Many employers are likely to find the rules for repayment of employer-share social security tax deferrals under the Coronavirus, Aid, Relief and Economic Security (CARES) Act to be confusing. Employers may also be surprised to learn that a 10% penalty on the entire deferral is assessed in the case of underpayments and late deposits. Employers should plan to repay deferred amounts timely and be certain to designate the quarter for which each payment is intended.
Thousands of US employers took advantage of the program under the CARES Act to defer the deposit and payment of the employer's share of Social Security taxes owed on wages paid from March 27, 2020 through December 31, 2020. The due date for half the deferred amount–Monday, January 3, 2022 (and not December 31, 2021)—is fast approaching, and many outside payroll providers are insisting that employers pay weeks earlier if the provider is expected to facilitate electronic payments.
This LawFlash outlines some of the key components of these complex repayment rules to help employers get up to speed, with the goal of timely and properly paying the deferred amounts due—and avoiding potentially significant penalties.
Timing & Allocation of Repayments
Section 2302 of the CARES Act states that half of the deferred amount is due December 31, 2021 (extended administratively to the next business day, Monday, January 3, 2022), with the remainder due December 31, 2022. The December 31, 2022 deadline likewise has been extended to January 3, 2023.
The IRS issued Frequently Asked Questions (FAQs) about the deferrals. Q&A 20 indicates that the IRS intends to issue a reminder notice to employers before each due date. These notices—designated “CP256V Notices”—were not sent until late October. Many companies have not yet received or located the mailing. The notice states the following:
What you need to know. The first installment amount, due December 31, 2021, is half the employer’s share of Social Security taxes that you could have deferred (which includes any amount of the employee’s share of Social Security taxes deferred under Notice 2020-65, as modified by Notice 20201-11) minus all deposits and payments we’ve received. For more information please review Q&A 18.
Q&A 18 explains that “if an employer pays any amount before the applicable dates, any such payment is first applied to reduce the employer's liability for an amount due on December 31, 2021 and then to the amount due on December 31, 2022.” The examples provided, however, do not address how quarterly payments—underpayments, payments in full, or overpayments—will be allocated.
Some companies have raised concerns that the language in Q&A 20 means that overpayments for a particular quarter made by December 31, 2021 will be applied to payments due in the same quarter of 2022, leaving taxpayers with a shortfall for the December 31, 2021 amounts due.
Unofficial IRS Guidance Imposes 10% Penalty on Full Deferred Amounts
The stakes for proper allocation of employer repayments are high. Unofficial IRS guidance PMTA 2021-07 (legal advice to program managers) was released in August 2021 and warns that if full repayment of the amount deferred in 2020 is not deposited by December 31, 2021 or December 31, 2022, as applicable, the IRS considers the deferral “completely invalid” and can assess the 10% section 6656 failure to deposit penalty on 100% of the amounts deferred. There is no mention of the PMTA in the IRS FAQs.
The PMTA uses a hypothetical $50,000 deferral to illustrate the penalty consequences of an underpayment as of December 31, 2021, and of a payment made after the December 31, 2022 deadline. In the first instance, the employer only deposits $5,000 by December 31, 2021. Because the $25,000 due was not paid, the entire $50,000 deferral is invalidated and the 10% failure to deposit penalty applies to the entire $50,000, in the amount of $5,000. Further, if the employer receives an IRS notice demanding payment of the balance on February 7, 2022 and does not pay the full amount by February 17, 2022, the penalty rate increases to 15% of the total deferred amount.
In the second scenario, the employer deposits timely the $25,000 due December 31, 2021, but does not deposit the remaining $25,000 until after the December 31, 2022 deadline, on February 28, 2023. If, on February 6, 2023, the IRS issues a notice demanding payment of the second installment of $25,000, and the employer does not pay the full amount by February 16, 2023, the penalty rate increases to 15% of the total deferral of $50,000. In other words, the penalty applies to the full amount deferred even though the first installment was paid on time.
The PMTA takes this extreme position by interpreting CARES Act section 2302(a)(2) to condition the waiver of penalties on the deposit of all “deferred amounts by the applicable installment due dates”; failure to do so renders the deposits due on “the usual [monthly, semi-weekly, or next-day] deposit due dates provided in Treas. Regs. §§ 31.6302-1 and 31.6302-2, which would be the due dates used in determining any penalties under section 6656”.
Moreover, the PMTA makes no carveout for the amounts that were repaid timely. The result is to strip away a significant portion of the deferral benefit, while seemingly punishing taxpayers that made payments before the PMTA was issued.
Methods of Repayment & Changes or Corrections Thereto
Repayments of deferred amounts can be made electronically through EFTPS, by credit or debit card, or by check or money order. Importantly, taxpayers must designate the quarter to which the payment relates.
For any payment through EFTPS, the employer is required to designate the quarter to which the payment relates. For any payment by check, the employer is supposed to include a 2020 Form 941-V Payment Voucher with a darkened circle identifying the quarter for which the payment is being made. Additionally, taxpayers should write their EIN, “Form 941,” and the calendar quarter in which the amount was originally deferred, e.g., “2nd Quarter 2020”. These instructions are consistent with the need to reconcile amounts due/owing on quarterly Forms 941.
Employers have raised concerns about the treatment of payments made without proper designation of the quarter to which the repaid amounts should be applied, or payments made to cover amounts due for multiple tax periods. A recent update to the Internal Revenue Manual (the Update) provides some reassurance.
The Update addresses a range of topics concerning payments for CARES Act tax relief provisions, including employer Social Security tax deferral amounts. Inquiries and cases concerning deferred Social Security tax payments will be handled by designated employees who have received training on the relevant procedures. It provides IRS agents with instructions on how to respond to a wide range of questions from employers about deferred amounts due, e.g., the treatment of overpayments, employer failures to properly report the amounts of taxes deferred and paid on Form 941, and penalty abatement. Throughout, the Update recognizes that limitations in the IRS computer system may result in a variety of errors that should be manually corrected and recorded.
The Update states that the IRS computer system cannot apply a single payment to multiple quarters, which means separate payments are required for each calendar quarter. Nevertheless, the Update appears to allow taxpayer requests to reapply payments to another quarter, and lays out detailed instructions for its agents to “carefully consider” and properly order any corrective transactions.
While there is no guarantee the IRS will agree to apply a single payment to multiple quarters, reallocation according to taxpayer intent would be consistent with instructions elsewhere in the I.R.M. See, e.g., recently added I.R.M. Section 126.96.36.199.7 (02-12-2021) on Special Payment Perfection Procedures instructing IRS agents to “[use] taxpayer intent when applying payments.”
Amount of Repayment
Consistent with the statute, FAQ 18 indicates that the amount to be paid by December 31, 2021, is half of the “eligible deferred amount.” The IRS reminder notices may not reflect amounts employers already repaid, whether because of delays in updating IRS records, or because the IRS computations are based on half the amount an employer could have deferred, and the employer actually paid some amount in 2020 that it could have deferred.
If an employer believes it owes more than the amount listed in the notices, we recommend that the employer pay the higher amount to avoid the penalties described above.
What If a Taxpayer Wants to Pay Less Than the Amounts Owed?
Employers that fail to meet the January 2022 and 2023 deposit deadlines discussed above risk exposure to penalties under Code sections 6651 (failure to pay) and 6656 (underpayment of deposits), as well interest on late payments.
The IRS advised informally that employers that are unable to meet the deadlines will be allowed to request installment agreements with the IRS. Under an installment agreement, the employer can repay its deferred taxes over a longer period of time but will owe interest and penalties on the late payments.
In addition, an employer that wishes to enter into an installment agreement must submit a substantial amount of paperwork to the IRS disclosing its financial condition, and the IRS can file a Notice of Federal Tax Lien, which may affect the employer’s access to credit. Because of this, employers may be better off borrowing from a third party to pay the deferred taxes on time. The cost of borrowing would have to be significant to exceed the interest and penalties the IRS would assess, and the employer would not have to deal with an IRS lien.
The IRS initially advised us that employers could not request installment agreements until after they received notice and demand for payment from the IRS, which probably will not happen until at least February 2022. But in more recent discussions, the IRS has indicated a willingness to negotiate installment agreements in advance.
Deadline for Repayments
Code section 7503 states that if the deadline for performing “any act” under the Internal Revenue laws falls on a Saturday, Sunday, or legal holiday, the deadline is extended to the next weekday that is not a legal holiday. Since December 31, 2021 is a Friday and a federal holiday, the deferred taxes due December 31, 2021 would be owed Monday, January 3, 2022.
Similarly, since December 31, 2022 is a Saturday, and Monday January 2, 2023 is a federal holiday, the remaining half of the deferred taxes would be due on Tuesday, January 3, 2023.
The PMTA specifically acknowledges, in a footnote, the January deadlines, and the instructions to the Form 941 (Rev. June 2021, p. 3) recognize these delayed deposit dates. But the IRS FAQs confusingly repeat the “December 31” statutory deadlines. While this slight due date extension does not provide significant savings on interest, delaying payment until the next calendar year could result in a “cash flow” savings on a company’s books, and, depending on an employer’s accounting method, might result in a one-year deferral of the deduction for the tax payment.
The PMTA could effectively be seen as setting up a trap imposing a 10% nondeductible penalty on the full amount deferred in 2020 if there is even a small shortfall or if the employer misses the payment deadlines. Our tax lawyers have raised a complaint to the IRS that we find the penalty terms in PMTA 2021-07 to be egregious for employers, and contrary to the purpose of the CARES Act deferral program to provide relief. Our concerns have been forwarded to the PMTA’s authors. It remains to be seen if and how the IRS will respond.
Since the first payment deadline is imminent, however, we advise employers to pay the full amounts due (including where an employer’s calculations are higher than the amounts owing according to the Notices CP256V). To do otherwise is to risk at least a 10% penalty on the full amount of the deferral. Taxpayers that failed to designate the quarter to which a repayment should be applied, or that paid an aggregate amount and did not allocate the payment across quarters, should contact the IRS to determine how the payment was allocated and request a reallocation, if possible.