Questions Remain for Social Security Tax Deferral Even After IRS Issues Guidance

Payrolls this Friday may provide employees with an additional 6.2% to their paycheck, but in the spring those individuals could have their paychecks reduced to make up for it. President Donald Trump issued the Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster (the “Memorandum”) on August 8, 2020. The Memorandum “makes available” a deferral of an eligible employee’s portion of the Social Security taxes from September 1, 2020 through December 31, 2020.  The Memorandum essentially gives employees a 0% loan that will be paid back in the first quarter of 2021 absent Congress taking steps to forgive the loan.

There are issues with the implementation of the Memorandum even after the IRS and Treasury provided guidance. The text of the Memorandum is minimal. Many CPAs and attorneys had been wondering how this deferral would be implemented because of this, and businesses and payroll companies are struggling to implement the deferral. The IRS and Treasury Department issued Notice 2020-65 as guidance on Friday August 28, 2020 around 5 PM. However, even with that guidance, there are still questions as to whether the Memorandum is Constitutional. Article I of the Constitution gives Congress the power “to lay and collect taxes, duties, imports, and excises.”

Prior to the guidance being issued there were questions as to who could choose the deferral, the employer or employee. The language of the Memorandum suggests it is optional. It reads “[t]he deferral shall be made available” not that there shall be a deferral. The Memorandum suggests that the employee should be the person making the election. The deferral is on the employee’s income, and the benefit is for the employee. That would mean repayment would most likely be on the employee as well. The IRS has given this option to the employer instead.

Based on the latest guidance, the employer will be able to elect not to withhold the 6.2% employee portion of the Social Security Tax. If an employer does not collect it, that employer will not have to forward that payment to the IRS as part of their quarterly filings in November and January. However, the tax will need to be collected unless Congress forgives the tax bill. The guidance suggests that employees will have 12.4% withheld from their paychecks from January 1, 2021 to April 31, 2021 to repay the taxes.

The decision as to which “taxpayer” has the election may also create issues. The employee is the taxpayer benefiting from the deferral. The language of the Memorandum suggests the employee should have the option of whether to defer the withholding. An employee who does not want to face an increased tax burden in the Spring may challenge their employer or perhaps the Treasury Department, IRS, or the Trump administration in court.

Another issue that many raised about the Memorandum is which employees were eligible. Notice 2020-65 provided clarity on the issue. The memorandum states “ [t]he deferral shall be made available with respect to any employee the amount of whose wages or compensation, as applicable, payable during any bi-weekly pay period generally is less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods.”  Wages are the gross pay prior to other withholdings or pre-tax deductions. The Notice makes it clear that the wages are Internal Revenue Code Section 3121 defined wages. This makes the most sense as Section 3121 defines the wages upon which the Social Security Tax is calculated.

The Notice states that the $4,000 is per pay period. If an employee is hourly or commission based and makes above the cap for a pay period, the employer must withhold the 6.2% from that pay period. The same would be true for year-end bonuses provided they are subject to the Section 3121 definition of wages.

Payroll companies and employers will need to track the “on/off” nature of the withholding for these employees. They will need to ensure the same amount of taxes not withheld are withheld and paid during the first quarter of 2021.

There are still questions concerning that repayment of taxes. The Notice does state that “An Affected Taxpayer must withhold and pay the total Applicable Taxes that the Affected Taxpayer deferred.” But the Affected Taxpayer is the employer is the Notice. That means that employers could be on the hook for the deferred taxes. President Trump has said he will work to have Congress forgive these taxes. That is not guaranteed. He may need to be re-elected, and at the very least Congress will have to pass legislation forgiving this tax debt. Both parties rejected President Trump’s proposal for a payroll tax holiday when they were negotiating the next Covid-19 relief bill back in July. It seems unlikely that there will be broad support for it when Congress resumes after its summer vacation.

In order to actually repay the taxes, Employers can plan to withhold the additional amounts from employees who are with the employer now and stay with the employer through April 31. However, the Notice fails to adequately address a number of situations. The employee could leave the company at any time between tomorrow and April 31, 2021 leaving the employer without easy recourse to increase the withholdings during the repayment period. The Notice does state the “[i]f necessary, the Affected Taxpayer may make arrangements to otherwise collect the total Applicable Taxes from the employee.” It does not offer examples as to what those alternative arrangement may be. If the employer cannot find alternative arrangements, they may be on the hook for those taxes.

Another concern is what will happen for the companies that elect to defer but go out of business during the last four months of 2020. We do not know who will be responsible for the repayment of the deferred taxes. Social Security is a trust fund tax. Under IRC 6672, an individual can be held liable for the willful failure to collect and pay of employment taxes like the Social Security taxes. Companies can name the individual responsible for collecting and paying these taxes. If found liable, a taxpayer may be subject to significant penalties. If a company cannot find an alternative arrangement to collect the social security tax from a former employee or former employees, that could be a huge figure to deal with. And it is not clear who will be responsible.

As it stands, attorneys, accountants, and other advisors will have difficulty providing recommendations to employers or employees as how best to proceed regarding the deferral.  For now, we will hope to get additional guidance.