Updates On Payroll Tax Exempt Rules
In response to Congress’ delay in providing additional relief in the wake of COVID-19’s economic impacts, on August 8, 2020, President Trump issued an executive order to the Department of Treasury to allow deferral of employee Social Security (SS) taxes. The Secretary of the Treasury is authorized under Section 7508A of the Internal Revenue Code to defer certain payroll tax obligations.
No matter the size of a business, each employee’s compensation is subject to various withholdings, including SS, which is at a rate of 6.2% of the employee’s compensation. SS tax must normally be withheld until cumulative compensation each year reaches $137,700 (the limit for 2020), after which no further SS tax withholdings are made. Employers also contribute equally to SS, matching the amount of employee withholding.
The President’s directive did not provide much in the way of detail other than to stipulate that the postponed withholding of SS taxes would apply to employees that are paid less than $4,000 bi-weekly (every two weeks) from September 1 to December 31, 2020 (roughly equating to a $104,000 or less annual salary). The gross $4,000 threshold is considered each pay period; amounts paid during other pay periods are ignored for purposes of determining whether postponing SS withholding is appropriate for this period. In addition, if an employer’s payroll period is other than bi-weekly, an amount equivalent to this dollar threshold should be calculated and used.
On Friday, August 28, the Internal Revenue Service released guidance in response to the order – Notice 2020-65. The guidance indicates that SS tax withholdings that would normally be withheld from September 1 to December 31, 2020, but that are postponed under this order, are to be withheld ratably during the period of January 1 to April 30, 2021. In other words, the withholding is put off for a few months. Then, during the first four months of 2021, withholdings are increased to make up for the deferred withholdings.
It is important to note that under this order, employers cannot withhold the SS tax from employees and wait to deposit it with the IRS in 2021. Once withheld, the standard tax deposit requirements apply. This is separate and not to be confused with previous CARES Act payroll tax deferral opportunities for employers. In addition, the President’s executive order does not affect the employer’s obligation to pay their portion of the SS tax; that portion must still be paid timely under the current deposit rules.
Unfortunately, the guidance is limited and leaves several questions unanswered.
Is postponement of the withholding mandatory or optional? Do employees have a say in that?
While Treasury Secretary Mnuchin separately commented that the postponement of these withholdings was optional, the IRS notice made no mention of this in its Notice. The President’s executive order also made no mention of this.
However, on September 3, 2020, an attorney with the IRS notified participants during a monthly payroll teleconference that “Employers may, but are not required, to utilize the relief.” The attorney also indicated that employers, not employees, have the controlling choice of whether to implement this payroll tax deferral.
What if the employee leaves the company before 2021 withholdings are completed?It is unclear, but it seems the employee is still on the hook for 2020 SS taxes not withheld under this order. The IRS notice says that employers “may make arrangements to otherwise collect the total Applicable Taxes from the employee.” But that will not be easy once an employee has left the company.
Will the postponed taxes be forgiven (i.e. no repayment required)?The executive order instructed the Secretary of the Treasury to explore avenues to eliminate the obligation to pay the postponed taxes, but at this point they will have to be withheld and paid come 2021. Most likely, only Congress can act to forgive the obligation.
How will the deferred tax withholdings be tracked and reported?Employers will need to track the postponed withholdings (amounts by employee) to ensure they are recovered during the first four months of next year. We assume that the IRS will revise the 2020 and 2021 Forms 941 to accommodate both the postponement as well as the subsequent remittances.
What about relief for self-employed workers?Self-employed workers are subject to self-employment (SE) tax on their profits. SE tax is equivalent to the sum of payroll taxes that employers and employees pay, including the 6.2% SS tax. However, the option to postpone SS taxes was not extended to self-employed individuals.
More guidance is certainly needed. With tomorrow being September 1, we can only hope that the guidance comes quickly.
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