On July 30, 2020, the IRS released guidance in the form of new frequently asked questions (“FAQs”) addressing the deferral of the employer portion of Social Security taxes under section 2302 of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. These FAQs are broad in nature, providing guidance on various considerations relevant to section 2302 of the CARES Act, including application of these rules to first calendar quarter deposits, coordination with the next-day deposit rule, and considerations for employers that use third parties to report and deposit employment taxes with the Treasury. Covington continues to review this guidance, and has summarized in this blog post some of the provisions we consider most relevant to employers.
When reviewing this latest guidance from the IRS, employers should be mindful that although they represent the current thinking of the IRS regarding section 2302, these FAQs are non-binding; the IRS is under no obligation to comply with these FAQs and could therefore take a different approach at any time. As we have noted previously, the IRS has changed course with respect to FAQs issued in connection with other provisions in the CARES Act, such as the employee retention credit.
Background on Section 2302 of the CARES Act
As explained in a previous blog post, section 2302 of the CARES Act permits an employer to defer deposits of the employer share of Social Security taxes, but not the employer share of Medicare taxes or the employee portion of these taxes. Applicable taxes owed by the employer may be deferred with respect to taxes that are required to be deposited from March 27, 2020 through December 31, 2020. If an employer elects to defer its share of Social Security taxes during this period, it must deposit 50% of the deferred taxes by December 31, 2021, and the remaining 50% of taxes by December 31, 2022.
Application to First Quarter Deposits
As noted above, section 2302 of the CARES Act provides for the deferral of taxes during all calendar quarters in 2020. In the first quarter, this deferral applies only to amounts required to be deposited in the final five days of the quarter (i.e., amounts required to be deposited between March 27, 2020 and March 31, 2020). Although the Form 941 and the accompanying instructions have been revised for the second, third, and fourth quarters of 2020, they were not revised for the first quarter of 2020.
Q&A-6 explains that in accordance with the instructions for the Form 941 applicable to the first quarter of 2020, the employer should have reported the full amount of its employment tax liability due, including any amounts deferred on or after March 27, 2020. In fact, unlike the Form 941 for the second, third, and fourth quarters of 2020 (available here), the Form 941 for the first quarter of 2020 (available here) does not include a separate line item in line 13 to account for the deferred amount of the employer share of Social Security taxes, and instead the full amount of the employment tax liability should be reported on line 13. Accordingly, for employers that did in fact defer taxes in the first quarter, this will result in a discrepancy between the liability reported on the first quarter Form 941 and the deposits actually made and recorded on the employer’s Form 941 account.
For these employers, the IRS will send a notice identifying this discrepancy. In Q&A-6 the IRS explains that this notice will include additional information instructing the employer how to inform the IRS that it deferred taxes in the first quarter under section 2302 of the CARES Act.
Coordination with the Next-Day Deposit Rule
In Q&A-16, the IRS has addressed the impact of section 2302 of the CARES Act on the next-day deposit rule. As summarized in prior blog posts, under the “next-day deposit rule,” an employer that accumulates $100,000 or more in liability for employment taxes on any day during any monthly or semiweekly deposit period must deposit employment taxes on the next business day. The regulations under sections 3111 and 6302 of the Internal Revenue Code provide that liability for the employer’s share of Social Security tax is deemed accumulated as wages are paid.
Q&A-16 explains that the next-day deposit rule must be applied by taking into account any taxes deferred under section 2302 of the CARES Act. Indeed, section 2302 of the CARES Act provides for the deferral of deposits, not deferral of the tax liability. Since application of the next-day deposit rule is based on tax liability, taxes deferred under section 2302 must therefore be taken into account. For example, if an employer accumulates $110,000 in aggregate payroll taxes and defers deposit of $20,000 related to the employer’s share of Social Security taxes under section 2302, the employer would still be required to deposit $90,000 pursuant to the requirements of the next-day deposit rule. In other words, the ability of the employer to defer its share of Social Security taxes does not reduce the required calculation of the accumulated payroll taxes for purposes of determining whether the liability triggers the next-day deposit requirement.
In Q&A-17, the IRS takes a similar approach to the reduction of deposits in anticipation of the Families First Coronavirus Response Act (“FFCRA”) paid leave credit and the employee retention credit. We have covered both credits in a number of previous blog posts including our series on the employee retention credit (available here), as well as our prior post on the FFCRA credit (available here). Neither credit reduces the amount of the employer’s Social Security tax liability. Rather, these credits are applied against the tax imposed. For this reason, any deposits reduced pursuant to these credits must be taken into account to determine whether the next-day deposit rule applies. For example, If an employer anticipates $110,000 of liabilities and reduces its deposits in anticipation of a $20,000 credit (as a result of the FFCRA paid leave credit and/or the employee retention credit), the employer must still deposit under the next-day deposit rule, but would only be required to deposit $90,000.
Application to Employers Relying on Third Parties
Q&A-26 explains the rules that would apply to an employer using a third party to report and deposit employment taxes. In summary, a common law employer that is otherwise eligible to defer deposits and payments of the employer’s share of Social Security taxes is entitled to do so, regardless of whether it utilizes a third party payer to report and deposit its federal employment taxes. However, different rules will apply depending on the type of third-party payer utilized by the employer.
- Reporting Agent. If a common law employer utilizes a reporting agent, such as a payroll services provider, to file Forms 941 under the common law employer’s EIN, the reporting agent will report the deferred amount of the employer’s share of Social Security taxes owed on the Form 941 filed on behalf of the employer (except, as noted above, the Form 941 with respect to the first quarter of 2020).
- CPEO or Section 3504 Agent. If a common law employer utilizes a certified professional employer organization (“CPEO”) or section 3504 agent that submitted Form 2678 to report taxes on an aggregate Form 941 using the CPEO’s or section 3504 agent’s EIN, such agent will report the deferred amount of the employer’s share of Social Security taxes on its aggregate Form 941 and Schedule R, Allocation Schedule for Aggregate Form 941 Filers.
- Non-Certified PEO or Other Third Party. If a common law employer uses a non-certified PEO or other third party payer (aside from a CPEO or section 3504 agent), that reports and deposits the employer’s federal employment taxes under the third party’s EIN, the non-certified PEO or other third-party payer will be required to report on an aggregate Form 941 and, using a Schedule R, separately report deferred taxes allocable to the employer (with the EIN of each employer) for which it is filing the aggregate Form 941.
In addition to the rules outlined above, the IRS has provided guidance on a variety of other topics in connection with section 2302 of the CARES Act. This guidance includes the following:
- Relief for Annual Employment Filers. In Q&A-7, the IRS has confirmed that employers that file annual employment tax returns (i.e., Forms 943, 944, and CT-1) are eligible to defer taxes under section 2302 of the CARES Act.
- Coordination with Research Payroll Tax Credit for Small Employers. Q&A-14 explains that an employer is entitled to defer deposit and payment of the employer’s share of Social Security taxes prior to applying the Research Payroll Tax Credit (the “RPTC”) against the employer’s liability for the employer’s share of Social Security taxes. Further, the IRS has explained that an employer may claim the RPTC regardless of whether it has already deferred the employer share of Social Security taxes under section 2302 of the CARES Act.
- Coordination with Work Opportunity Tax Credit. Similar to its guidance with respect to the RPTC, the IRS has explained in Q&A-15 that a tax-exempt employer eligible to claim the Work Opportunity Tax Credit (the “WOTC”) is entitled to defer deposit and payment of the employer’s share of Social Security taxes prior to determining whether the employer is eligible for the WOTC. An employer may also claim the WOTC regardless of whether the employer has deferred deposit and payment of the employer share of Social Security taxes.
- Reminder Notices Regarding Deferred Taxes. To remind employers of the total amount of taxes deferred under section 2302 of the CARES Act, the IRS noted in Q&A-20 that it intends to issue a notice to employers before each applicable due date. This means that Form 941 filers, which treat each quarter separately for purposes of determining taxes due, may receive up to four reminder notices corresponding to each calendar quarter in 2020. These notices will state the amounts due on December 31, 2020 and December 31, 2021.
- How to Pay Deferred Taxes in Advance of Applicable Deadline. As noted above, taxes deferred under section 2302 of the CARES Act must be deposited 50% by December 31, 2021, and 50% by December 31, 2022. The IRS has explained in Q&A-29 that employers may pay all or a portion of the amount deferred in advance of the applicable deposit deadline, and the preferred method of payment is through the Electronic Federal Tax Payment System.