President Trump made major headlines in August with his Executive Order deferring payroll tax withholding, deposit, and payment from September 1 to December 31, 2020. Although the order is now in effect, it’s still unclear how the payroll tax deferral will play out. The executive order directed the Secretary of the Treasury to “explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred….” Because the tax is not currently forgiven, only deferred, employers and employees alike unsure of how to proceed. The IRS has released some guidance, but much remains to be seen in the coming months.
Whether you’re an employer or an employee, it’s important for you to understand the facts as they stand right now, as well as possible outcomes, before making any decisions. We’re addressing the concerns of both parties here.
What is payroll tax?
Payroll tax refers to the 6.2% withheld from every W-2 employee’s paycheck that contributes to Social Security, as well as the 1.45% for Medicare. Your annualized earnings of up to $137,700 are subject to Social Security tax. Employers match the amount withheld from their employees’ paychecks, which means Social Security receives 12.4% of employee wages, while a total of 2.9% goes toward Medicare. The payroll tax deferral, in effect, should be a boon for both employees and employers as it’s an area where they both contribute. However, the consequences aren’t so clear at this point.
An earlier relief effort, as part of the CARES Act, allowed employers to withhold their portion of Social Security tax temporarily in an attempt to provide needed cash to businesses. Under the CARES Act, the withheld payments have hard deadlines (half is due by the end of 2021, and the other half by the end of 2022).
It’s important to note that this deferral does not apply to withhold of Federal income taxes, or the employer portion of Medicare tax.
What did President Trump’s executive order accomplish?
The President’s Executive Order, in Section 4, states that the deferred tax should be forgiven, but that forgiveness would need to be passed by Congress. The Executive Branch isn’t able to forgive a tax. Taxpayers won’t be charged penalties or interest on the deferred amounts—but as of now, they will have to pay that amount back to the government next year. The guidance released by the IRS explicitly states that employers remain liable for payroll taxes, regardless of whether those taxes were withheld from workers’ paychecks.
How should employers respond to the payroll tax deferral?
First, here’s an explanation of the facts that are clear as of now. Under Notice 2020-65, employers are allowed to defer withholding, deposit, and payment of the employee’s portion of Social Security tax on wages that are less than $4,000 during a bi-weekly pay period. Each pay period must be considered separately, and no deferral is allowed for any payment to an employee of taxable wages of $4,000 or more for a bi-weekly pay period.
An employee’s applicable wage limit will vary based on the payroll period used by the employer. Generally, the employee wage limit appears to be:
- Weekly pay-period wages of less than $2,000
- Biweekly pay-period wages of less than $4,000
- Bimonthly pay-period wages of less than $4,333
- Monthly pay-period wages of less than $8,666
Nonrecurring compensation—such as overtime, bonuses, and equity awards—may increase the amount of wages during a pay period. If an employee who is normally below the threshold receives additional compensation (such as a bonus), the employee’s wages may become ineligible for deferral during that particular pay period. When the employee’s wages are over the limit for any given pay period, that employee is ineligible for deferral.
The payroll tax deferral is not a hard requirement at this time—but it’s still unclear whether there will be a formal process to opt into or out of the deferral. Employers can provide employees with the option to defer, or not defer, their payroll taxes from September 1-December 31. The IRS recognizes that most employers will be unable to implement the deferral by September 1, and it’s acceptable to put it into effect at any time during the designated period.
If you are an employer, the law holds you liable for employment taxes, regardless of whether you withhold those taxes from your employees’ paychecks. The Treasury’s notice allows an employer, if necessary, to “make arrangements to otherwise collect” the total deferred taxes from the employee, but it doesn’t provide additional guidance on how to collect those taxes. Hence, the media soundbite you’ve probably heard by now: employees may see larger paychecks this fall while taxes are deferred, only to have more withheld from their paychecks at the beginning of 2021 in order to make up the difference. If an employer fails to withhold and pay the total deferred taxes by April 30, 2021, interest, penalties, and additional tax will begin to accrue.
How should employers proceed if they wish to implement payroll tax deferral?
First, ensure your payroll provider is set up to defer payroll tax withholding. If you’re running manual payroll or using an outdated process, GCT Technology & Accounting can help you get set up with a cloud-based payroll provider. Not only will your payroll provider need to be able to adjust withholdings for the deferral period, but there should also be a process to collect the deferred taxes beginning in January.
Once you’ve verified the technical process required, we recommend taking the following steps:
- Inform employees of the expectation that deferred Social Security taxes will have to be paid back between January 1 and April 30, 2021. If they receive larger paychecks this fall, they may receive a smaller check for the first four months of 2021.
- Have employees sign a contract agreeing to additional withholding—up to double the normal amount of Social Security taxes in the period from January 1 through April 30, 2021.
- Include in the employee contract that the employee will reimburse the employer for any deferred payroll taxes should the employee leave the company prior to repaying all deferred payroll taxes.
- Have a plan in place to account for repayment of deferred payroll taxes should the affected employee be earning less in 2021 than he or she earned in 2020.
Will the deferred payroll taxes be forgiven?
There’s no official word on forgiveness at this time. Due to the uncertainty, we recommend that employers continue to withhold the Social Security portion from employees and not defer any portion of payroll tax payments. We will continue to monitor the progress of this order, as well as IRS guidance as it becomes available.