IRS Guidance Implementing Payroll Tax Deferral Raises Many Questions

Author: Rena Pirsos, XpertHR Legal Editor

August 31, 2020

Late on Friday, August 28, 2020, the IRS issued Notice 2020-65 in an attempt to provide employers with guidance on how to implement President Trump's payroll tax deferral Memorandum issued earlier in the month. Although the intent of the Memorandum is to provide employees affected by COVID-19 with temporary financial relief, the Notice leaves employers with many unanswered questions.

The guidance allows, but does not require, employers to defer the withholding and payment of the employee share of the Social Security tax that is normally due on wages paid from September 1, 2020, through December 31, 2020. The deferral applies to employees who are paid taxable wages of less than $4,000 during a biweekly pay period, or the equivalent threshold amount for other pay periods. This limits the deferral to employees who earn less than approximately $104,000 a year.

The guidance does not mention whether employees have any choice regarding tax deferral; how or whether employers need to obtain employees' consent to opt into or out of deferral; or how employers should go about implementing deferrals. But it does mention that employers that do not deposit all deferrals on time may be liable for interest, penalties and additions to tax accruing as of May 1, 2021.

Under the guidance, each pay period is considered separately. So deferrals do not apply to an employee whose wages fluctuate above the $4,000 threshold in a pay period. Only the tax that would have been withheld on the wages paid below the threshold can be deferred. For example, an employee whose taxable wages qualify for tax deferral because they are usually less than $4,000 biweekly will become ineligible for deferral if they receive overtime pay or a bonus that puts their wages over the threshold for the pay period. Employers, therefore, must ensure that their payroll systems can switch withholding on and off, depending on employees' wages in any given pay period.

The guidance provides that employers must withhold and pay over the deferred taxes during the period of January 1, 2021, through April 30, 2021. Consequently, affected employees will actually owe more in Social Security taxes during that period - the taxes deferred in 2020, plus the taxes due for the first four months of 2021. This may make the prospect of deferring Social Security taxes unpalatable to employees.

However, an employer is permitted to make alternative arrangements to collect the taxes if necessary. An alternative arrangement may be necessary if, for example, an employee has insufficient or no wages on which the employer can withhold the taxes to be deferred during the allowed time period. This may occur if an employee is terminated or furloughed before the full tax obligation is withheld and paid.

One example of an alternative arrangement would be for the employer to pay the employee's taxes on their behalf. But this raises the question of whether the employer's payment of the taxes is itself taxable to the employee, which is normally the case. Another question is whether an employee could be legally required to sign an agreement allowing the employer to recoup any unpaid deferred amounts from the employee if they terminate employment before April 30, 2021, either via the employee's final wage payment or by personal check.

The IRS's Notice also does not address whether Form W-2 reporting of deferrals will be required and how tax deferral will impact employers' COVID-19 payroll tax credits. The agency did not indicate whether it would issue further guidance to clarify these concerns.