With four days to spare before the effective date of Tuesday, September 1, Treasury finally released guidance implementing the President’s August 8 Executive Order allowing taxpayers to defer withholding of the employee’s portion of Social Security taxes. At two and a half pages, (double spaced with wide borders) the guidance is brief, and leaves employees, employers and their tax advisors with many unanswered questions. It also creates potential traps for the unwary.
The Notice (which can be read here) applies to any employee whose pretax compensation during any biweekly period is less than $4,000 and permits employers to refrain from withholding Social Security taxes on such wages during the period September 1, 2020 through December 31, 2020. However, the Notice goes on to say that the employer must withhold and pay the total Applicable Taxes deferred ratably from wages and compensation paid between January 1, 2021 and April 30, 2021 or make arrangements to otherwise collect the total Applicable Taxes from the employee.
In other words, if the taxes aren’t forgiven, the employee will pay double Social Security taxes during the first four months of next year. The employer must deposit the additional taxes collected by May 1, 2021 or face penalties.
Among the unanswered questions and built-in traps for the unwary are:
- What if an employee leaves before the deferred tax is collected? Unless the employer has made some arrangement to collect the taxes prior to the employee’s departure, or Congress passes legislation forgiving the tax, it would appear that the employer is on the hook for the uncollected balance.
- If the employer pays the tax on behalf of the employee, is that additional taxable income to the employee? We hope Treasury will clarify this issue quickly.
- If an employer doesn’t want to participate in the program, could they be open to legal action from their employees? We will keep an eye out for any litigation testing an employer’s legal responsibilities with respect to this deferral opportunity.
- What penalties might an employer face if they can’t pay the deferred tax?
--Employee tax withholdings are also known as Trust Fund taxes because they are taxes the payer collects on behalf of the government rather than taxes on the income of the payer itself. Since the funds belong to the government, they are particularly protective of them.
--There are various failure to deposit and failure to pay penalties associated with tax withholdings. The failure to deposit penalty starts at 2% but quickly goes to 10% if the deposit is 16 or more days late, and, in certain instances, can go to 15%. Similarly, the failure to pay penalty is 0.5% of the unpaid tax per month.
--More draconian is the Trust Fund Recovery Penalty. Under this provision, individuals may be held personally liable for a penalty equal to 100% of the unpaid tax. Such responsible persons include any officer or employee of a corporation or any member or employee of a partnership who has the duty to collect or pay employment taxes.
--While the Notice mentions that interest, penalties, and additions to tax will begin to accrue on May 1, 2021, it doesn’t specify which penalties, if any, it includes. Therefore, employers must assume that they could be exposed to interest plus ALL of these penalties if they are unable to deposit the deferred taxes on time.
We will, of course, continue to monitor developments. And we encourage you to discuss your potential participation in this program with your Friedman LLP advisor.