Making Sense of IRS, Treasury Guidance on Deferring Social Security Taxes

September 3, 2020 Marshall Slaybod, J.D.

 

Employers can choose to defer certain payroll taxes from September 1 to December 31 

September 9, 2020 Update:

In an attempt to overturn recent guidance to defer payroll contributions, House Ways and Means Social Security Subcommittee Chairman John B. Larson – along with Ways and Means Committee Chairman Richard Neal and 19 colleagues – introduced the Save our Social Security Now Act on Friday, September 4.

Brought “in a parallel effort with Senators Schumer and Wyden, to initiate a Congressional Review Act resolution to expedite the vote,” the act builds upon the opposition from more than 30 business groups urging Congress and the Treasury to find a solution that “provides much-needed tax relief for families without the uncertainty associated with the recent payroll tax Executive Order.

When introducing the act, Larson expressed concern for President Trump’s payroll tax deferral because he sees it as a first step toward defunding the Social Security program.

“Americans are relying on Social Security more than ever during this pandemic. They need to know that Social Security is secure and will be there for them.” Larson and other Democratic members of Congress fear that eliminating payroll contributions “would destroy the financial stability these benefits have provided for generations of retirees, widows, children, and people with severe disabilities.”

At this time, President Trump’s executive order and the IRS’s guidance on implementing the order remain in effect, and employers may choose to defer the employee portion of the payroll tax used to fund Social Security.

Background 

On August 8, 2020, President Trump published an executive order directing the United States Department of Treasury to “to defer certain payroll tax obligations with respect to the American workers most in need” for wages paid in the final third of 2020.  

The current order, however, does not forgive these payroll taxes but states all deferred taxes must be paid to the IRS when the “tax holiday” concludes.

What We Know Now 

Pursuant to President Trump’s executive order, the Treasury and the IRS recently released joint guidance in IRS Notice 2020-65 (PDF) that gives employers the option to defer payment of the employee’s portion of the Social Security payroll tax,  governed by the Federal Insurance Contributions Act (FICA).

Therefore, as an employer, you are free to decide whether to celebrate the “tax holiday”  by deferring taxes for qualified employees for the remainder of 2020 or continuing to take Social Security taxes out of all employees’ paychecks.  

Who qualifies for the “tax holiday”? 

Any employee who earns less than $4,000 in pre-tax wages on a bi-weekly basis could qualify to have their Social Security taxes deferred between September 1 and December 31, 2020.  Employees currently do not have the ability to opt in or out of the Social Security payroll tax regardless of their income. Only employers can choose to defer the taxes or continue to collect and pay them.

Important facts: 

  • Pre-tax wages are used to determine if an employee’s wages exceed the $4,000 bi-weekly threshold.  
  • Each pay period is evaluated independently, not averaged. 
  • For employees paid in frequencies other than bi-weekly,  their eligibility will be based on “the equivalent threshold amount with respect to other pay periods.”  

Employee risks and responsibilities

The recent guidance focuses on the deferment — a delay in payment — not forgiveness of the taxes owed.

It is important to remember the tax deferment does not release employees from the obligation of paying these taxes. Only a Congressional act that forgives these taxes can change this obligation. Employees whose taxes are deferred must pay them by the extended deadline or face penalties.  

According to the IRS Notice, employer-taxpayers affected by this relief “must withhold and pay the total Applicable Taxes” or “interest, penalties, and additions to tax will begin to accrue on May 1, 2021.” 

How to manage employer tax reporting  

Employers must manage the processes they use to deduct and defer employee taxes. Recent federal guidelines do not clearly define how you should document or report the tax deferrals.

The IRS did, however, release an updated draft Form 941, which includes line 13b: Deferred amount of Social Security tax. We expect employers will be required to report the deferred amounts here, but it is still unclear how or if Form W-2 or Form 1040 will be affected.   

What We Want to Know

Tax Forgiveness 

In President Trump’s executive order, he contemplated forgiving the applicable taxes owed so they would not need to be repaid. However, the executive order puts the research and potential execution of this option in the hands of the Treasury:  

“The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.” 

The executive order rightly mentions potential new legislation. Keep in mind that only Congress has the power to reduce or forgive taxes. Congress would need to enact a new law to create a mechanism able to forgive employee payroll taxes deferred during the tax holiday. 

We, however, believe it is unlikely Congress will pass new legislation to forgive Social Security taxes in upcoming weeks due to the:

  • Political sensitivity surrounding the Social Security program since its inception.
  • Significant impact on the federal budget that tax forgiveness may have.
  • Upcoming major election that could make it difficult for lawmakers to pass potentially controversial legislation.

Can employees opt out?

Neither the executive order nor the IRS Notice specify if employees have a role in deciding to defer their Social Security taxes. If an employer opts into the deferral program, it is unclear whether individual employees can choose not to participate. As written, the decision appears to lie solely with employers. 

Will employers want to defer? 

The deferment program is intended to help provide tax-paying employees greater financial stability now with the understanding they must pay the taxes in full later unless new legislation emerges. 

On the positive side, deferring payment of the employee’s portion of the Social Security tax could provide employees additional net pay on a temporary basis during a time when our country continues to reel from the impact of the global COVID-19 pandemic. Employees could invest the additional money and set aside  the amount they need to repay.  

On the other hand, the program seems to introduce employers to considerable risk especially if they cannot afford to pay back these taxes within the deadline. As a result, more than 30 business groups issued a letter urging Congress and the Treasury to find a solution that “provides much-needed tax relief for families without the uncertainty associated with the recent payroll tax Executive Order.” Referring to the Executive Order as “unfair” and "unworkable,” the letter states their concern plainly: 

“Without Congressional action to forgive this liability, it threatens to impose serious hardships on employees who will face a large tax bill, as a result of deferral.”

Employees who are accustomed to their employers deducting the appropriate amount of taxes from their paychecks, understandably, are not in the habit of including these tax obligations in their budgets. In addition, many employees saw a significant drop in their household incomes due to temporary part-time and full-time furloughs and the inability to work full time due to childcare demands. It would therefore be even more difficult for these taxpayers to put the additional money aside to pay it back in a few months.

In addition, it is unclear who will be responsible for collecting and paying back the deferred taxes.  There are several unanswered questions, including:

How will employers who take advantage of the program ensure the deferred taxes are paid on time? 

  • Will employers leave it up to their employees to plan accordingly to pay the deferred amounts back at the end of the tax holiday, or will employers potentially withhold higher amounts January – April 2021 to compensate?  
  • What sorts of repayment arrangements will surface between employers and their employees? 

As much as the relief would help now, the requirement to pay back the deferred amounts by May 1 would potentially leave employees in a  tighter financial situation in the first half of 2021.

The IRS Notice contemplates employers playing a role in collection, stating they “may make arrangements to otherwise collect the total applicable taxes from the employee.”  

This assumption also leaves a lot of questions unanswered. In particular:

  • Will employers be responsible if employees fail to pay back the deferred amounts? There appears to be no current mechanism for the government to bill employees, so it appears that employers will be responsible for collecting the taxes. 
  • Are there special considerations for employees who had their taxes withheld and were later terminated?  Will employers be responsible if former employees fail to pay back the amounts deferred by that employer? 

Before you decide to defer applicable Social Security taxes from employee pay, take time to thoroughly evaluate potential benefits for your business and your employees against the uncertainty and risk.

What You Can Do  

Develop a plan 

With new guidance coming just days before the first effective pay period, it is important to review the deferral program and decide how your business will move forward.

This information can serve as a starting point for leadership discussions. Make sure to evaluate each of your available options and their implications. Then develop a plan on how to approach the deferral of taxes typically withheld from employee paychecks to fund Social Security.  

Keep employees informed and involved 

Please share this information with your employees and strive to keep them informed. Although it is unclear if employees will have any control over their participation,  understanding how they feel about the deferred tax payment program can help guide your business strategy. We recommend surveying your employees to see how many are interested in deferring. 

In these uncertain times, it’s difficult to navigate the changing business environment let alone evaluate the implications of new tax deferment options.  Hopefully, this information will shed some light on this complex subject and help guide your decision-making process.

Remember to consult a tax professional when making important financial decisions. Keeping your employees in the loop will show them you care about their concerns and are thoughtfully considering what’s best for them in the long term as well as the short term.

Disclaimer: The information contained in this communication is NOT intended to be relied on as legal or tax advice. It is being provided for informational purposes only. 

 

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