Tax forms on a desk.

How to Implement the Payroll Tax Holiday

Recently, the President issued a memorandum on “Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster.” This memorandum institutes a payroll tax holiday for the rest of 2020, specifically for social security. The IRS also issued guidance on the memorandum for interpretive purposes.

General Policy

Employers that are required to withhold and pay the employee’s share of social security tax (or the railroad retirement tax equivalent) have the option of deferring those taxes for the period of September 1, 2020 through December 31, 2020. However, employers must still contribute their own portion for each worker.

This deferral is only to be made available to employees with pre-tax wages less than $4,000 in a biweekly pay period, or the equivalent amount with respect to other pay periods. Amounts deferred pursuant to this tax holiday will be deferred without any penalties, interest, additional amount, or addition to the tax.

However, this is a deferral, not a waiver. While not in the executive memorandum itself, the IRS guidance states that any and all withheld taxes must be paid back between January 1, 2021 and April 30, 2021. In the event that the funds are not paid back, interest, penalties, and additions to the tax will begin to accrue on May 1, 2021 on the amount of the unpaid taxes. Further, the guidance states that, if necessary, employers may “make arrangements to otherwise collect the total Applicable Taxes from the employee.”

Who Gets to Decide Whether the Deferral Is Made?

Nothing in the memorandum or IRS guidance specifically lays out whether the employer or employee is the one who has the discretion to choose the deferral. However, the IRS guidance does make references to “allowing employers” to make the deferral, and employers are defined as the “Affected Taxpayers” in the guidance, as well. So, while not explicit, the executive branch has suggested that employers are the ones who have the discretion on whether to defer the tax, not employees.

What If an Employee’s Wages Fluctuate?

While the payroll tax deferral only applies to employees who make less than $4,000 in a biweekly pay period, this determination should be made on a pay period-by-pay period basis. If an employee makes $4,005 during the first biweekly pay period but makes $3,997 the following pay period, the employee is eligible to have their taxes deferred during that second pay period, but not the first.

While this is good news for employees whose wages may fluctuating above and below the threshold amount, it is doubly important for employers to make sure they are keeping accurate accounts of when these employees are eligible for the deferral and when they are not.

Do I Have to Withhold Double the Taxes Next Year?

That seems to be the case. Presumably, social security taxes will be due as normal throughout the months of January 1, 20201 to April 30, 2021. So, absent any information to the contrary, it is likely that employees will be taxed as usual for those months, and will also need to pay back the deferral amount during that period, as well. The most straightforward interpretation seems to suggest that employers could potentially withhold double the amount of social security during those months for each biweekly pay period that they were deferred in 2020. However, the Treasury Department may very well come out with more guidance in the following months that provides insight into how the deferred taxes should be paid back next year.

Can Employees Instruct Employers Not to Defer the Taxes?

Nothing in the memorandum or IRS guidance speaks to this. What we do know is that, as mentioned above, the language in the IRS guidance suggests that employers are the ones who have the discretion of whether or not to defer the taxes.

Should I Defer or Should I Not?

That’s a business operational question that largely depends on your individual circumstances. In terms of the big picture implications, that are pros and cons. The payroll tax deferral could be a huge help to employees who may be financially struggling during this pandemic. But while they might receive larger paychecks this year, their checks could be significantly smaller next year if they are double-taxed.

For employers, you could provide a real boost in morale in the workplace by allowing employees to take home a bit more on their paychecks this year, however there is a lot of detailed bookkeeping that needs to happen in order to make sure only eligible employees are receiving the tax deferral and that the money is paid back next year.

There is also the potential issue that an employee quits during the repayment period next year. In the event that an employer decides to defer the taxes for this year but an employee quits in January, the employer may become liable for the amount that was deferred.

If I Choose to Defer, Do I Need to Notify Employees?

While the memorandum and IRS guidance don’t provide instruction on how employers are supposed to go about making the deferral, notifying your employees about your decision is advisable. For transparency’s sake, employees should be definitively told whether or not their paychecks will be affected.

In the event that you choose not to defer, a simple notice to your employees stating that you will continue withholding social security from their paychecks as normal should suffice.

However, if you do choose to defer, further detail should be provided to employees so they are on notice of what to expect regarding their paychecks going forward. In your notice, you should include what makes an employee eligible for the deferral, what percentage of their check will not be withheld, the period during which you plan to defer the taxes, and a reminder that the taxes must be paid back during the first four months next year.

Another potential avenue that employers could take is to offer the option to employees. However, if you allow employees to voluntarily opt in or out of the deferral, you should do so by using a request form for employees to fill out.

There may also be applicable state laws that affect the type of notice you need to provide to employees regarding the tax deferral. It is important to speak with an attorney prior to making the deferral to make sure you are in compliance with both federal and state law.

Is There a Chance of This Deferral Becoming a Waiver?

While the President has stated that he may make the decision to waive the taxes, the executive branch’s power only goes so far as deferral. It would take Congressional action to turn the tax deferral into a waiver, and as of right now, such legislation is not on Congress’s calendar. So, for now employers should assume that this will remain a deferral and act on that accordingly.

Should you have any questions about the payroll tax holiday or any other laws that may affect your business, or would like to schedule an initial consultation, please contact Waltz, Palmer & Dawson, LLC at (847) 253-8800 or contact us online.

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