On August 8, 2020, the President of the United States issued an executive order, 85 Fed. Reg. 49,857 (Aug. 13, 2020) (“Presidential Memorandum”) directing the United States Secretary of the Treasury (“Treasury”) to authorize deferral by employers, generally deemed affected by Covid-19, a Presidentially declared disaster pursuant to section 501(b) of the Stafford Act, 42 U.S.C. 5121 et seq (“Affected Taxpayers”), of withholding, deposit and payment of certain payroll taxes until January 1, 2021.
On August 28, 2020, Treasury and the IRS issued Notice 2020-65 implementing the Presidential Memorandum and setting forth procedures and requirements for employers in connection with deferral of the employee portion of social security tax under the Federal Insurance Contribution Act, 26 U.S.C. section 3101 et seq (“FICA”) or the Railroad Retirement Tax Act, 26 U.S.C. section 3201 et seq (“RRTA”) equivalent (the “Notice”).
This article discusses the payroll tax deferral requirements in the Notice and alerts employers to required actions or considerations in deferring withholding, deposit and payment of employee portion of withholding taxes and interaction with other Covid-19 payroll tax relief.
The period, for which the Applicable Taxes may be deferred begins September 1, 2020 and ends December 31, 2020 (for purposes of this article, the “Deferral Period”). The period, during which the deferred Applicable Taxes must be paid to the IRS begins on January 1, 2021 and ends April 30, 2021 (for purposes of this article, the “Payment Period”). Thus, employers must deposit all of the Deferred Applicable Taxes within four months of end of the Deferral Period. The Notice clarifies that the beginning date of the Deferral Period is based on the payroll date, not the first day of the payroll period.
Limitation on Applicable Wages
The Applicable Wages limitation is determined based on each payroll period, so the wages or compensation are not aggregated or annualized for purposes of determining eligibility for deferral of Applicable Taxes. As the accompanying news release, IR-2020-195 (Aug. 28, 2020) clarifies, the limitation is an amount that is below $4,000 per bi-weekly payroll period. The limitation of $104,000 of Applicable Wages, if annualized, is somewhat below the wage base for aggregate 12.4 percent social security tax or RRTA equivalent payable by employer and employee, which is $137,700 for earnings in calendar year 2020.
In the event an employer pays wages weekly or more frequently, the Presidential Memorandum provides that the limitation amount is prorated with respect to other pay periods. Thus, in the event of a weekly payroll schedule, the limitation on wages per payroll period would be $2,000. The Notice does not clarify whether an employer may reduce wages, subject to applicable federal, state and local tax, labor and employment laws, including without limitation the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) to meet the Applicable Wages threshold.
Scope of Applicable Wages
Applicable Taxes on wages or compensation, which may be deferred under the Notice, apply to amounts deemed wages under section (“Section”) 3121(a) of the Internal Revenue Code of 1986, as amended (“Code”) or compensation under Section 3231(e) for purposes of the Railroad Retirement Tax Act (“RRTA”). Thus, Applicable Wages exclude parsonage, or amounts paid to certain clergy workers for housing and related expenses under Section 107, which are not withheld or reported as wages on IRS Form W-2. Applicable Wages also exclude qualified plan contributions. Likewise, Applicable Wages exclude certain fringe benefits, and employer contributions to certain accident, health or medical expense reimbursement plans not subject to employment taxes or withholding and excludable from employee gross income under the Code.
Interaction with FFCRA and CARES Act Payroll Credits, Covid-19 PTO Programs
In addition, Applicable Wages exclude amounts of qualified sick leave or family leave wages under the Families First Coronavirus Response Act, Pub. L. No. 116-127 (2020) (“FFCRA”), allocable qualified health plan expenses and creditable employer portion of FICA Medicare tax on such wages. Furthermore, Applicable Wages exclude the creditable portion of qualified wages, including allocable health plan expenses subject to an employee retention credit available under the Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No. 116-136 (2020) (“CARES Act”).
Also, Applicable Wages exclude surrendered or deposited leave from wages of donor employees pursuant to a qualified employer-sponsored medical leave-sharing plan originally authorized under Revenue Ruling 90-29, a bona fide employer-sponsored major disaster leave-sharing plan under IRS Notice 2006-59 and IRS FAQs released on August 3, 2020, or a Covid-19 leave-based donation program under the safe harbor in IRS Notice 2020-46.
Scope of Applicable Taxes
Applicable Taxes include only the employee portion of the FICA social security tax under Section 3101(a) or the RRTA equivalent under Section 3201(a). Thus, employer portion of FICA social security tax under Section 3111(a), FICA Medicare tax (Sections 3101(b), 3111(b)), the Federal Unemployment Tax Act, 26 U.S.C. section 3301 et seq (“FUTA”) tax, state or local taxes on employee compensation, including state unemployment insurance paid by employers are excluded from deferral relief in the Notice.
Further, Applicable Taxes are distinguished in scope from withheld payroll taxes, which an employer may retain in anticipation of a payroll credit under FFCRA or the CARES Act, and for which an employer did not file an advance credit payment request on IRS Form 7200. The payroll credits generally are effective until December 31, 2020. Employers generally may reduce deposit, but not withholding, of the employer and employee portion of FICA taxes or of RRTA tax amounts attributable to the applicable FICA social security tax rate in anticipation of receiving refundable employment tax credits due to Covid-19 circumstances.
The excess amount of the credit not applied to employer social security tax liability for a calendar quarter is refundable to the employer by filing Form 7200. Waiver of failure to deposit penalty under Section 6656 applied to retained payroll taxes that did not exceed the actual amount of allowed payroll credit for the calendar quarter. Similar relief with respect to the refundable tax credits was available to self-employed individuals, including certain religious workers within the meaning of Section 3401(a)(9), with respect to estimated tax payments for a calendar quarter.
Under FFCRA, qualified sick leave or family leave wages paid to employees were creditable only against the employer portion of FICA social security tax or RRTA equivalent. Thus, the employer portion of Medicare tax on qualified sick leave or family wages was creditable together with the qualified sick leave or family leave wages and allocable qualified health plan expenses. Conversely, qualified sick leave or family leave wages, allocable qualified health plan expenses or creditable Medicare tax liability were not creditable against employer portion of Medicare tax. Therefore, an employer may reduce deposit of Medicare tax in anticipation of payroll credits for a calendar quarter. However, the withheld Medicare tax amounts generally would be deposited on the next regular deposit date, absent anticipation of additional applicable payroll credits.
In addition, CARES Act section 2302 permits employers to defer the employer portion of FICA social security tax or the RRTA tax amount under Sections 3211(a) or 3221(a) attributable to the tax rate set forth in Section 3111(a) beginning March 27, 2020 and until January 1, 2021. Self-employed individuals may obtain similar relief with respect to 50 percent of tax liability under Self-Employment Tax Act, 26 U.S.C. section 1401 et seq (“SETA”), which is equivalent to the combined employer and employee portions of FICA social security and Medicare taxes.
Section 4 of the Flexibility Act, Pub. L. No. 116-142 (2020), extended deferral under CARES Act section 2302 to employers receiving forgiveness of all or a portion of Paycheck Protection Program (“PPP”) loan amounts under CARES Act section 1106. PPP is administered by the Small Business Administration (“SBA”) pursuant to new section 7(a)(36) of the Small Business Act, Pub. L. No. 85-536 (1953). Section 4 of the Flexibility Act also applied to recipients of forgiveness of loans issued by certain non-SBA lenders pursuant to CARES Act section 1109.
Payment of Deferred Applicable Taxes; Penalties for Noncompliance with the Notice
Failure to withhold and pay the Deferred Applicable Taxes timely would result in penalties, interest and additions to tax accruing to the Affected Taxpayer beginning May 1, 2021. The Notice provides that an employer must withhold and pay over the Deferred Applicable Taxes ratably during the Payment Period. The Notice does not clarify how the “ratable” withholding and deposit requirements apply. Without clarification, an employer might allocate the Deferred Applicable Taxes equally among the payroll dates between January 1, 2021 and April 30, 2021.
Thus, an employer may have Deferred Applicable Taxes only for the fourth quarter of calendar year 2020. A reasonable interpretation of the ratable withholding and deposit rule may require an employer to apportion the total amount of Deferred Applicable Taxes equally among the payroll periods beginning on or after January 1, 2021, the payroll dates for which are included within the Payment Period. Alternatively, the Notice allows an Affected Taxpayer to make other arrangements with the employee, if necessary, to collect the total Deferred Applicable Taxes.
Considerations and Action Items for Employers with Respect to Payroll Tax Deferral
IRS Notice 2020-65 permits only deferral, and not forgiveness of employee portion of social security tax or equivalent railroad tax for the period from September 1, 2020 to December 31, 2020. The deferred tax liability must be paid within four months, from January 1, 2021 to April 30, 2021 to avoid accrual of interest, penalties or additions to tax under the Code for failure by employer to withhold or deposit the employee portion of payroll taxes. The relief is optional and employers may have alternate methods for collecting deferred payroll tax amounts from employees to meet the payment requirements.
However, employers should consider in general whether additional economic hardship to employees may result from the deferral, the risk of incurring penalties or interest for failure to comply timely with the Notice requirements, and the additional operating costs associated with implementing deferred withholding, deposit and reporting. Many employers have claimed refundable payroll credits under FFCRA or CARES Act or deferred employer portion of FICA social security tax or RRTA equivalent under the CARES Act. Such employers must comply with both the deadlines for deferring deposit of employer or employee portions of withholding taxes and the due dates for withholding and payment of Applicable Taxes under Notice 2020-65.
Employers should consult with tax counsel regarding applicability of reduced deposits in anticipation of FFCRA or CARES Act payroll credits, employer social security tax deferral under CARES Act section 2302, as amended, and employee payroll tax deferral under the Notice to ensure compliance with employment tax withholding, deposit or payment requirements with respect to wages or compensation for pay periods through December 31, 2020.