The IRS recently announced that it erroneously sent failure-to-deposit (“FTD”) penalty notices to certain employers that reduced their employment tax deposits on Form 941 (Employer’s Quarterly Federal Tax Return) in anticipation of claiming sick and family leave credits under the Families First Coronavirus Response Act (“FFCRA”) or the employee retention credit (“ERC”) under the Coronavirus, Aid, Relief and Economic Securities (“CARES”) Act.
In March 2020, Congress passed the FFCRA and the CARES Act to provide relief for employers and employees affected by the COVID-19 Emergency. The legislation provides for paid sick and expanded family and medical leave as well as an ERC. The IRS subsequently issued Notice 2020-22 to address relief from late deposit penalties for employment tax deposits that are reduced in anticipation of one of the employer social security tax credits. (See prior coverage regarding IRS guidance on payroll tax credits under the FFCRA and CARES Act here and our primer on how to claim the credits here.)
Employers are generally required to deposit federal employment taxes (federal income tax withholding, FICA taxes, and Railroad Retirement taxes) based upon the time periods described under Treas. Reg. §§ 31.6302-1 and 31.6302-2. These rules place employers onto monthly or semi-weekly deposit schedules based upon the amount of the employer’s employment tax deposits, although next-day deposits are required when an employer accumulates $100,000 or more of employment taxes. When an employer fails to timely deposit employment taxes, FTD penalties may be assessed under section 6656. The FTD penalty rate depends on how late the deposit was made. The penalty rate is (i) 2% for deposits made not more than 5 days late, (ii) 5% for deposits made not more than 15 days late, and (iii) 10% for deposits made more than 15 days late. Section 6656 provides for relief from such penalties in cases where the employer establishes reasonable cause.
Erroneous IRS Notices
The IRS announcement states that it is aware that a “small population of employers” that took advantage of the FFCRA and CARES Act by reducing employment tax deposits on the Form 941 may have received notices imposing FTD penalties. The IRS explained that the cause of the error relates to discrepancies between the liabilities reported in the Schedule B to Form 941 and the amount of the deposits actually made. (The liabilities reported on Schedule B are not reduced to reflect the credits, so employers claiming the credits will generally report liabilities in excess of deposits.) Although the IRS attempted to take steps to implement rules to prevent such erroneous penalty notices, the IRS programming glitch appears to arise in situations in which deposits were reduced by amounts in excess of the liability for the employer portion of social security for a particular pay date. The IRS announcement does not state the specific notice number that will be issued, but it may be a Notice CP161. (IRS information on understanding Notice CP161 may be found here.)
The IRS states that it is taking action to identify those employers that received the erroneous notices and correct them as soon as possible. Although the IRS states that employers receiving these erroneous notices do not need to take action, employers that find themselves in this situation should carefully review the notice to ensure that it relates solely to late deposit penalties triggered because of claimed FFCRA credits and ERCs. Even if the notice does, employers should consider responding to the notice in writing to explain concisely that the reduction in employment tax deposits relates to the credits provided under the FFCRA and the CARES Act. Calling the IRS to discuss the notice may also be an effective approach, and employers should memorialize their call with the IRS, including the identity of the IRS representative, the date and time of the call, and a summary of the issues discussed. Such an approach is prudent because it demonstrates an employer’s diligence by responding to IRS correspondence and increases the likelihood that the penalties will be withdrawn by the Service. Further, in the event that the IRS fails to withdraw the FTD penalties within a reasonable time, an employer is in a better position to contest penalties at a later stage if it has promptly responded to the notice and clearly explains why it believes its position is correct.
The IRS release also states in its announcement that employers should check here for future guidance when reporting liabilities when reducing deposits using Form 941.