This Legal Update is both an explanation of how to secure an interest-free loan under the CARES Act, and a warning of the dangers carried by such loans.
Virtually all private employers are required to withhold social security taxes from wages paid to employees. Internal Revenue Code (IRC) Section 3111(a). Railroads have similar obligations to withhold tax under the Railroad Retirement Tax Act (RRTA). IRC Sections 3211(a) and 3221(a). Self-employed individuals are subject to self-employment (SECA) tax, effectively paying both the employer and employee share of social security taxes. IRC Section 1401(a)).
That burden changed slightly when the President signed the CARES Act.
The CARES Act does many good things, the business provisions of which are summarized here. This article focuses on Section. 2302(a)(1), which allows taxpayers to defer paying the employer portion of the social security taxes discussed above through the end of 2020. Half of the deferred amount will be due at the end of 2021 and the other half will be due at the end of 2022. Basically this provision amounts to an interest-free loan with no strings attached — unless the business fails to pay when that loan matures.
Specifically, notwithstanding any other provision of law, the payment for "applicable employment taxes" for the "payroll tax deferral period" will not due before the "applicable date." (CARES Act Section 2302(a)(1)).
To understand what this means, we need to unpack those definitions.
Applicable employment taxes means:
Applicable employment taxes do not include the employer portion of Medicare taxes imposed under IRC Section 3111(b).
Payroll tax deferral period means the period beginning on the date of enactment of the CARES Act (March 27, 2020) and ending before Jan. 1, 2021, i.e., December 31, 2020. (CARES Act Section. 2302(d)(2)).
Applicable date means:
In other words, payment for half of these taxes will not be due until the end of 2021 and the other half will not be due until the end of 2022. Technically, this interest-free loan is accomplished by providing that, notwithstanding IRC Section 6302 (which authorizes IRS to set deadlines for tax deposits), an employer will be treated as having timely made all deposits of applicable employment taxes deferred by the CARES Act if all such deposits are made no later than the applicable date (December 31, 2021 for half and December 31, 2022 for the other half). (CARES Act Section 2302(a)(2)). In effect, employers will be treated as having timely paid these taxes retroactive to their due date so long as they are ultimately paid by the extended due dates.
Similar rules (both deferral and risks) apply to half of the SECA taxes paid by self-employed individuals related to social security tax (but not Medicare tax). CARES Act Section 2302(b)(1).
Comment. Significantly, this interest-free loan for the employer portion of social security taxes is not available to any taxpayer that “has had indebtedness forgiven” under CARES Act Section 1106 with respect to a Payroll Protection Program or PPP loan (a loan under paragraph (36) of Section 7(a) of the Small Business Act as amended by Section 1102 of the CARES Act). (CARES Act Section 2302(a)(3)) So, the first trap for the unwary is that getting a PPP loan may prevent or limit a taxpayer from availing themselves of these delayed payroll tax provisions.
Of course, entitlement to forgiveness of a PPP loan depends on the ability of the taxpayer to establish that it has deployed the funds on covered expenses and that can’t happen until sometime in the future — making it hard for taxpayers to make an informed decision. So one ambiguity in the provisions allowing delayed payment of an employer’s share of social security taxes is whether the mere receipt of a PPP loan disqualifies the taxpayer from delaying social security tax payments or causes the deferred social security tax payment to become due once the indebtedness is forgiven — and whether interest and penalties might then apply. We hope the IRS will provide guidance quickly on the meaning of the phrase “has had indebtedness forgiven.”
Until such guidance is issued, some taxpayers may not want to take advantage of the ability to delay payment of payroll taxes, especially because (1) the payroll tax credit provided by CARES Act Section 2301 does not apply to employers getting a PPP loan (CARES Act Section 2301(j)), and (2) most businesses taking a PPP loan anticipate having the maximum amount of the indebtedness forgiven.
For self-employed individuals, it appears that taking a PPP loan, even with the prospect of having it forgiven, should not preclude their ability to delay payment of the on 50% of the social security portion of their SECA taxes. (The limitation for forgiven indebtedness only applies to a delay allowed by CARES Act Section 2302(a); the SECA delay is in CARES Act Section 2302(b).)
Applicable tax law generally imposes third party liability on certain people for failing to timely deposit (i.e., pay to the U.S. Treasury) withholding taxes, including the employer’s share of FICA/SECA. IRC Section 3504. In general, individuals can be held personally liable for taxes that should have been deposited if their job requirements make them responsible for ensuring timely withholding and paying/depositing payroll taxes. Fortunately, a special provision exempts those people from personal liability if their employer directed them to defer payment of any applicable employment taxes during the payroll tax deferral period. CARES Act Section 2302(c)(1), Of course the employer remains (solely) liable for the payment of the deferred applicable employment taxes.
Comment. Employees should seek formal instruction from their employer to delay payment of the employer’s share of FICA and to preserve those instructions in the event of audit.
Similar immunity is provided for certified professional employer organizations (often referred to as “CPEOs”) that are treated as employers for employment tax withholding purposes. See generally IRC Sections 3511 and 7705. CARES Act Section. 2302(c)(2).
Comment. The CARES Act does not change the responsible person rules that generally can apply to officers or employees. These responsible person rules, however, generally concern trust fund taxes (e.g., the employee shares of FICA withheld by the employer). Accordingly, responsible persons generally are not liable for the taxes deferred under the CARES Act. That said, the IRS takes seriously the failure to timely pay employment taxes. Employers availing themselves of this interest-free loan are well-advised to take extra care to ensure that they have the funds available to timely pay amounts borrowed under this provision.
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