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IRS Guidance Allows Workers a Payroll Tax 'Holiday'

Companies would repay deferred Social Security taxes next year

A person writing on a paper with the word payroll.

Update: Repayment Period Extended for Deferred Payroll Taxes

Under the IRS guidance issued in August 2020, employers were allowed to defer withholding employees' share of Social Security taxes from Sept. 1, 2020 through Dec. 31, 2020. Originally, employers were required to increase withholding and pay the deferred amounts ratably from wages and compensation paid between Jan. 1, 2021 and April 31, 2021, and beginning on May 1, 2021, penalties and interest on deferred unpaid tax liability would begin to accrue.

However, the Consolidated Appropriations Act that President Trump signed at the end of 2020 extended the repayment period through Dec. 31, 2021. Now, penalties and interest on deferred unpaid tax liability will not begin to accrue until Jan. 1, 2022.

Guidance Update:

In January 2021, the IRS has issued guidance (Notice 2021-11) to address how employers who elected to defer certain employees’ payroll taxes can withhold and pay the deferred taxes throughout 2021 instead of just the first four months of the year. Penalties, interest and additions to tax start on Jan. 1, 2022, for any unpaid balances.

​On Aug. 28, the IRS issued Notice 2020-65, allowing employers to suspend withholding and paying to the IRS eligible employees' Social Security payroll taxes, as part of COVID-19 relief.

The payroll tax "holiday," or suspension period, runs from Sept. 1 through Dec. 31, 2020, and applies only to employees whose wages are less than $4,000 for a biweekly pay period, including salaried workers earning less than $104,000 per year.

Companies that suspend collection of employees' payroll tax would collect additional amounts from workers' paychecks from Jan. 1 through April 30 next year to repay the tax obligation.

President Donald Trump sent a memorandum on Aug. 8 to the Treasury Department to defer collection of the employee portion of Social Security from Sept. 1 through the end of 2020.

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Bare Bones Guidance

At just 2 1/2 double-spaced pages, Notice 2020-65 provides a minimum amount of information and leaves many questions to be answered, presumably in follow-up guidance.

As to whether employers will comply with the notice and suspend employees' Social Security FICA withholding, "It's too early to say," according to Pete Isberg, vice president of government relations at HR and payroll services firm ADP Inc. Employers "are just now considering how the program would work."

Isberg said that whether to suspend withholding of employees' payroll tax was in effect "voluntary." Although the language of the notice is directive, it includes no penalties for noncompliance.

It remains uncertain, however, how many private-sector employers will suspend collection of their employees' Social Security taxes, and, if they decide to do so, when they could reasonably adjust their payroll systems to stop withholding these taxes.

If employers suspend Social Security payroll tax withholding for eligible employees, the guidance does not provide for allowing individuals to opt out, which had been an administrative concern employers had raised.

Adjusting Payroll Systems

Employers that use a payroll firm should look for announcements on how the tax holiday will work, including any notices to employees, Isberg said. Given that many September payrolls were already processed in the closing weeks of August, before the guidance came out, "generally it will be shortly after Sept. 1" before Social Security tax withholding could be deferred, he noted.

"Employers that maintain their own payroll systems may need weeks or months to get the technical work done, so it may be October, November or even later," he said, adding that "the IRS has said that any changes must be prospective."

Employers Responsible for Repaying Taxes in 2021

Employers that suspend collection of eligible employees' Social Security payroll taxes during the four-month suspension period must repay the deferred taxes to the IRS during the first four months of 2021, unless legislation is enacted to forgive the uncollected taxes.

"Employers will need to withhold the total taxes deferred by each employee 'ratably' over the four-month period," Isberg said, so "employees will notice reduced net pay in 2021 equal to any increase in net pay in 2020 if they defer the tax."

After April 30, 2021, penalties, interest and "additions to tax" will begin to accrue on employers for tax amounts that have not been repaid, according to the guidance.

White House economic advisor Larry Kudlow has said, "We will take any steps possible to forgive this deferral" so employees would not be required to pay back tax amounts deferred through Dec. 31, The Hill reported. However, doing so would require new legislation.

Democratic presidential nominee Joe Biden and other Democrats have raised concerns that if these taxes are not eventually repaid, it could imperil the Social Security fund.

Departing Employees

Employers, referred to as "affected taxpayers" in the guidance, "may make arrangements to otherwise collect the total applicable taxes from the employee," the IRS said. 

But if an employer suspends collection of an employee's Social Security tax—which is 6.2 percent of his or her pay—during the last four months of this year, to be repaid by doubling the employee's Social Security tax to 12.4 percent during the first four months of 2021, for instance, what happens if an employee leaves at the end of the year?

The employer remains liable for the employee's share of Social Security taxes; the due date is just extended to next year, according to the guidance. The employer can make repayment arrangements with the employee, such as deducting the amount owed from the final paycheck. Otherwise, the employer would have to pay the balance owed.

There is nothing more specific in the guidance "about what happens when an [employee] quits, and there's no way to get that deferral back," tweeted Adam Markowitz, vice president at Howard L Markowitz PA CPA, in Casselberry, Fla. "The fact that this guidance is 3 pages leaves way more questions than answers. For that reason alone, this is a hard pass."

Jonathan Barber, head of compensation and benefits policy research at Ayco, a Goldman Sachs company that provides financial counseling, said that "although the notice allows employers to make other arrangements to collect the deferred Social Security taxes from the employee other than through payroll, 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."

To Suspend Withholding or Not

Lisa Galletti, owner of LMG Bookkeeping & Payroll Services in Ukiah, Calif., tweeted "don't defer, carry on as usual and save yourself the headache."

Still, some companies whose employees have struggled to make ends meet due to reduced wages or hours may think it worthwhile to give their workers a bit more in their paychecks now, to be repaid next year.

"Workers must understand that right now this is only a tax deferral, not tax forgiveness, so it's temporary relief," said Timothy Flacke, co-founder and executive director of Commonwealth, a nonprofit that focuses on financial security for low-income Americans. But, he added, "it still represents an opportunity for workers to start building or adding to an emergency savings account, without seeing any change in take home pay, by diverting the tax deferred amount into savings. This also ensures workers will have savings on hand" when it's time to repay the taxes out of next year's paycheck, he said.

Barber expressed a cautious view. "It is really just a very short-term, interest-free loan," he said. "Employers will need to evaluate whether employees would even appreciate this deferral. The additional amount being collected during the time period of repayment would mean a lesser amount of net pay then what the employee is used to—which could result in more financial stress versus the benefit the deferral may have provided."

Update: Some Questions Now Answered

In a follow-up article, SHRM Online looks at answers to some common questions about the payroll deferral holiday, and at issues employers are taking into consideration regarding whether they will participate. See Employers Hesitant, Confused Over Payroll Tax Suspension.

Form 941 Revised

The IRS also released a draft version of a revised Form 941, Employer's Quarterly Federal Tax Return, to take into account Social Security withholding that is deferred from Sept. 1 to Dec. 31. "The key change is found on page 3 … which asks for the 'Deferred amount of the employee share of Social Security tax included in line 13b,' " wrote Ed Zollars, a tax CPA in Phoenix and author of the Current Federal Tax Developments website.

Applicable Wages

Law firm Covington & Burling's Tax Withholding & Reporting Blog points out that Notice 2020-65 states, in footnote 3, that compensation excluded from FICA taxes does not count in making a determination of eligibility, based on an employee having biweekly earnings of less than $4,000. Payroll deductions into an employee's health savings account or flexible spending account, for instance, are excluded from FICA taxes.

Zoller blogged that "amounts removed from wages to pay for health care under a cafeteria plan will serve to reduce the amount of Applicable Wages, potentially allowing an employee who is just over the limit without a cafeteria plan deferral to qualify for a payroll tax deferral by making such a deferral to the cafeteria plan (assuming the plan allows for such a deferral to be elected at this point)."

Employer and Employee FICA Tax Relief

Social Security and Medicare payroll taxes are collected together as the Federal Insurance Contributions Act (FICA) tax. Social Security is financed by a 12.4 percent payroll tax on wages up to employees' taxable earnings cap—$137,700 for 2020—with half (6.2 percent) paid by workers and the other half paid by employers. There is no earnings cap on the Medicare portion of FICA, for which employers and employees separately pay a 1.45 percent wage tax.

The COVID-19-related payroll tax relief applies only to the Social Security portion of FICA.

Separately, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in March and implemented through IRS Notice 2020-22 and a series of IRS FAQs, allows eligible employers to defer the deposit and payment of the employer's share of Social Security FICA taxes from March 27, 2020, through Dec. 31, 2020. The deferred payments must be paid back to the Treasury Department, with half due by Dec. 31, 2021, and the other half by Dec. 31, 2022.

The CARES Act provision and related guidance did not apply to employees' share of the Social Security tax, which was the focus of the president's directive and the new IRS guidance.

Related SHRM Articles:

Employee Social Security Tax Deferral Guidance: Too Little, Too Late?SHRM Online, September 2020

Employers Hesitant, Confused Over Payroll Tax Suspension, SHRM Online, September 2020

2020 Payroll Taxes Will Hit Higher IncomesSHRM Online, October 2019

Related SHRM Resources:

Notice to Employees of Temporary Social Security Tax Deferral

Notice to Employees Explaining the Decision Not to Defer Social Security Tax Withholding

Workers' Payroll Tax Deferral Express Request

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