Coronavirus (COVID-19), HR Management & Compliance

Tax Holiday or Headache? Deferral Plan Presenting Challenges for Employers

President Donald Trump’s plan to defer payroll taxes for many employees through the end of the year is sparking questions and criticism from employers—questions about how to implement the plan and criticism that the “tax holiday” may hurt more than it helps.

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On August 8, Trump issued a memorandum providing for the deferral of payroll taxes for employees making less than $4,000 before taxes in any 2-week payroll period during the deferral period, which goes from September 1 through December 31, 2020. The intent is to provide financial relief during the COVID-19 pandemic.

The president’s memorandum doesn’t provide forgiveness of the payroll taxes, just deferral. That means any deferred taxes will have to be paid by April 30, 2021, or interest and penalties will begin to accrue to the employer.

Whether the deferral is optional or mandatory is one question employers have, although it appears to be optional. Jonathan Barber, senior vice president and head of compensation and benefits policy research at Ayco, a Goldman Sachs Company, says guidance from the IRS issued on the eve of the deferral period didn’t provide total clarification.

But he says the guidance “seems to somewhat suggest” it will be the employer’s decision and not up to individual employees whether taxes will be withheld or not. “If the deferral is elective, the IRS will need to clarify whether an employer would have liability to employees for failing to make the deferral available,” Barber says.

The IRS guidance “effectively makes it optional,” according to a summary of the guidance prepared by Jason P. Lacey, an attorney with Foulston Siefkin LLP in Wichita, Kansas. Employers choosing not to defer “may continue to withhold and deposit the affected taxes on their regular schedule.”

The choice is up to employers, Lacey says. “Nothing in the guidance indicates that employees have the option to elect or otherwise direct their employer to defer withholding of the applicable taxes,” his summary says.

Employer Liability

Just how employers should implement a deferral of payroll taxes—the taxes that fund Social Security and Medicare—is one major question employers face, Barber says.

“By far, the major issue is the employer liability to pay the deferred employee taxes,” Barber says. The IRS guidance indicates that employers are to collect the deferred Social Security taxes during the January 1, 2021, through April 30, 2021, period, he says.

That can be a problem if employees quit or otherwise lose their jobs during the deferral period, leaving employers unable to withhold taxes from their paychecks.

“The notice makes it clear that it is the employer’s responsibility to withhold and pay these deferred taxes during this period,” Barber says. “If not, interest, penalties, and additions to tax will begin to accrue to the employer.”

The IRS guidance says employers can “make arrangement to otherwise collect” the taxes if withholding isn’t an option. “However, it is not clear just how far an employer could go to collect such amounts and what means (if any) the employer would have to enforce collection,” Barber says.

Also, employers need further clarification on any applicable penalties for improperly deferring payroll taxes for employees whose wages are ultimately determined ineligible for deferral, Barber says.

What if an employer is unable to withhold all the deferred taxes by April 30, 2021? Lacey says the IRS guidance indicates the employer will be “on the hook” for any taxes deferred but unable to be withheld from employee pay.

“This raises particular risks for situations such as employee terminations, furloughs, and unpaid leaves of absence where there may be insufficient wages available after January 1, 2021, to withhold all deferred taxes,” Lacey says. “Employers that choose to utilize the deferral option will want to carefully plan for any such situations.”

Another complication centers on eligibility for deferral, since some employees whose paychecks aren’t the same each pay period may fall in and out of eligibility during the deferral period, Barber says.

What About Forgiveness?

The president’s memorandum says the secretary of the Treasury “shall explore avenues, including legislation” to provide forgiveness of deferred taxes, but that is unlikely, Barber says, since the Internal Revenue Code gives the president the power only to postpone—not forgive—tax payments during a federal disaster declaration.

“Any forgiveness of the underlying tax liability will require congressional action,” Barber says. “Historically, both Republicans and Democrats in Congress have been very reluctant to reduce FICA taxes (even on a short-time basis) given the financial impact on Social Security and Medicare.”

In addition, Barber says if Congress were to forgive the deferred taxes, the forgiven amount probably would constitute additional income, meaning employees would need to pay additional income tax.

Advice to Employers

Even though questions remain, Barber says employers should start identifying the employees who might qualify for the deferral and determine what systematic administrative changes might be necessary.

Communication to employees also is a major challenge for HR departments. “Where a company chooses to defer, it will be critical to educate the employees that this is merely a deferral and this amount will be due starting in January of 2021,” Barber says. “Employees should be well advised not to rely on forgiveness of this amount.”

Barber advises employers to consider providing hypothetical examples showing the savings the deferral would provide through the end of the year and the increased tax—lower net pay—that employees can expect between January 1 and April 30, 2021.

“The key is making sure the employee will not be surprised once repayment begins,” Barber says.

In his summary of the IRS guidance, Lacey says if employers choose to defer withholding, they will need to communicate to employees why their take-home pay has increased through the end of the year. Likewise, employees also will need to understand why take-home pay will decrease between January 1 and April 30, 2021.

Barber says the tax deferral is “akin to a short-term interest-free loan,” and employers will need “to evaluate whether employees would even appreciate this deferral versus the administrative hassle of implementation.” He points out that the additional amount to be collected between January 1 and April 30, 2021, will mean lower take-home pay than an employee was used to before the deferral period.

“This could certainly enhance financial stress, which is typically heightened following the holidays, when repayment is required to begin,” Barber says.

Tammy Binford writes and edits news alerts and newsletter articles on labor and employment law topics for BLR web and print publications.

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