Guidance on Directive to Defer Payroll Tax Obligations Leaves Unanswered Questions

On August 8, 2020, the President directed the Secretary of the Treasury to authorize the deferment of certain payroll tax withholding, depositing, and payment obligations otherwise incurred on wages and compensation paid between September 1, 2020 and December 31, 2020. In general, the deferral is to be made available with respect to any employee whose compensation payable during any bi-weekly pay period is less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods.

On August 28, 2020, just days before the directive was to be implemented, the Secretary of the Treasury issued Notice 2020-65 (the “Notice”) which sets forth guidance and answers some questions on this initiative, but leaves others unaddressed.

1. What Tax Obligations Are Postponed?

The postponed tax obligations all relate to the employee’s share of social security taxes imposed under Section 3102(a) of the Internal Revenue Code (the “Code”), or the railroad retirement tax equivalent assessed under Code Section 3202(a) on “Applicable Wages”, i.e. wages or compensation paid for a bi-weekly pay period between September 1, 2020 and December 31, 2020 that do not exceed $4,000, or the equivalent threshold amount with respect to other pay periods. 

The Notice only postpones withholding and payment obligations incurred with respect to these payroll taxes. No explicit extension is being made with respect to payroll tax deposit obligations because, as noted in the Notice, deposit obligations do not arise until the tax is withheld. Thus, according to the Notice, by postponing the time for withholding, the deposit obligation is delayed by operation of the regulations. 

2. Who Can Postpone Payroll Tax Obligations?

The Notice makes it clear that it is employers who can postpone their payroll tax withholding and payment obligations. While this comes as no surprise, it is a gentle reminder that, even though the postponement is occurring with respect to the employees’ share of certain payroll taxes, it is ultimately employers who are responsible for withholding, depositing, and paying these taxes, and it is employers who will be penalized if mistakes are made. 

3. How Are Applicable Wages Calculated?

The determination of Applicable Wages is made on a pay period-by-pay period basis. If the amount of wages or compensation payable to an employee for a pay period is less than the corresponding pay period threshold amount, then that amount is considered Applicable Wages for the pay period, and the relief provided in the Notice applies to those wages, or that compensation, paid to that employee for that pay period, irrespective of the amount of wages or compensation paid to the employee for other pay periods. In other words, the employer need only consider actual wages or compensation paid during a pay period to an employee in calculating whether wages are Applicable Wages or not. The annualized compensation of that employee, scheduled bonuses and potential raises are irrelevant.

4. When Do the Taxes Have to Be Withheld and Paid?

Employers who take advantage of this deferment must withhold and pay the total taxes deferred ratably from wages and compensation paid between January 1, 2021 and April 30, 2021 or interest, penalties, and additions to tax will begin to accrue on May 1, 2021. As a result, their employees will receive smaller paychecks in 2021 when they have the deferred payroll taxes withheld from their paychecks. According to the Notice, if necessary, employers may make arrangements to otherwise collect the total deferred taxes from the employee. That said, as explained above, these deferred tax obligations are ultimately obligations of the employer. If an employee quits, is fired, or otherwise leaves employment for any reason, including death or disability, and the employer cannot make arrangements to withhold the taxes from the employee’s wages, the employer must still remit those taxes to the Treasury Department.

5. Can I Withhold Payroll Taxes From Employees as Usual and Deposit the Withheld Taxes in an Escrow Account Until 2021?

It appears not. As explained above, the Notice did not extend any payroll tax deposit obligations. Deposit obligations arise once taxes are withheld. If an employer withholds the employee’s share of payroll taxes from wages, those taxes must be timely deposited with the Treasury Department.

6. Am I Liable to My Employees If I Do Not Take Advantage of This Deferment?

Employers who choose not to take advantage of this deferment opportunity should be protected in two ways. First, the Anti-Injunction Act protects an employer from an employee’s claim that the employer improperly withheld federal taxes from wages. The Anti-Injunction Act provides that, except in specific circumstances, no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed. The Supreme Court has held that an employer's withholding of tax payments from wages constitutes a method of tax 'collection,' and that an order enjoining employer withholding therefore stops collection of the tax. In a recently decided case[1], a federal district court dismissed an individual’s claims against his employer for improperly withholding federal taxes from his wages, even when it was clear the employer had improperly rounded up the amount of tax to be withheld, rather than rounding down as required by the Treasury Regulations. According to the court, such claims are barred by the Anti-Injunction Act.

Second, Under Code Section 7422, no suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof. Thus, if an employee believes an employer withheld excessive payroll taxes, he or she must first seek a refund from the Treasury Department, before pursuing a claim against the employer.