Locke Lord QuickStudy: Initial Thoughts Regarding the IRS’ Employee Payroll Tax Deferral Guidance in IRS Notice 2020-65

On August 8, 2020, President Trump issued the Presidential Memorandum on Deferring Payroll ‎Tax Obligations in Light of the Ongoing COVID-19 Disaster (the “Executive Order”).  The ‎Executive Order instructed the Treasury Department to provide guidance authorizing employers ‎to defer the collection and deposit of employee payroll tax obligations.  On August 28, 2020, the ‎Internal Revenue Service (“IRS”) issued IRS Notice 2020-65 (the “Notice”), which provides ‎guidance to employers regarding how they may implement the Executive Order.‎

Overview of the Rules

The Notice authorizes employers to defer the withholding, deposit, and payment of the employee ‎portion of the Old Age, Survivors, and Disability Insurance segment of FICA taxes (i.e., the ‎‎6.2% payroll tax)^‎1‎ on wages paid from September 1, 2020 through December 31, 2020 (the ‎‎“Applicable Period”). ‎

The tax deferral applies to employees with wages and compensation below $4,000 for a bi-‎weekly payroll period during the Applicable Period, as determined based on Box 3 of IRS Form ‎W-2 (which includes elective deferrals to an employer’s 401(k) plan but excludes amounts ‎deducted under Section 125 of the Internal Revenue Code to fund benefit plan premium ‎payments, contributions to an employee’s health savings account, or contributions to a flexible ‎spending account).  This amount is adjusted for employers who use a different payroll cycle.  The ‎Notice provides that the deferral is determined based on the specific payroll period and does not ‎look to the amount of wages in prior payroll periods.‎

• Note: since this determination is made on a payroll period basis, an employee who ‎receives variable compensation (e.g., overtime, bonuses or commissions) may be ‎eligible for this deferral during some payroll periods but not others.  This may ‎create issues for an employer’s payroll system.‎

An employer is required to collect and deposit the deferred tax amount during the period ‎between January 1, 2021 and April 30, 2021.  The Notice contemplates that the employer will ‎collect the deferred taxes from employees through increased wage withholding ‎occurring ratably ‎during the four month collection period.  To the extent the deferred tax amount is not deposited ‎during that period, interest and penalties will begin to accrue on the unpaid amount on May 1, ‎‎2021.‎

Following the release of the Notice, the IRS released a draft version of a revised Form 941, ‎Employer’s Quarterly Federal Tax Return, to take into account the Social Security withholding ‎that is deferred.‎

Key Issues and Questions

‎1. Is this mandatory?  The Notice does not state whether employers are required to ‎implement this payroll tax deferral for their employees.  Section 7508A of the Code, which is the ‎basis for this guidance, permits the IRS to postpone deadlines for various acts (including, as ‎stated in the guidance, tax withholding) but does not permit the IRS to prohibit timely ‎withholding and payment of taxes.  As such, this should be optional for employers.  That ‎conclusion is consistent with the press releases issued by the IRS and the Treasury Department, ‎which state that this form of relief is “available” to employers, and statements from ‎Administration officials.‎

• Due to the high level of publicity regarding this issue, the availability of payroll ‎tax deferral may create a communications issue for an employer who does not ‎elect to implement deferrals.  As a result, employers who do not implement payroll ‎tax deferrals may decide to prepare an explanation for their employees regarding ‎the decision not to defer payroll taxes.‎

2. Can employees require an employer to permit them to defer their taxes?  As noted above, ‎the Notice authorizes employers to defer withholding, deposit and payment of the employee ‎portion of payroll taxes.  It does not contain any guidance allowing employees to elect to defer ‎these tax payments.  As a result, an employer has a right to decide whether to use this form of ‎relief.   ‎

‎3.‎ Can an employer allow employees to elect to defer their taxes?  Probably.  The Notice ‎does not address whether the election to defer withholding, deposit and payment of the ‎employee portion of payroll taxes must be made on a uniform basis for all employees.  It also ‎does not contain any guidance regarding whether an employer can allow an employee to elect to ‎defer these tax payments.  As a result, an employer may be able to permit deferrals based on an ‎employee’s election.  ‎

• If an employer makes this deferral elective, it also could require an employee to ‎agree that the employer is permitted to withhold the unpaid portion of any ‎deferred taxes from an employee’s final paycheck.  As noted below, however, an ‎employer should review its ability to enforce that type of agreement under ‎applicable state law.  ‎

4.‎ What happens if the employer cannot withhold the deferred taxes from an employee?  ‎The Notice requires the employer to repay such deferred taxes by withholding such amounts ‎from an employee’s future compensation payments.  As a result, the employer will be required to ‎pay this amount on or before April 30, 2021, even if an employee with deferred taxes is ‎terminated, is furloughed, or goes on an unpaid leave of absence, before the deferred taxes are ‎collected.  If that occurs, the Notice provides that an employer may make arrangements to ‎‎“otherwise collect” this amount from its employees.  ‎

• Employers may elect to withhold this amount from an employee’s severance ‎payment or final paycheck.  This action, however, may be limited by applicable ‎state wage payment laws or collective bargaining arrangements.  That issue should ‎be considered carefully by an employer who wishes to adopt this type of action.‎
• An employer might address this situation by allowing its employees to elect to ‎participate in a payroll tax deferral program and conditioning such participation on ‎execution of a repayment agreement.  That type of agreement should be reviewed ‎for compliance with applicable state law.  ‎
• If an employer ultimately pays the deferred tax obligation on behalf of the ‎employee, the payment would be considered additional compensation to the ‎employee.  As such, it is likely that the employer will need to increase the payment ‎amount to fund income and employment taxes on this amount.‎

‎5.‎ How will this work?  The mechanical aspects associated with implementing payroll tax ‎deferrals under the Notice are critical.  At a minimum, an employer’s human resources ‎information system and/or payroll tax provider will need to revise the employer’s payroll system ‎to not withhold payroll taxes from payments which are below the $4,000 limit provided in the ‎Notice.  Given the timing involved, that may be difficult to accomplish and it may require ‎manual intervention to make this work from an operational perspective.  ‎

6.‎ How does this affect the employee retention credits and payroll tax deferral under the ‎CARES Act and the paid sick and family leave credits under the Families First Coronavirus ‎Response Act?  It is unclear how this payroll tax deferral will affect payroll-related credits.  The ‎Notice did not provide any guidance regarding this issue.‎

‎7.‎ Is this worth the effort?  Maybe.  Under the current guidance, the Notice effectively ‎provides an interest-free loan to employees by allowing them to defer payment of their payroll ‎taxes for four months.  As such, there is a “time value of money” benefit for an employee. ‎

• If there is a future change in law, this deferral opportunity could become ‎permanent.  That future change in law would, most likely, address the treatment ‎of employees who did not benefit from the deferral opportunity.  While we would ‎anticipate that those individuals would be able to obtain a refund of payroll taxes ‎paid during the Applicable Period, it is possible that the relief provided by a ‎future change in law will be more limited.  ‎
• If there isn’t a change in law to make this deferral opportunity permanent, the ‎administrative complexity involved in making a significant change to an ‎employer’s payroll system, combined with the risk that an employer will be unable ‎to collect the deferred tax amount from terminated and/or furloughed employees, ‎may outweigh the fairly limited value received by the employees.  ‎

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_{1 Section 3101(a) of the Internal Revenue Code of 1986, as amended, and the equivalent amount under the ‎Railroad ‎Retirement Tax Act under Section 3201(a) ‎ of the Internal Revenue Code of 1986, as amended.‎}