Implementing the payroll tax deferral

Hosted by Paul Bonner

In this episode, we touch base with Ed Karl, the AICPA’s vice president–Tax Policy & Advocacy, to discuss questions the AICPA Tax Executive Committee has raised in official comments to Treasury and the IRS concerning President Donald Trump’s Aug. 8 memorandum ordering Treasury to defer the withholding, deposit, and payment of payroll taxes imposed by Sec. 3101(a) — better known as the employee portion of Social Security tax, currently 6.2% of covered wages and compensation — and a comparable rate of tax under Sec. 3201 — that’s the Railroad Retirement tax — for Sept. 1, 2020, through the end of the year. We’ll explore the range of issues that Treasury and the IRS face as they implement this order and what it all could mean for employers and employees.

What you’ll learn from this episode:

  • Who is — or might be — eligible to make the tax deferral, and why employees should be required to make an affirmative election to do so.
  • The range of types of wages or compensation that might (or might not) be counted toward the eligibility ceiling of $4,000 biweekly (or equivalent amount and pay period).
  • What employers might have to do to make the deferral available and then report the amount deferred.
  • If the taxes are not forgiven (the presidential memorandum instructs Treasury to “explore avenues, including legislation” to waive the taxes altogether), how and when they might be required to be paid.

Play the episode below or read the edited transcript:

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Paul Bonner: Thank you, Ed, for joining us on this podcast about the payroll tax deferral. This has come up rather suddenly, hasn’t it, and raised lots of questions. And I understand that the AICPA has issued a comment letter to the IRS and Treasury about it with 10 recommendations for guidance — I’m sure there could be many more. What do you feel is the biggest question surrounding this executive order, and the prospects of doing this?

Ed Karl: Thanks for having me, Paul. Yes, there is a base question about whether or not this executive order is mandatory and who is it mandatory on, but I think maybe a very brief conversation about the context, about how this came up, is also in order, because you made a reference that this sort of came out of the blue, and in some sense it did, but in some sense, also, it didn’t.

The context is that Congress and the administration have been speaking for several months now about the next phase — some people call it phase 4 of coronavirus relief; some refer to it as CARES [Coronavirus Aid, Relief and Economic Security Act] 2.0 — but we know that, in those conversations, providing some kind of aid to the states has been a focus in the House of Representatives, and the Senate has been focusing on liability relief. But the administration has said for all of these months that some kind of payroll tax relief or payroll tax deferral was really important to the president. So, from that perspective, it did not come out of the blue.

Bonner: One thing I see some people mentioning, but not many, was that, actually, something like this was done in 2011, I seem to recall, when we had a two-percentage-point cut temporarily in the Social Security tax. But that was approved by Congress, wasn’t it?

Karl: Right, that was a legislative change that temporarily cut the payroll tax and had the result of putting more money in people’s pockets, and then from their pockets into the economy; that was the idea. It wasn’t at all a deferral; it was a permanent cut, albeit a temporary cut, but a permanent cut of the payroll taxes done legislatively. So it really was quite different.

Bonner: Perhaps the goal of this is the same, but the mechanism is so much different that it raises a host of problems, doesn’t it? One of the recommendations is that the IRS and Treasury identify an eligible employee, which there’s one guideline already in the executive order, and that is an income ceiling, or a wage ceiling, but there could be other parameters for an eligible employee, couldn’t there?

Karl: That goes to the definitional challenges that we frequently have with legislation or rule changes. You’re identifying one of the key ones: How do you define an “eligible employee”? It raises certain questions: What happens if that employee or an employee has more than one job? What happens if an employee changes jobs? What happens if an employee stops work for the same employer in this period? It’s intended to cover the period Sept. 1 through the end of December. What happens if — and this is not at all far-fetched — what happens if the business opens, the business closes because of health concerns, and then reopens again? And things like that. There are all sorts of challenges in understanding that term, “eligible employee.” How do you define wages or compensation? Because that’s what the memorandum refers to, to the wages and compensation.

Bonner: Yeah, presumably, that would be wages and compensation subject to Social Security tax, I imagine, but that’s not defined yet.

Karl: It’s not. And also, does it include bonuses or doesn’t it include bonuses? Certainly, as you get to the end of the year — I mean, maybe there are businesses doing well where their employees get bonuses. But it’s not far-fetched at the end of the year to think that certain employees might be subject to bonuses. And would that bonus figure throw them out of the availability of this deferral? We don’t know.

Likewise, sick leave, vacation leave — those types of questions typically come up when you’re talking about compensation issues in the tax Code. You have those come up with certain types of retention credits and those types of things where there may be wage caps and things like that. So, it is important to have these terms defined.

Bonner: Right, and as you said earlier, [Treasury] Secretary [Steven] Mnuchin has said this will be voluntary, but even that leaves a lot of questions, as voluntary with respect to whom, the employer, the employee, or both, right?

Karl: Right, that’s a pretty important question. It’s a sort of a baseline question. In an interview the other day, Secretary Mnuchin indicated that this would not be mandatory, that the employer would have an option here of participating in the program or not. But the statute indicates that it’s the employee who’s subject to the tax. The statute indicates that the tax is imposed on the income of each employee. It’s imposed on the income of each employee, and the deferral impacts the employee. And we also believe that, therefore, the repayment of the deferral should be up to the employee. Then the option, opting in or opting out, should be up to the employee.

Bonner: And I believe the suggested guidance includes revocation of an election to opt in, right? But only one of each.

Karl: Right, so you get into all the procedural aspects, as we believe that this should be an affirmative election by the employee, now you have to develop a process for making that election — probably, a form that would have to go to the employer. You have to work out the timing of how that works because you have to give notification to the employer.

So what happens if we get to Sept. 1, when this is supposed to start, and employees don’t make the election, and, therefore, the employer would continue to withhold the Social Security tax from those particular employees. But then, all of a sudden, the employee says, “You know what, I could use the extra pay right now, and I’m not going to worry about when I have to repay it, so I want to make the election.” Can they still make that election? How long does it take? Does it apply immediately? Do you give the employer two weeks to make it effective, and then, as you just asked, if they then opt in, can they decide after a month, “You know what, I’m worried about repaying this later, I want to revoke my election.” And then, again, you go through the whole conversation on how you make that revocation: Is there a particular form you have to file? When does it become effective? Does it mean that an employer has to do it the very next pay period? Do you give them two weeks? What are the processes that make it reasonable to effectuate?

Bonner: Let’s war-game this a little bit here. Most workers don’t like owing money at the end of the year, in my experience; they would prefer to not have that obligation hanging over their heads. Let’s say that an employee does have the employment taxes deferred. Presumably, this guidance will include some way of repaying, the mechanism for repaying it, which looks like it would have to be on an income tax return. But this employee, a hypothetical employee who has deferred the taxes, doesn’t file an income tax return next year. Can you foresee any scenario in which that taxpayer becomes a responsible person under the trust fund penalties provisions and thereby incurs not only the tax but penalties?

Karl: The memorandum does indicate that there shouldn’t be penalties associated with it, but it’s not entirely clear what that means. So you’re raising a valid point. Let’s just say that IRS indicates in the guidance that it’s repaid not through the payroll tax system but through the income tax system. So it would get reported on a [Form] 1040. Now, we have questions as to which 1040 that is; would it be the 2020 1040, or is it the 2021 1040? Those are questions. And then what happens if the employee isn’t otherwise obligated to file a 1040 in either 2020 or 2021? And then what is the mechanism for the repayment, and then once that mechanism for repayment is fixed, and they don’t comply with that, would they be subject to some kind of a penalty? And we know that the responsible-party penalties can be rather significant.

So even though the memorandum says that the withholding would be deferred without any penalty, is the repayment subject to penalties somehow? I can only talk to you, Paul, in hypotheticals, as you say, because I don’t know the answers to these. These are all critical and important questions that have to be resolved through guidance.

Bonner: I understand you’ve been receiving lots of calls from news organizations covering this development, and one of the things they’ve been asking are, what are we telling our members, CPAs, about how they should be advising their business clients, which seems to me a good question.

Karl: It is a good question, and we certainly can’t answer that. We can’t advise them yet because we couldn’t possibly begin to advise them without starting to see the guidance.

Bonner: I saw in the recommended guidance some, I thought, imaginative solutions to how employers would report this deferral to employees on a [Form] W-2. Seems reasonable to me. But then I can imagine some instances where the employer has some difficulty in determining the amount to put in that box. And of course that would have to have guidance from the IRS as to the use of that box, inventing a new code, and may even require reprinting W-2s, right?

Karl: There’s a good chance of that, yes. Certainly, the instructions, at a minimum, would have to change. I suspect also that the quarterly payroll tax form, the [Form] 941, would have to change as well, because the quarterly 941 gets reconciled with the W-2, to the extent that some of the Social Security wage base number would change because it’s not subject to certain withholding for the last four months of the year. So now you have two 941s that are impacted. But I suspect that they’re going to have to change a lot of things.

Bonner: Yeah. The kinds of actions that business owners would be taking at this point — as you say, it’s a little premature for anybody to say what should be done — but presumably, once the guidance comes out, we can imagine that it is in fact voluntary. But if it’s up to the employee to determine, then the employer probably has some responsibility to let the employees know about it and offer them the possibility of it. It seems like to me if the choice is with the employee, then it has to be more or less mandatory for the employer, doesn’t it? How would the business owners, the employers, notify the employees that it’s available?

Karl: As I said earlier in our conversation, that we believe that the decision to opt in or out should be up to the employee. And so that raises the question as to what the employer’s role is in this whole decision-making process, and that’s open-ended right now. But any way you look at it, there’s going to be a strong responsibility for the employer to have notification and communication with all of their employees. Either way you look at it, there will be a process for the employer to implement this system. So there has to be strong communication between the employer and the employee, whatever decisions Treasury makes in terms of the responsible parties for the opt in/opt out.

Bonner: Right. And, presumably, that would have some kind of standard notice attached to it, too.

Karl: So the communication may not have a standard notice, but it’s possible the guidance that comes out from Treasury may require the employer to notify the employee of certain things, so there may be some kind of a list of information that has to be either explicitly or implicitly communicated with the employees. So, for example, if they agree with us that there has to be an explicit opt-in, that means that the employer would have to notify the employee of the opt-in form, or opt-out form if it’s either way. Do they would require them both ways upfront? Do you have to opt out and opt in upfront, or do you just opt in and not worry about opting out at the beginning? What kind of lead time do you have to give both parties? Do they have to give the employees a certain amount of lead time to make the decision? Does the employee have to give notification by a certain deadline to the employer? So, either explicitly or implicitly there’s likely to be a list of information that the employer is going to have to provide to all of their employees.

Bonner: And as we were talking earlier, a lot hinges on whether, as the executive order contemplates, these taxes would be forgiven entirely, as to how desirable it is to seek the deferral. But Congress, I think as of this weekend, is on recess until, I think it’s Sept. 8, so chances are this will be implemented before that fact is known, right?

Karl: We run up into some questions in terms of timing. What is the timing that Treasury will come out with guidance? What is the timing that Congress will come back? You had it right, it’s Sept. 8, after the Labor Day recess. They’re on recess now. The next two weeks they have conventions. Then a little bit more time off, they come back after Labor Day. Even when they come back, there’s an extremely limited legislative calendar before they break for the election.

So I think the next part of this, Paul, is the wait-and-see for the guidance. You asked the right question earlier, about what our members need, what we’re going to provide them, what they’re asking for. Really, that needs to come from Treasury and IRS by way of guidance. As I’ve said several times, the memorandum could not be implemented without that guidance, and that’s the next waypoint, to see what that guidance looks like.

Bonner: Thank you, Ed, so much for talking with us about this sudden and perplexing development in the tax world, and we will stay posted on this and see what happens.

Karl: Stay tuned, as they say, yes, absolutely. Thanks very much, Paul, I appreciate it.

Bonner: OK, thank you.