On August 8, President Trump issued a document entitled “Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster.” Despite the impression of sloppy reporters in the non-tax press, the memorandum actually does not do anything yet. In fact, the memorandum merely instructs Treasury Secretary Mnuchin to exercise his authority under section 7508A to extend certain tax deadlines for up to one year on account of Presidentially-declared disasters with respect to certain employees’ Social Security taxes.
read more...The operative part of the memorandum’s instructions read as follows:
Sec. 2. Deferring Certain Payroll Tax Obligations. The Secretary of the Treasury is hereby directed to use his authority pursuant to 26 U.S.C. 7508A to defer the withholding, deposit, and payment of the tax imposed by 26 U.S.C. 3101(a), and so much of the tax imposed by 26 U.S.C. 3201 as is attributable to the rate in effect under 26 U.S.C. 3101(a), on wages or compensation, as applicable, paid during the period of September 1, 2020, through December 31, 2020, subject to the following conditions:
(a) The 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.
(b) Amounts deferred pursuant to the implementation of this memorandum shall be deferred without any penalties, interest, additional amount, or addition to the tax.
As you can see, the President is asking Secretary Mnuchin essentially to provide an extension to pay for the compensation period from September 1 to December 31 of this year, but the instructions do not provide for a date by which those taxes must be paid. That is being left to the IRS.
Obviously, the statute prevents Secretary Mnuchin from providing for a deferral of more than one year. However, the President is asking the Secretary to try to figure out a legal way that the taxes can simply be forgiven. Section 4 of the memorandum states: “The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.”
The extensions will only apply to taxes imposed by section 3101(a) (and the equivalent portion of employment taxes imposed under the Railroad Retirement Act at section 3201). Section 3101(a) imposes a 6.2 % Social Security tax on employees, which is withheld from their wages. Thus, the extension does not apply to any amount of taxes imposed by section 3101(b) – the 1.45% Medicare taxes imposed on employees – or to any employment taxes normally imposed on employers under section 3301.
Equivalent self-employment taxes under section 1401 are usually paid by the self-employed as part of their quarterly estimated tax payments. Note that the extension will not apply to any portion of self-employment taxes.
Not to mislead anyone, in section 2302 of the CARES Act, Congress already extended, for the period from the date of enactment through the end of 2020, the times for (1) employers to pay the employer share of Social Security taxes and (2) self-employed taxpayers to pay 50% of self-employment taxes related to funding Social Security. The deferred amounts are payable, instead, 50% on December 31, 2021 and 50% on December 31, 2022.
The IRS may also need to provide some detail as to how to apply the provision that the extension is only with respect to employees “the amount of whose wages or compensation, as applicable, payable during any bi-weekly pay period is generally less than $4,000, calculated on a pre-tax basis”. I can see a whole host of complicated issues that the IRS and employers must face in interpreting the word “generally”. For example, what if an employee gets a regular salary plus commissions, so that the employee’s compensation varies considerably each pay period? If the IRS instructs to take an average of pay, what will be the testing period for the average? Year to date during 2020 (when many employees had their incomes plunge starting in March)? Or will it be the average earnings for a one-year period ending in February 29, 2020, before the country largely shut down? I am sure others can come up with many other interpretive issues.
Then, will employers even be able to figure out who are the employees to whom the extensions applies? Employers don’t currently have software to deal with compliance with any formula that Secretary Mnuchin will come up with. And presumably, Secretary Mnuchin needs to figure this all out and issue an IRS Notice sufficiently prior to September 1 so that employer computers can be reprogrammed (if they can be) to do appropriate paycheck withholding.
I would not be surprised if it takes employers months to figure out the correct amount of the reduced employment tax that they are required to withhold and pay over to the IRS in each pay period. However, the memorandum contemplates that the IRS Notice will provide that nothing be withheld of the 6.2% taxes during the deferral period. The memorandum contemplates not just an extension for the employers to pay the tax, but deferral of “withholding”.
Assuming that employers are not allowed to withhold these taxes during the deferral period, how are employers later going to collect these taxes so that they can be paid over sometime in 2021? The Notice will have to deal with this, though the President has indicated he doesn’t believe that any employer will eventually have to pay over these taxes. Politically, he may be right. But, what if he is wrong because Congress doesn’t forgive the taxes – worrying about the financial stability of the Social Security trust fund?
One former IRS employee (who will remain nameless) speculated to me that, perhaps, the amounts to make the employer whole (so that funds could be paid over) could be withheld from the first paycheck of 2021. I don’t know if that is a good idea or even possible for all employees. For example, assume an employee worked for all of the last four months of 2020. She was in 2020 and will in 2021 be paid $3,500 per bi-weekly pay period. The deferral would be $217 per pay period (6.2% of $3,500). The deferral would apply to approximately 9 pay periods, so the total deferral would be $1,953 (9 x $217). That first paycheck of 2021 will have to reflect current income tax withholding (federal and state) and 7.65% current employee employment tax obligations. Current 7.65% withholding would be $268. State and local income tax withholding could eat up more than the rest of the $3,500 gross pay.
And, of course, what happens when an employee leaves between September 1, 2020 and December 31, 2020? Say, an employee left in October and her last paycheck was October 20? There won’t be any paychecks in 2021. Can the employer take the money out of her last paycheck, anyway, even if that paycheck is during the extension period?
Finally, remember that failure to pay over the right amount of employment taxes could result in very large failure to deposit and failure to pay penalties, if the employers are wrong in their calculations.
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Another question: What if the employer by January 2021 has gone out of business and filed for bankruptcy?
Well, I suppose there’s the good ol’ 100% (Trust Fund) Penalty.
My favorite line about the EO’s, from the New York Times’ Jim Tankersley:
“The executive actions President Trump took on Saturday were pitched as a unilateral jolt for an ailing economy. But there is only one group of workers that seems guaranteed to benefit from them, at least right away: lawyers.”
So maybe to that, we should add Revenue Officers and Appeals Office Settlement Officers.
I don’t believe that the CARES Act deferred the payment of Medicare Tax as stated in the post. Act Sec. 2302(d)’s definition of “applicable employment taxes” is limited to the 6.2% OASDI (or equivalent rate for RRTA). I believe this is clear in existing guidance but would not want someone to mistakenly cease timely depositing the ER portion of Medicare Taxes and be subject to late-deposit penalties.
Upon rereading the statute and the Code, I agree with your comment. I have corrected the offending sentence in the post so that no one inadvertently is misled. Thanks for the comment.