into action on August 8 in his Presidential Memorandum. According to IRS Notice 2020-65, payroll tax relief is available for employers and is applicable to wages paid from September 1, 2020, through December 31, 2020.

Employers are allowed to defer withholding, deposit, and payment of the employee's portion of Social Security tax on wages that are less than $4,000 during a bi-weekly pay period. Each pay period is to be considered separately, and no deferral is allowed for any payment to an employee of taxable wages of $4,000 or more for a bi-weekly pay period. Technically the requirement to deposit employee Social Security tax does not occur until the tax is withheld; thus, by postponing the withholding of the employee Social Security tax, the deposit obligation is delayed.

The choice to defer withholding, deposit, and payment of the Social Security taxes are optional.

Note that this is a deferral of the payroll tax and not an exemption from payroll tax. The due date for deferred employee Social Security taxes is postponed until the tax period beginning on January 1, 2021, and ending on April 30, 2021. Deferred payroll taxes not paid during this period will be subject to interest and penalties.

Joe Bishop-Henchman, vice president of tax policy at the National Taxpayer Union Foundation posted an interpretation of this guidance on Twitter wherein he suggested that the Treasury Department is encouraging employers to forego withholding from September 1 through December 31, 2020, and then withhold double the normal amount from January 1 through April 30, 2021.

Bishop-Henchman also suggests that if an employee leaves his or her job prior to May 1, 2021, and there are uncollected Social Security taxes still owing, the employer has the right to collect a lump sum from the employee to make up the uncollected amount. In a continuation of this discussion on Twitter, James Valvo, chief policy counsel at Americans for Prosperity Foundation, warns that an employer who chose not to withhold Social Security taxes from an employee who leaves his employment before the end of 2020 would be "on the hook for the taxes [the employer] didn't withhold."

CPA Practice Advisor spoke with Pete Isberg, vice president of government affairs for payroll software company ADP, regarding recommended guidance to employers who might be considering implementation of this deferral program. "We're working on systems and how this will be orchestrated," said Isberg. "There are some questions about how to offer this to employees, how employees should elect whether they want this deferral or not. We know that it's optional for employers, although it is pretty clear employees will have an opinion about this. It's pretty hard for an employer to implement this deferral without an employee-by-employee conversation. Do we default people in? Do we default people out? This guidance applies to 100 million people! There's a lot of work to be done really which wasn’t apparent looking at the IRS Notice."

President Trump's Executive Order includes a suggestion that the Secretary of Treasury "shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum." Certain members of Congress, however, have balked at the idea. Last week, 143 House Democrats publicly denounced the deferral program in a letter to the President and demanded that President Trump reverse the executive action, so the likelihood of a forgiveness program coming out of Congress seems slim.

For employers who plan on implementing the payroll tax deferral program, here are some suggestions to make the process easier and to protect all involved parties:

  • Make sure you inform employees that it is expected that deferred Social Security taxes will have to be paid back between January 1 and April 30, 2021.
  • Have employees sign a contract agreeing to additional withholding up to twice the normal amount of Social Security taxes in the period from January 1 through April 30, 2021.
  • Include in the employee contract the agreement that the employee will reimburse the employer for any deferred payroll taxes should the employee leave the company prior to such a time when all deferred payroll taxes have been repaid.
  • Have a plan in place to account for repayment of deferred payroll taxes should the affected employee be earning less in 2021 than he or she earned in 2020.
  • Make sure your payroll team or payroll provider understands its obligations for adjusting paychecks to reflect the deferral and then, next year, adjusting paychecks to repay the deferred amount.

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