The ability to defer the employer share of payroll taxes is a particularly helpful option to improve liquidity offered by Coronavirus Aid, Relief, and Economic Security (CARES) Act, but deferring payment may also defer the income tax deduction. The deferral of the deduction could create a higher tax bill for 2020 and require employers to adjust their current year estimated income tax payments to take into account the delayed income tax deduction. However, with planning and careful cash flow considerations, certain employers may be able to defer the 2020 Social Security tax deposits until 2021 and still receive a tax deduction for those payments in 2020. Employers should assess their liquidity needs and work through their options for recognizing the deduction when determining whether to defer Social Security tax deposits until the due dates in 2021 and 2022.
Deferral of Social Security tax deposits
The CARES Act allows employers to defer deposits of their 6.2% share of the Social Security tax due from March 27, 2020, through Dec. 31, 2020. Half of the deferred amount is due by Dec. 31, 2021, with the other half due by Dec. 31, 2022. There is no cap on the total amount of Social Security tax that can be deferred, but the Social Security taxes only apply to the first $137,700 of an employee’s wages for 2020. Employers are not required to defer payment of Social Security taxes and may instead choose to pay their 2020 tax liability in 2020 or before the due dates described below.
There is no application process to defer Social Security taxes. Employers may begin deferring payment without notifying the IRS by simply reducing their deposit amounts. The deferred amounts are then reported on the employer’s Form 941 for the calendar quarter in which the Social Security taxes would have been deposited if not deferred. A Form 941 for a calendar quarter is required to be filed on or before the last day of the month following the end of the calendar quarter.
In general, all employers are eligible to defer payroll taxes. As originally enacted, the CARES Act required employers who received a Paycheck Protection Program (PPP) loan to stop deferring the Social Security tax after receiving notification of loan forgiveness. However, the CARES Act was recently amended to allow employers to continue to defer Social Security tax deposits after the PPP loan is forgiven, which greatly expands the amount of Social Security taxes PPP loan recipients are permitted to defer.
For additional details on the Social Security tax deferral and a summary of the frequently asked questions issued by the IRS, see our Tax Insights article, “IRS issues FAQ clarifying payroll tax deferral.”
Deduction timing for payroll taxes
The timing for when an employer is allowed an income tax deduction for its share of Social Security taxes depends on the employer’s method of accounting and, for accrual method taxpayers, whether they are using the recurring item exception. As discussed below, deferring payment of the Social Security taxes may defer the employer’s tax deduction.
Cash method taxpayer
In general, the cash method of accounting allows a deduction for employment taxes in the year the deposit is made to the IRS. If the employer defers half of the 2020 Social Security tax payment to Dec. 31, 2021, and half to Dec. 31, 2022, then the employer is allowed an income tax deduction in those taxable years that includes the actual payment dates.
Alternatively, employers can defer depositing their portion of the 2020 Social Security tax until the last day of the 2020 taxable year and still receive a tax deduction in that taxable year. For a calendar year taxpayer, the employer could defer the Social Security taxes until Dec. 31, 2020, and then pay all or a portion of the deferred amount on Dec. 31, 2020, in order to receive a tax deduction in 2020. The employer would generally be allowed a deduction in 2020 for whatever portion of the 2020 Social Security tax it pays in 2020, and then the employer would be allowed a tax deduction in later years for whatever deferred amount is paid in such later years.
This strategy would allow the employer to retain the full deduction in 2020 while deferring payment and retaining cash through the end of 2020. Calendar year taxpayers can wait until the end of 2020 to measure immediate liquidity needs and determine whether it is beneficial to pay some or all the deferred Social Security taxes in 2020 in order to receive an income tax deduction in 2020.
Non-calendar year taxpayers can apply the same planning opportunity. Consider an employer with a June 30 taxable year end that decides to defer Social Security tax for the entire 2020 calendar year. That employer could pay the entire deferred amount by June 30, 2021 and receive a tax deduction for the amount paid in the taxable year ending Jun. 30, 2021. Alternatively, the employer could balance the deferral and tax deduction timing by paying 50% of the deferral by Jun. 30, 2021, thereby receiving a tax deduction for the amount paid in that taxable year, and defer the remaining amount until Jun. 30, 2022, or as far as Dec. 31, 2022, with the deduction being delayed until the taxable year in which payment is made.
Accrual method taxpayer
The tax deduction timing rules may be more favorable, although more complicated, for certain accrual method employers deferring the employer’s share of Social Security tax. Accrual method taxpayers are generally allowed an income tax deduction in the taxable year when the “all-events” test is met and economic performance occurs. However, as discussed in more detail below, the recurring item exception may provide an opportunity to accelerate the deduction.
The all-events test is met in the taxable year in which 1) all the events have occurred that establish the fact of the liability, and 2) the amount of the liability can be determined with reasonable accuracy. In general, the all-events test for payroll taxes is met when the all-events test for the compensation to which the payroll taxes apply has also been met. The all-events test is generally met with respect to normal wages, such as salary and hourly pay, when the employee provides the services to earn the compensation because the employer is legally obligated to pay a specific amount to the employee once the services are provided. Special rules apply to other types of compensation such as deferred compensation or bonuses and other compensation payments that are not fixed because, for example, they are subject to the employer’s discretion.
For purposes of economic performance, payroll taxes, including the employer’s share of Social Security taxes, is considered a payment liability. This means economic performance generally occurs as the Social Security taxes are paid to the federal government. Because the employer’s share of Social Security taxes is a payment liability, the employer is generally allowed a deduction in the year the Social Security taxes are paid.
However, accrual method taxpayers that have adopted the recurring item exception for payroll taxes have an opportunity to defer payment to 2021 and still deduct the amount in 2020. Under the recurring item exception, an employer is allowed a tax deduction in the taxable year the all-events test is met as long as the liability is paid before the earlier of 1) the date the employer timely files its federal income tax return (including extensions) for that taxable year or 2) the 15th day of the ninth calendar month after the close of that taxable year.
For example, an employer with a calendar taxable year defers its applicable 2020 Social Security taxes. If the employer has adopted the recurring item exception with respect to payroll taxes, and pays all or a portion of its deferred payroll taxes by the earlier of either Sept. 15, 2021 (assuming the return is extended), or the date the 2020 income tax return is filed, the employer can deduct such amount paid on the 2020 federal income tax return. However, amounts paid after Sept. 15, 2021 (or the date the return is filed, if earlier), would only be deductible in the taxable year of payment.
Grant Thornton Insight: This is an opportunity for employers to reassess their cash position in 2021 to determine if it makes sense to accelerate the payment of Social Security taxes. Because half of the tax is due by Dec. 31, 2021, it may make sense to accelerate payment of at least 50% of the employer’s Social Security tax liability to Sept. 15 in order to take a deduction in 2020. However, employers should carefully consider the timing implications for filing their income tax returns. For example, it may be more advantageous for employers to file their 2020 income tax returns before Sept. 15, 2021 (assuming a calendar-year taxpayer), in order to take advantage of other federal income tax incentives (e.g., NOL carryback claims, refunds of estimated income tax payments).
Accounting method considerations
An accrual method taxpayer should assess its current method of accounting with respect to payroll taxes and determine whether a change in accounting method to apply the recurring item exception to its payroll taxes may be appropriate to allow the flexibility to deduct all or a portion of the deferred Social Security tax in 2020.
Accounting method changes
A change to using the recurring item exception for payroll taxes is an automatic accounting method change pursuant to Rev. Proc. 2019-43. Employers are generally required to file a Form 3115 when changing to the recurring item exception. Because it is an automatic method change, employers can wait to file the Form 3115 until they timely file their income tax return for the period in which the method change will apply. For a calendar year taxpayer, this means the employer can wait until 2021 to file the Form 3115 with its 2020 tax return to adopt the method for the 2020 taxable year.
However, employers may not adopt the recurring item exception for payroll taxes unless they are in compliance with the uniform capitalization (UNICAP) requirements under Section 263A with respect to payroll taxes. Additionally, employers may not adopt the recurring item exception for a given taxable year if they have made an accounting method change (with or without permission) with regard to payroll taxes within the past five years.
Grant Thornton Insight: Employers should exercise care to avoid unintentional accounting method changes. A common situation is where a taxpayer historically applied the recurring item exception, but later switches to a new tax return preparer. If the taxpayer fails to inform the new tax return preparer to apply the recurring item exception as part of its tax accounting method and the new tax service provider prepares the taxpayer’s return without applying the recurring item exception two years in a row, the taxpayer has inadvertently changed its accounting method for federal tax purposes and may not be able to change back to the recurring item exception without requesting advance consent from the IRS.
The payroll tax deferral provision is designed to provide employers with quick access to cash to improve liquidity, but it can have an impact on the employers’ income tax deduction. A delayed tax deduction could increase an employer’s 2020 income tax liability, which could require the employer to make increased estimated tax payments. With planning and careful cash flow considerations, certain employers may be able to defer the 2020 Social Security tax deposits until later in 2021 and still receive a tax deduction for those payments in 2020. Employers on the accrual method of accounting for income taxes should consider their current accounting method for payroll taxes and determine if an accounting method change is needed to pay the 2020 Social Security tax obligation in 2021 while deducting the payment in an earlier taxable year.
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Partner, Washington National Tax Office
Sharon Kay is the National Managing Partner of Grant Thornton LLP's Washington National Tax Office. Sharon has over 25 years of tax experience and primarily advises clients on federal income tax issues such as accounting method changes, income and expense recognition, inventories, tangible and intangible asset capitalization and recovery, and certain business credits.
Washington DC, Washington DC
- Strategic federal tax
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