On August 8, 2020, President Donald Trump issued a public executive memorandum to Treasury Secretary Steven Mnuchin directing him to find a way to defer and possibly forgive an employee’s payroll taxes paid from September 1, 2020, to December 31, 2020. But this deferral is only limited to employees who make less than $4,000 every two weeks or an equivalent amount.
The memorandum was controversial as it raised a lot of questions from the tax professional community. How will employers and their payroll providers implement this on such short notice? Can the president unilaterally forgive tax liabilities? What happens if employers don’t comply? And how does this help people who are jobless because of COVID-19? And since payroll taxes fund Social Security, will this affect its solvency?
On August 25, almost a week before the memorandum was to take effect, the IRS issued Notice 2020-65 which provided guidance on implementing the memorandum. The three page notice stated that employers can increase their employees’ take-home pay starting September 1, 2020, by deferring the withholding of their payroll taxes until December 31, 2020. But this deferral must be paid back by withholding this amount ratably between January 1, 2021 and April 30, 2021.
So basically this so-called relief order is really just a short-term loan.
Also, what happens if the employer cannot pay due to unforeseen circumstances? For example, when an employee stops working for the employer during the January-to-April payback period. It is likely that the employer will then be responsible for the tax. But this creates a problem for the employer that goes beyond getting an annoying letter from the IRS. You see, an employer is required to withhold the employee’s share of the payroll taxes and they are deemed to hold the withheld money in trust to pay the IRS. If the employer does not pay, the IRS doesn’t go after the employee. They go after the employer for that withheld money and call that the trust fund penalty. The government takes this penalty so seriously that they specifically made it nondischargeable in bankruptcy. So it is slightly worse than a student loan bill.
Most tax professionals believe that because of the complexity, risk, and time pressure, employers will not follow this notice and will continue withholding as normal. Most employees will not really benefit since they have to pay the deferred tax back through an additional withholding on top of their usual tax withholdings. Employees are likely to complain about the additional withholding since they need the money to pay their credit card bills in January after their holiday shopping.
The notice did not mention how the deferred tax can be forgiven. Many tax professionals have said that the president or the IRS cannot unilaterally forgive taxes. This is not really true. While neither the president nor the Treasury Department can cancel the tax laws, it is allowed to forgive existing liabilities.
Section 7122 of the Internal Revenue Code allows the Internal Revenue Service to compromise any civil or criminal tax debt. In the vast majority of cases, the IRS forgives existing tax debts through its Offer In Compromise (OIC) program. This allows taxpayers to submit an offer to settle their outstanding tax liabilities for less than what they owe. Most of the time, financially distressed taxpayers submit OICs, but like any creditor, the IRS will not easily settle. However, as many tax practitioners will brag about on their websites, the IRS has accepted settlement offers for pennies on the dollar in certain cases. So in effect, the IRS can forgive tax liabilities — sometimes substantially — without new legislation.
The federal statute authorizing compromises did not give a lot of rules because it was assumed that the IRS and the Treasury Department would work in the best interest of the government. So the Treasury Department issued regulations on OICs.
So if the Treasury Secretary wants to forgive the tax, it can do so by issuing temporary regulations. Temporary regulations have the force of law even without public notice and comment, but they are only good for three years after enactment which is more than enough time in this case.
Assuming the deferred tax can be forgiven, because of the short notice of the memorandum and the IRS notice, it will be difficult to implement a feasible forgiveness plan. The IRS can create a form or modify existing employment tax return forms which can reduce the employers’ tax bill to account for the employees’ payroll taxes that were not withheld. But what happens to the employers who disregarded the notice and withheld like normal? Will they be eligible for a refund? If so, how can the IRS ensure that the refund will be given to the employees?
The president’s executive memorandum designed to provide tax relief for employees is likely to be ignored by employers because, as it currently stands, it is difficult to implement and provides no real relief to employees. For the memorandum to have impact, there needs to be a simple procedure to forgive the deferred taxes. It could be possible to forgive the taxes without additional legislation, but the Treasury Department must issue guidance quickly.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.