Deferral of penalties for failure to timely deposit employment taxes

Editor: Susan Minasian Grais, CPA, J.D.,LL.M.

In a Program Manager Technical Advice memo from the Chief Counsel’s office (PMTA 2021-07), the IRS determined that a failure to deposit any portion of the federal employment taxes deferred by Section 2302 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, by the applicable installment due date will result in a penalty under Sec. 6656 that runs from the original due date and applies to the entire deferred amount.

The CARES Act delayed the timing of required federal employment tax deposits for certain employer payroll taxes and self-employment taxes incurred from March 27, 2020 (the date of enactment), through Dec. 31, 2020. The CARES Act treats these amounts as timely paid if 50% of the deferred amount was paid by Dec. 31, 2021, and the remainder by Dec. 31, 2022.

Because these dates fall on (and are immediately followed by two additional) Saturdays, Sundays, or legal holidays, the Chief Counsel memo confirms that the deadlines are actually Jan. 3, 2022, and Jan. 3, 2023, under the rules of Sec. 7503. All employers may avail themselves of the payroll tax deposit deferral.

Applicable employment taxes include:

• The employer’s share of Old-Age, Survivors, and Disability Insurance Tax (Social Security) under Sec. 3111(a), which is 6.2% of wages up to the wage base ($137,700 in 2020); and
• The portions of the employer’s and employee representatives’ shares of Tier 1 Railroad Retirement Tax Act (RRTA) tax under Secs. 3221(a) and 3211(a), respectively, that each correspond to the 6.2% Social Security tax rate due.

Under Sec. 6656, the penalty is 10% of the underpayment if the failure is for more than 15 days and 15% if the tax is not paid within 10 days of the first notice sent to the taxpayer demanding payment. The penalty does not apply: (1) if the failure is due to reasonable cause and not willful neglect; (2) to certain first-time depositors; and (3) to the extent that a failure to deposit any or all of the tax was due to the taxpayer’s anticipating refundable credits allowed under COVID-19-relief provisions.

As explained in the instructions to Form 941, Employer’s Quarterly Federal Tax Return, and FAQs posted on the IRS website (available at www.irs.gov), the deferred tax may be repaid using the Electronic Federal Tax Payment System (EFTPS) or by mailing in the payment with a 2020 Form 941-V, Payment Voucher.

The IRS gave two examples in the PMTA memo showing that the penalty would apply to the entire amount deferred whether the late payment was for the first installment or the second installment.

Implications

Most employers chose to defer tax payments in accordance with Section 2302 of the CARES Act and thus are potentially liable for Sec. 6656 penalties on the full amount of tax deferred if they fail to pay any portion when due.

Flexibility in repayment deadlines: The extension of the deadlines under Sec. 7503 gives employers income tax planning opportunities. Employers may generally deduct employment taxes in the tax year in which the taxes are paid. Thus, an employer may choose to delay its payments until Jan. 3, 2022, and Jan. 3, 2023, if it would benefit from doing so. For example, if corporate income tax rates are higher in 2022 than in 2021, a corporate employer with a calendar tax year might benefit from paying its first installment of deferred employment tax on Jan. 3, 2022, rather than in 2021. Because taxpayers are not required to apply Sec. 7503, the employer could later decide whether to make the second installment payment in 2022 or 2023.

Some employers may wish to pay their deferred employment taxes well before these deadlines. For example, an employer with a calendar tax year may benefit from claiming an income tax deduction for the deferred taxes on its 2020 return. Despite the general rule that taxes are deductible in the year paid, taxes paid within 8½ months after the end of the tax year may be deducted in the prior tax year if the recurring-item exception under Sec. 461(h)(3) applies.

In sum, employers may have flexibility to deduct at least some portion of their deferred taxes in 2020, 2021, 2022, or 2023, depending on when they choose to pay them. On the other hand, if an employer does not pay the full amount due by each of the two installment deadlines, significant penalties may apply to the entire amount of employment tax deferred from 2020.

Repayment timing and amounts: A separate payment must be made for each quarter in which the taxes are deferred. Half of the Social Security tax that could have been deferred, without regard to how much was actually deferred, must be paid by Jan. 3, 2022. For an employer that deferred less than the eligible amount for a quarter, Social Security taxes already paid count toward the repayment. For example, an employer that could have deferred $20,000 in Social Security taxes for a quarter but deferred $15,000 must pay $5,000 by Jan. 3, 2022, and the remaining $10,000 by Jan. 3, 2023.

It was previously unclear whether the IRS would treat the tax to be repaid in the first installment as 50% of the total tax that could have been deferred for all of 2020 (that is, an annualized approach), or instead 50% of the tax that could have been deferred for each quarter. The IRS has informally indicated that it expects employers to use the quarterly approach. For example, under an annualized approach, an employer with $4,030,000 in deferrable Social Security tax liability would owe $1,705,000 by Jan. 3, 2022; under a quarterly approach, the employer would owe a different amount depending on what was deferrable and actually deferred in each quarter. Thus, if the employer were to use the annualized approach instead and pay only $1,705,000 by the Jan. 3, 2022 deadline, it seems the IRS would treat the entire $4,030,000 that was deferred from 2020 as ineligible for deferral and assert a $403,000 failure-to-deposit penalty under Sec. 6656 (10% of $4,030,000) if the amount paid is less than what would be due when computing the liability using a quarterly approach.

EditorNotes

Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. For additional information about these items, contact Ms. Grais at 202-327-8788 or susan.grais@ey.com.

Contributors are members of or associated with Ernst & Young LLP.