Look Before You Leap: Trump Payroll Tax Deferral

by Prof. Robert Bloink and Prof. William H. Byrnes

Beginning September 1, 2020, employers have the option of deferring the employee portion of the payroll tax through December 31, 2020. This payroll tax “holiday” is a temporary measure designed to provide workers with extra income while the economy remains sluggish in the wake of the COVID-19 pandemic. Before jumping in, however, employers should take a close look at the rules—and work to help employees understand what deferring taxes today could mean for the future. While it remains possible that Congress could pass legislation to forgive any payroll taxes that are deferred during 2020, it is far from certain, meaning that some employees could face a tax hike surprise starting in just a few short months.

Payroll Tax Holiday: The Basics

Employers can choose to stop withholding the 6.2% employee portion of the Social Security tax for employees who earn less than $4,000 bi-weekly (pre-tax) or $104,000 annually. According to IRS guidance on the issue, the $4,000 threshold amount is determined on a pay period-by-pay period basis. In other words, if the employee makes less than $4,000 for the current pay period, the employee qualifies for deferral regardless of amounts earned in other pay periods.

An equivalent threshold amount can be used to determine eligibility for employees who are not paid bi-weekly. Importantly, if an employee’s income exceeds the $4,000 threshold, that employee is not eligible for any deferral—even on the amounts that fall below the actual threshold. In other words, all employees are not eligible for deferral on the first $3,999 of bi-weekly income.

During the deferral period, deferred taxes will not accrue interest or penalties. However, employees should note that under current IRS guidance, deferred employee payroll taxes must be repaid during the period beginning January 1, 2021 and ending April 30, 2021. Taxes that are not repaid as of May 1, 2021 will accrue interest and penalties, and employers can pass those amounts on to employees who have not repaid their deferral amounts.

Employers are required to continue contributing the employer half under preexisting rules. Medicare taxes (both the 1.45% tax on all employee wages and the 0.9% additional Medicare tax on high-income taxpayers) must also continue to be paid under preexisting rules.

Employer Considerations for Implementing the Program

It’s important for employers to note that current IRS guidance does not release employers from their obligation to pay over the payroll tax if they are unable to collect deferred amounts from employees. In other words, if an employee terminates employment once the repayment period begins, the employer may be required to cover the cost of reimbursing that employee’s deferred payroll tax liability.

It seems possible that the employer could enter into some sort of arrangement with the employee to avoid liability—such as requiring employees to agree that the deferred amounts will be withheld from any final paycheck (assuming state employment laws permit this type of agreement).

It is the employer’s obligation to withhold and pay employees’ payroll taxes, but ultimately, it is the employee who will see a tax hike beginning January 1, 2021. Absent Congressional action to forgive deferred taxes, employees will be subject to payroll taxes equal to the typical 7.65 Medicare and Social Security taxes plus the 6.2% that was deferred late in 2020. IRS guidance provides that the repayment must occur “ratably” beginning January 1.

Before implementing the payroll tax deferral option, employers should make sure that employees understand that they’ll be facing what might feel like a substantial tax hike beginning in 2021—at a time when many employees might not have extra disposable income following the holiday season.

Conclusion

The payroll tax holiday seems to be completely voluntary—meaning that employers can choose whether or not to participate. However, it remains unclear whether employees can elect to opt-out if the employer chooses to participate. In any case, it’s important for participating employers and employees to have all the facts—including as to the questions that remain pending future guidance—to avoid unpleasant surprises down the road.