On August 28, the Internal Revenue Service finally issued guidance that businesses had been waiting for since President Donald Trump signed a memorandum on August 8 granting a federal “payroll tax holiday” for the last four months of 2020. The memo was part of a series of executive orders Trump signed to help Americans cope with the ongoing economic damage caused by the COVID-19 pandemic.
The Memorandum on Deferring Payroll Tax Obligations in light of the Ongoing COVID-19 Disaster directed the Treasury Secretary to defer certain federal payroll taxes for U.S. workers in need between September 1 and December 31, 2020. The Internal Revenue Code allows the Treasury Department to delay the date taxes are due for those affected by an emergency.
Payroll taxes are also known as FICA (Federal Insurance Contributions Act) taxes and are split 50-50 between employees and their employers. The portion of the Social Security tax that is paid by employees is 6.2% of wages of up to $137,700. Employees also pay a tax of 1.45% to fund Medicare.
IRS Guidance Answers Lingering Questions
The memorandum signed by Trump left a number of questions unanswered, such as how the employee withholding of payroll taxes should be handled during the four-month holiday, whether the program is mandatory, and when the payroll taxes would be due. IRS Notice 2020-65 is only 2 ½ pages long, double-spaced, and doesn’t quite answer all of the questions employers had about the memorandum.
The notice said the payroll tax on bi-weekly wages of up to $4,000 from September 1 to December 31, 2020, would be deferred until the end of April, 2021. Employees with bi-weekly income of more than $4,000 are not eligible for the deferral. The notice says that the determination of whether an employee has exceeded the threshold amount will be made on a pay-period by pay-period basis and employees with variable incomes may be eligible for the deferral in some periods, but not others.
Essentially, the notice says the employer may stop withholding payroll taxes for the remainder of 2020, but employees would need to pay those deferred liabilities before May 1, 2021. Participation is not mandatory; therefore, employers may still choose to continue withholding.
Employers Must Make a Choice
Trump’s memorandum leaves it up to employers to determine whether continuing to withhold is best for their employees. Unfortunately, there are no clear-cut answers. The most obvious benefit of stopping payroll withholding for the rest of 2020 is it would increase the take-home pay of lower-income employees by 7.65%. However, those employees will take home less money in the first quarter of 2021 while they repay the deferred amounts through increased withholdings.
One question that was not addressed in either Trump’s memorandum or the IRS guidance is how an employer should collect and repay the deferred withholdings if an employee leaves the company or is fired before he or she has repaid the deferred tax. The notice only says that, if necessary, the employer “may make arrangements to otherwise collect the total Applicable Taxes from the employee.” Many employers have noted that withholding a large amount from an employee’s final paycheck to repay the deferred taxes could be damaging to employee morale.
Trump Wants to Make Deferral Permanent
The Trump memorandum directs the Secretary of the Treasury to explore legislation or other ways in which to eliminate the employees’ obligation to repay the deferred taxes, but it is not clear that the secretary has that power. Section 7508A of the Internal Revenue Code allows the Treasury Department to take actions like deferring the dates taxes are due, but most experts say it does not allow the department to excuse tax payments completely.
Forgiving the deferred payroll taxes would likely take an act of Congress. While Trump has raised the possibility of pursuing legislation to cut payroll taxes if he wins a second term, many observers have noted that doing so could significantly reduce funding for Social Security and Medicare, which could lead to future cuts in benefits. Such cuts would likely be deeply unpopular with voters.
Questions Remain for the Self-Employed
Unfortunately, Trump’s memorandum did not mention whether the payroll tax holiday would apply to self-employed individuals. Those individuals who are self-employed must pay the employee and employer portions of federal payroll taxes, which total 15.3%.
After a number of critics pointed out the self-employed do not appear to benefit from the payroll tax deferral, Larry Kudrow, an economic advisor to the Trump administration, said on August 13 that a “technical change” would be issued allowing them to obtain relief. However, it does not appear that an updated version of the memorandum has been released, and the IRS notice makes no mention of the self-employed.