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| James Malone |
However, to understand the present state of employment taxes, it is essential to understand how the employment tax system normally operates.
How Employment Taxes Normally Work
At each payroll, employers are responsible for a series of taxes:
- The Federal Insurance Contributions Act, or FICA, tax on employees, which is deducted from their wages;[3]
- The FICA tax on employers, which is paid directly by the employer;[4]
- Income tax, which is also deducted from employees' wages.[5]
With the exception of very small employers, these taxes are reported quarterly on Form 941.[6]
The FICA tax has two components that are applicable to both employers and employees: First, there is a 6.2% tax that funds Social Security benefits; second, there is a 1.45% tax that funds Medicare benefits.
Both income taxes and taxes under FICA are subject to periodic deposit requirements. Specifically, most employers are subject to either a monthly deposit requirement or a semi-weekly deposit requirement. An employer that does not make timely deposits is subject to penalties. The penalties start at 2% for delays of up to five days and then escalate.
The FICA and income taxes collected from employees are impressed with a trust in favor of the U.S.[7] An employer who converts trust fund taxes collected from employees[8] faces both civil and criminal liability. Those who willfully fail to collect, account for, and pay trust fund taxes may be assessed with a penalty equal to the amount due.[9] The same conduct is a potential felony that may be prosecuted under Section 7202 of the Internal Revenue Code. [10]
How Employment Taxes Work in the Pandemic
Two pieces of legislation and some IRS pronouncements have made radical changes in the normal employment tax regimen.
First, the FFCRA created a series of tax credits tied to new family leave and sick leave requirements imposed on employers with fewer than 500 employees. Second, the CARES Act also includes employment tax provisions. Third, the IRS has published guidance under the FFCRA and the CARES Act, altering the normal rules for employment taxes.
The FFCRA
The tax provisions of the FFCRA are tied to two new forms of leave that the act created, emergency paid sick leave, and emergency family and medical leave. The provisions alter the employer's obligation as follows:
- First, to the extent that an employer pays wages under the leave provisions, those wages are not subject to the Social Security tax component of FICA.[11] The employer still has to pay the 1.45% Medicare tax.
- Second, to the extent that an employer pays wages under the leave provisions, it will receive a credit towards its Social Security tax obligations.[12]
- Third, the employer receives a credit for an allocated portion of the cost of its health plans associated with the payment of wages under the leave provisions.[13]
- Fourth, the employer receives a credit for the Medicare tax of 1.45% paid on wages under the leave provisions of the act.[14]
The credits are all tied to the caps on wages contained in the various leave provisions. They are also subject to various rules designed to bar duplicative benefits, including a requirement that they be treated as income.[15]
The credit provisions contained a flaw: A credit essentially becomes available when the employer files Form 941 after the close of a particular quarter. Meanwhile, the employer is subject to deposit rules that would require it to pay the Medicare tax on wages and then claim the credit when it filed its return.
It frankly would have been much simpler if Congress had simply indicated that the Medicare tax was not payable on wages paid under the leave provisions, as it did with the employer's Social Security tax. While Congress did not directly address the deposit rules, it gave the IRS regulatory authority to do so by providing for a waiver of deposit penalties by regulation.[16]
The CARES Act
The CARES Act has a series of provisions that are relevant to employment taxes. First, although it is not a tax provision, the Paycheck Protection Program, or PPP, of forgivable loans has employment tax implications because wages paid during leave under the FFCRA are not subject to forgiveness. This is because Section 1102 of the CARES Act carves FFCRA leave wages out of the definition of "payroll costs," which removes these wages from the forgiveness provision.[17]
The CARES Act also provides two forms of employment tax relief.
Section 2301 of the CARES Act provides a potential credit against the employer's FICA obligations for Social Security tax of 50% of qualified wages paid by an eligible employer.[18]
The size of the employer is not relevant to eligibility, which is measured under two tests:
- Employers are eligible if operations are fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority" that limit commerce due to COVID-19; or
- An employer is also eligible during a period beginning during a calendar quarter in which gross receipts are less than 50% of the same period in a prior year and ending after the first calendar quarter in which gross receipts exceed 80% of the like period in a prior year.[19]
"Qualified wages" generally are wages paid to employees who are not providing services due to either a suspension or limitation of operations, or due to a drop in gross receipts.[20] For smaller employers (100 or fewer employees) the requirement that the wages be paid to employees who are not providing services due to the suspension of operations, or due to a drop in gross receipts does not apply. [21]
In calculating credits for employee retention wages, wages paid under the leave provision of the FFCRA are not included.[22] As with the FFCRA, the credit also includes health care costs associated with retention wages.[23]
The CARES Act does not alter the Medicare tax obligation of the employer or provide any offsetting credit. The employee retention credit is refundable.
Section 2302 of the CARES Act provides for deferral of the employer's Social Security taxes.[24] The deferral period began when the CARES Act was passed on March 27 and continues through the end of 2020.[25]
The deferred taxes are due in two installments. One half is due on Dec. 31, 2021, and the balance is due Dec. 31, 2022.[26] The deferral under the CARES Act Section 2302 is linked to the forgiveness provisions under the PPP. Deferral is not available for an employer who has debt forgiven under a PPP loan.[27]
Although the language of the statute suggests that a recipient of a PPP loan will not also be able to defer, recent IRS guidance indicates that deferral may still be permitted.
IRS Guidance
IRS guidance relating to employment taxes during the present health crisis has included informal FAQ documents — the COVID-19-Related Tax Credits for Required Paid Leave Provided by Small and Midsize Businesses FAQs and the Deferral of Employment Tax Deposits and Payments Through December 31, 2020 FAQ — as well as two formal notices — Notice 2020-21 and Notice 2020-22.[28]
The tax credits FAQ is probably the most startling of the four pronouncements, as it explicitly provides that an employer can fund qualified leave wages with federal taxes that it has withheld.[29] Normally, if an employer used taxes withheld from employees for another purpose, individuals in control of the business could face personal liability for the funds or even criminal prosecution.
The tax credits FAQ also indicates that a penalty will not be imposed on deposits that are delayed in anticipation of credits, which is consistent with the grant of regulatory authority that Congress provided in the FFCRA. The FAQ also provides for advance credits where the employment taxes withheld from other employees are not sufficient.[30]
Finally, the tax credits FAQ provides standards for documenting the employer's entitlement to credit. In addition to obvious items of information, such as the employee's name and the dates the employee took leave, employers are required to have "[a] statement of the COVID-19 related reason the employee is requesting leave and written support for such reason," and a statement that the employee cannot work or telework for such reason.[31]
Employers are also required to maintain documentation to show how they determined how much credit they could claim, including work records, as well as data supporting the allocation of health care costs.
Notice 2020-21 addresses the relevant time period when credits will be available, which is between April 1 and Dec. 31.[32]
Notice 2020-22 formalizes the deposit penalty relief provided under the FAQ, and makes clear that it applies to both qualified leave wages under the FFCRA, and to qualified retention wages under the CARES Act.[33]
The deferral of employment tax FAQ is the most recent IRS pronouncement, and it offers significant guidance on the ability of an employer to defer payroll taxes. Section 2302 of the CARES Act generally authorizes an employer to defer its Social Security tax payments as noted above. But Section 2302 also provides as follows:
While the language of the statute suggests that an employer with a PPP loan cannot defer, that is not the position of the IRS:This subsection shall not apply to any taxpayer if such taxpayer has had indebtedness forgiven under [S]ection 1106 of this Act with respect to a loan under paragraph (36) of [S]ection 7(a) of the Small Business Act (15 U.S.C. 636(a)), as added by [S]ection 1102 of this Act.[34]
Employers who have received a PPP loan may defer deposit and payment of the employer's share of Social Security tax that otherwise would be required to be made beginning on March 27, 2020, through the date the lender issues a decision to forgive the loan in accordance with paragraph (g) of [S]ection 1106 of the CARES Act, without incurring failure to deposit and failure to pay penalties. Once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer deposit and payment of the employer's share of Social Security tax due after that date. However, the amount of the deposit and payment of the employer's share of Social Security tax that was deferred through the date that the PPP loan is forgiven continues to be deferred and will be due on the "applicable dates[.]"[35]
Issues for Employers
I commend the IRS for taking a pragmatic view in the current health crisis and relaxing the deposit requirements. For employers who lack the funds to pay qualified leave wages under the FFCRA or qualified employee retention wages under the CARES Act, the IRS has plainly blessed the use of employment taxes withheld from employees for this purpose.
But employers should take caution to avoid doing so unless absolutely necessary. One concern is that habits developed in the present crisis could continue when we revert to the normal rules. But there are also some ambiguities presented by the recent legislation.
First, under the FFCRA, one of the events that will make an employee eligible for sick leave is where "[t]he employee is subject to a [f]ederal, [s]tate, or local quarantine or isolation order related to COVID–19."[36]
Colleagues in the employment bar advise that there are substantial questions about whether the existing orders issued by various governmental authorities meet that standard.
While the ambiguity of Section 5102(a)(1) is an employment law issue, it has tax law consequences, as the credit for sick leave wages is for "qualified sick leave wages." The FFCRA defines "qualified sick leave wages" as "wages ... and compensation ... paid by an employer which are required to be paid by reason of the Emergency Paid Sick Leave Act."[37] As the statute is written, if the employer makes a decision to provide leave when it is not actually required, the credits might be reversed in an audit.
Similarly, one of the reasons for sick leave is when an "employee is experiencing symptoms of COVID–19 and seeking a medical diagnosis."[38] What if the employer tells the employee to visit a doctor because the employee appears symptomatic, is told that the employee visited a doctor and was cleared, but the employee is lying? Technically, the wages paid for the leave are not required to be paid under the FFCRA because the employee did not seek a diagnosis.
Accordingly, employers should understand that there may be instances in which the amount of credits to which an employer is entitled may be uncertain. Relief from the deposit penalties is only for credits anticipated for qualified wages and associated health plan costs.[39]
At this juncture, it is impossible to tell how the IRS will address a situation in which an employer pays sick leave wages or family leave wages that arguably might not have been required. Normally, good faith surrounding a claim for a credit or a deduction is only relevant to the question of whether an employer is penalized, not whether it is entitled to a credit.
Accordingly, employers should resist the temptation to apply employment taxes withheld as a funding source for leave wages and retention wages if at all possible. To the extent they cannot afford to make deposits without relying upon the credits, they should consider building in an assumption that some portion of the potential credits will not be allowed and deposit accordingly.
Employers should study the substantiation requirements in the IRS' tax credits FAQ closely.
Finally, in view of the deferral of employment tax FAQ, employers with PPP loans should avail themselves of the right to defer the payment of social security taxes provided under Section 2302 of the CARES Act up until the time that a decision on forgiveness of the loan is made.
James R. Malone Jr. is a principal at Post & Schell PC.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Families First Coronavirus Response Act
Publ. Law No. 116-127, 134 Stat. 137 (Mar. 18, 2020).[2] Coronavirus Aid, Relief, and Economic Security Act
, Publ. Law 116-137, 134 Stat. _ (Mar. 27, 2020).[3] I.R.C. § 3102(a)
.[4] I.R.C. § 3111
.[5] I.R.C. § 3402(a)(1)
.[6] Employers with annual employment tax liability of $1,000 or less report on Form 944 annually, and they deposit annually. Treas. Reg. § 31.6302-1(c)(5)
.[7] I.R.C. § 7501(a)
.[8] The employer's FICA obligation is not a trust fund tax as it is not collected from someone else. See I.R.C. § 7501(a)
(imposing a trust "[w]henever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States")[9] I.R.C. § 6672(a)
.[10] I.R.C. § 7202
.[11] FFCRA § 7005(a)
, 134 Stat. at 219.[12] FFCRA §§ 7001(a)
, 7003(a) , 134 Stat. at 210, 214[13] FFCRA §§ 7001(d)(1)
, 7003(d)(1) , 134 Stat. at 211, 215[14] FFCRA, § 7005(b)(1)
, 134 Stat. at 219.[15] FFCRA §§ 7001(e)(1)
, 7003(e)(1) , 134 Stat. at 211, 215-16.[16] FFCRA §§ 7001(f)(3)
, 7003(f)(3) , 134 Stat. at 211-12, 216.[17] See CARES § 1106(b)
.[18] CARES § 2301(a)
, (c)(1)(A). [19] See CARES § 2301(c)(2).
[20] CARES § 2301(c)(3)(A
).[21] CARES § 2301(c)(3)(A)(ii)
.[22] CARES § 2301(c)(3)(A).
[23] CARES § 2301(c)(3)(C)
.[24] See CARES § 2302(a)(1).
[25] CARES § 2302(d)(2)
.[26] CARES § 2302(d)(3)
.[27] CARES, § 2302(a)(3)
.[28] Notice 2020-21, 2020 IRB LEXIS 103 (Mar. 27, 2020)
, Notice 2020-22, 2020 IRB LEXIS 106 (Apr. 1, 2020) .[29] See Credits FAQ, No. 38
[30] See Credits FAQ, No. 40.
[31] See Credits FAQ, No. 44
[32] 2020 IRB LEXIS 103
at *1[33] Notice 2020-22
, § 3, 2020 IRB LEXIS 106 at *7-*10[34] CARES, § 2302(a)(3).
[35] Deferral FAQ No. 4
[36] FFCRA § 7001(a)
, 134 Stat. at 210[37] FFCRA § 7001(c)
, 134 Stat. at 211 (emphasis added)[38] FFCRA § 5102(a)(3)
, 134 Stat. at 195[39] Notice 2020-22
§ 3, 2020 IRB LEXIS 106 at *7For a reprint of this article, please contact reprints@law360.com.