How employers can respond to the Presidential order on payroll taxes

A Presidential directive was issued on Saturday, August 8, 2020, deferring collection of certain U.S. payroll taxes normally withheld from employees’ paychecks from September 1 through the end of the year. 

The IRS issued guidance on August 28, 2020, attempting to implement the directive, allowing employers to defer withholding the employee portion of certain payroll taxes (where pretax wages or compensation during any biweekly pay period is less than $4,000) during the last four months of 2020. But this is no free lunch, as the withholding and payment of these taxes is only postponed until the period beginning Jan. 1, 2021, and ending April 30, 2021.

The deferral only applies to any pay period in which the employee is paid less than $4,000. The notice leaves unclear whether this limit applies solely to wages and compensation or if items such as bonuses, commissions, or overtime hours should be included. Deferral of Social Security tax for self-employed persons is entirely unaddressed.

The burden of repaying any deferred taxes is on the employer, not on the employee. If an employer elects to defer withholding under the notice, then the employer must either withhold and pay or pay the deferred taxes during the period from Jan. 1, 2021, to April 30, 2021. Interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid taxes.

This leads to several problems. Employees may object when they realize that the employer is withholding at a higher than normal rate (essentially double) during early 2021. While employers are allowed to “make arrangements to otherwise collect the total applicable taxes from the employee,” there are no details on allowable alternatives. Also, if an employee leaves the company after having taxes deferred or has insufficient wages to pay back the tax, the employer is left holding the bag for the deferred taxes which would otherwise have been the employee’s obligation.

The Guidance does not address whether deferral is optional. Businesses are left to re-tool their payroll systems to withhold the proper amount of tax from certain employees’ paychecks, and to figure out how to coordinate this with state and local tax withholding. Employers with collective bargaining agreements will need to determine if they are permitted to adjust withholding under those agreements before implementing any changes.

We are advising our clients that, unless additional guidance makes it clear that the deferral is mandatory, they may disregard the Presidential directive. Any short-term cash flow benefit to employees is highly unlikely to be justified by the cost of retooling their payroll systems, the potential confusion or unhappiness of their employees from increased withholding in 2021, and the possibility of the employer being responsible for deferred taxes if an employee leaves or has insufficient wages before fully repaying the deferred taxes.

 Should you have any questions regarding these developments, or on any matter, feel free to contact us.