A Short Story About Connecticut Unemployment Reporting

I read that the Governor of Connecticut has signed a bill repealing certain additional payroll reporting requirements otherwise slated to start next year.

As background, all state quarterly unemployment returns include certain basic information, including:

·       Name

·       Social security number

·       Wages paid in the quarter

Prior to repeal, Connecticut employers were to report additional information with their quarterly unemployment returns. The reporting was to start in 2024, with the exact phase-in depending on the number of employees:

·       Gender identity

·       Age

·       Race

·       Ethnicity

·       Veteran status

·       Disability status

·       Highest education completed

·       Home address

·       Address of primary work site

·       Occupational code under the standard occupational classification (SOC) system of the federal Bureau of Labor Statistics

·       Hours worked

·       Days worked

·       Salary or hourly wage

·       Employment start date in the current job title

·       Employment end date (if applicable)

Ten of the above 15 data elements are not collected by any other state.

There was concern that the additional elements could negatively impact people filing for benefits – that is, the actual purpose of unemployment taxes.

“The Department of Labor would need to edit incoming reports against certain standards and reject employer wage/tax reports or suspend processing while seeking clarification of elements reported.   

“Rejected or suspended wage reports could make wage information unavailable when unemployment claimants apply for benefits.”

It appears a breath of sanity.

Do Not Do This When Buying Disability Insurance

 

It is a tax trap. An employer thinks that they are doing a boon for their employees by providing a tax-exempt fringe benefit.

Where is the trap?

CTG: it has to do with insurance.

I don’t get it, you say. My employer pays for some/most/all my health insurance. When I see a doctor, the insurance pays some, I pay some. Granted, some health insurances are better than others, but where is the trap?

CTG: it is not health insurance.

I get life insurance at work, you continue. It is equal to a year’s salary or something like that. I have noticed that they charge me something for this on my W-2 every year.

CTG: Life insurance has a split personality. An employer can offer you up to $50 thousand of life insurance as a nontaxable fringe. Any insurance above that amount (for example, if your annual salary is more than $50 grand) is taxable to you. Mind you, the charge tends to be minimal - as the IRS uses favorable rates - but you are charged something.  

It is not life insurance.

It is disability insurance.

Let’s look at John Linford.

John sold Medicare supplement and Medicare Advantage plans. His employer decided to do a nice, and in 2011 it purchased a group disability policy from Principal Life. On the plan’s first iteration, the company paid 100% of the premiums. In 2013 the plan was amended, giving the company the option to charge an employee 25% of the premiums. The company said “nah” to the option, choosing to continue paying 100% of the premiums.

At first blush, this sounds like a beneficent employer.

John incurred a disability in 2014. He filed a worker’s compensation claim in December 2014.

John was fired a year later, in November 2015.

This may still be a beneficent employer. They might have been assisting John in getting to that disability policy.

In May 2017 Principal Life approved his disability claim.

At that speed, one could be homeless before the insurance kicks-in.

Principal Life paid him a $105 grand in retroactive benefits.

John heard that disability is generally nontaxable.

Yep.

John left the $105 grand off his tax return.

Nope.

The IRS caught it, of course.

The IRS wanted almost $22 thousand in tax, as well as a penalty chop of over $4 grand.

Off to Tax Court they went.

There is a Code section for this type of employer-provided insurance: Section 105.

           § 105 Amounts received under accident & health plans.

(a)  Amounts attributable to employer contributions.

Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer.

Read the verbiage at (a).

Except as otherwise provided, any accident or health insurance is taxable to the extent the employer provides the insurance as a tax-free benny. Wait, you say, what about health insurance? That is not taxable. True, but health insurance is nontaxable via the “except as otherwise provided” language. There is no such exception for disability insurance.

This stuff can be confusing.

John had one more swing at the plate. Remember that the company amended the plan allowing them to charge employees 25% of the cost. John wanted to know if there was some relief there. I get it: 25% nontaxable is not as good as 100% nontaxable, but it is better than 100% taxable.

The Court said no. Potential is not actuality, and John never paid any of the premiums.

What about the penalties? Did the Court cut John some slack? One can get confused here: one rule for health insurance, another rule for different insurance.

Based on the record the Court concludes that the petitioner husband did not have reasonable cause and did not act in good faith in not reporting the disability payments.”

The Court upheld the penalties. There went another $4-plus grand.

Some companies allow one to purchase short-term disability through their cafeteria plan. Mind you, this means that the premiums are paid with pre-tax money and will result in taxable income if benefits are ever collected. I tend to back-off on short-term disability, although I prefer that one pay with after-tax dollars for either short- or long-term disability.

I, however, feel strongly about paying after-tax for long-term disability. Those benefits may continue until you reach social security age, and you do not need to be dragging taxes behind you until then. The small rush of a tax-free benny is insignificant if you are ever – in fact – disabled.

Our case this time was Cynthia L Hailstone and John Linford v Commissioner, T.C. Summary Opinion 2023-17.

Can A Severance Be A Gift?

I am looking at a case wondering why a tax practitioner would take it to Tax Court.

Then I noticed that it is a pro se case.

We have talked about this before: pro se means that the taxpayer is representing himself/herself. Technically that is not correct (for example, someone could drag me in and still be considered pro se), but it is close enough for our discussion.

Here is the issue:

Can an employer make a nontaxable gift to an employee?

Jennifer Fields thought so.

She worked at Paragon Canada from 2009 to 2017. Apparently, she was on good terms with her boss, as the company …

·      Wired her 35,000 Canadian dollars in 2012

·      Wired her $53,020 in 2014 to help with the down payment on a house in Washington state.

I am somewhat jealous. I am a career CPA, and CPA firms are not known for … well, doing what Paragon did for Jennifer.

She separated from Paragon in 2017.

They discussed a severance package.

Part of the package was forgiveness of the loan arising from those wires.

Forgiveness here does not mean what it means on Sunday. The company may forgive repayment, but the IRS will still consider the amount forgiven to be taxable income. The actual forgiveness is therefore the after-tax amount. If one’s tax rate is 25%, then the actual forgiveness would be 75% of the amount forgiven. It is still a good deal but not free.

Paragon requested and she provided a Form W-9 (the form requesting her social security number).

Well, we know that she will be getting a W-2 or a 1099 for that loan.

A W-2 would be nice. Paragon would pick-up half of the social security and Medicare taxes. If she is really lucky, they might even gross-up her bonus to include the taxes thereon, making the severance as financially painless as possible.

She received a 1099.

Oh well.

She left the 1099 off her tax return.

The IRS computers caught it.

Because … of course.

Off to Tax Court they went.

This is not highbrow tax law, folks. She worked somewhere. She received a paycheck. She left work. She received a final paycheck. What is different about that last one?

·      She tried to get Paragon to consider some of her severance as a gift.

The Court was curt on this point. You can try to be a bird, but you better not be jumping off tall buildings thinking you can fly.

·      She was good friends with her boss. She produced e-mails, text messages and what-not.

That’s nice, said the Court, but this is a job. There is an extremely high presumption in the tax Code that any payment to an employee is compensatory.

But my boss and I were good friends, she pressed. The law allows a gift when the relationship between employer and employee is personal and the payment is unrelated to work.

Huh, I wonder what that means.

Anyway, the Court was not buying:

Paragon’s inclusion of the disputed amount in the signed and executed severance agreement and the subsequent issuance of a Form 1099-MISC indicates that the payments were not intended to be a gift.”

She really did not have a chance.

The IRS also wanted penalties. Not just your average morning-drive-through penalties, no sir. They wanted the Section 6662(a) “accuracy related” penalty. Why? Well, because that penalty is 20%, and it is triggered if the taxpayer omits enough income to underpay tax by the greater of $5 grand or 10% of what the tax should have been.

Think biggie size.

The Court agreed on the penalty.

I was thinking what I would have done if Jennifer had been my client.

First, I would have explained that her chance of winning was almost nonexistent.

COMMENT: She would have fired me then, realistically.

Our best course would be to resolve the matter administratively.

I want the penalties dropped.

That means we are bound for Appeals. There is no chance of getting that penalty dropped before then.

I would argue reasonable cause. I would likely get slapped down, but I would argue. I might get something from the Appeals Officer.

Our case this time was Fields v Commissioner, T.C. Summary Opinion 2022-22.

 

Repaying a COVID-Related Distribution

Do you remember a tax break in 2020 that allowed you to take (up to) $100,000 from your IRA or your employer retirement plan? These were called “coronavirus-related distributions,” or CRDs in the lingo. In and of itself, the provision was not remarkable. What was remarkable is that one was allowed three years to return some, all, or none of the money to the IRA or employer plan, as one wished.

I was thinking recently that I do not remember seeing 2021 individual returns where someone returned the money.

Granted, we have a flotilla of returns on extension here at Galactic Command. I may yet see this beast in its natural state.

Let’s go over how this provision works.

To make it easy, let’s say that you took $100,000 from your 401(k) in 2020 for qualifying COVID-related reasons.

You had an immediate binary decision:

·      Report the entire $100,000 as income in 2020 and pay the taxes immediately.

·      Spread the reporting of the $100 grand over three years – 2020, 2021 and 2022 - and pay taxes over three years.

There was no early-distribution penalty on this distribution, which was good.

You might wonder how paying the tax immediately could be preferable to paying over three years. It could happen. How? Say that you had a business and it got decimated by COVID lockdowns. Your 2020 income might be very low – heck, you might even have an overall tax loss. If that were the case, reporting the income and paying the tax in 2020 might make sense, especially if you expected your subsequent years’ income to return to normal levels.

What was a COVID-related reason for a distribution?

The easy ones are:

·      You, a spouse or dependent were diagnosed (and possibly quarantined) with COVID;

·      You had childcare issues because of COVID;

·      You were furloughed, laid-off or had work hours reduced because of COVID.

Makes sense. There is one more:

·      You experienced other “adverse financial consequences” because of COVID.

That last one has an open-gate feel to me. I’ll give you an example:

·      You own rental cabins in Aspen. No one was renting your cabins in 2020. Did you experience “adverse financial consequences” triggering this tax provision?

You have – should you choose to do so – three years to put the money back. The three-year period starts with the date of distribution, so it does not automatically mean (in fact, it is unlikely to be) December 31^st three years later.

The money doesn’t have to return to the same IRA or employer plan. Any qualifying IRA or employer plan will work. Makes sense, as there is a more-than-incidental chance that someone no longer works for the same employer.

 Let’s say that you decide to return $50 grand of the $100 grand.

The tax reporting depends on how you reported the $100 grand in 2020.

Remember that there were two ways to go:

·      Report all of it in 2020

This is easy.

You reported $100 grand in 2020.

When you return $50 grand you … amend 2020 and reduce income by $50 grand.

What if you return $50 grand over two payments – one in 2021 and again in 2022?

Easy: you amend 2020 for the 2021 and amend 2020 again for the 2022.

Question: can you keep amending like that – that is, amending an amended?

Answer: you bet.

·       Report the $100 grand over three years.

This is not so easy.

The reporting depends on how much of the $100 grand you have left to report.

Let’s say that you are in the second year of the three-year spread and repay $30,000 to your IRA or employer plan.

The test here is: did you repay the includable amount (or less) for that year?

If yes, just subtract the repayment from the includable amount and report the difference on that year’s return.

In our example, the math would be $33,333 - 30,000 = $3,333. You would report $3,333 for the second year of the spread.

If no, then it gets ugly.

Let’s revise our example to say that you repaid $40,000 rather than $30,000.

First step: You would offset the current-year includable amount entirely. There is nothing to report the second year, and you still have $6,667 ($40,000 – 33,333) remaining.

You have a decision.

You have a year left on the three-year spread. You could elect to carryforward the $6,667 to that year. You would report $26,666 ($33,333 – 6,667) in income for that third and final year.

You could alternatively choose to amend a prior year for the $6,667. For example, you already reported $33,333 in 2020, so you could amend 2020, reduce income by $6,666 and get an immediate tax refund.

Which is better? Neither is inherently better, at least to my thinking. It depends on your situation.

There is a specific tax form to use with spreads and repayments of CRDs. I will spare us the details for this discussion.

There you have it: the ropes to repaying a coronavirus-related distribution (CRD).

If you reflect, do you see the complexity Congress added to the tax Code? Multiply this provision by however many times Congress alters the Code every year, and you can see how we have gotten to the point where an average person is probably unable to prepare his/her own tax return.

 

Receiving An IRS Lock-In Letter

 

A client recently picked up his personal tax return. He asked to see me.

There was tax due with the return. I thought he had adjusted his withholding to increase his take-home pay, as he had spoken to me of financial stress. I am not a fan of doing this, as tax is due whether one withholds or not.   

He could not have tax due with his return, he explained, as he had received a lock-in letter from the IRS.

There is something I do not often see.

There are two versions of the lock-in letter: one sent to the employee and another to the employer. The IRS is telling both that it wants additional withholding from each paycheck, commonly meaning single withholding with no dependents.

The lock-in surprised me, as my client is not one to game the system. What he did was fall behind on his taxes due to a failed business. There are liens – IRS and private - that he is working through.

The IRS sends the employee a letter informing him/her that his/her withholdings are too low. The IRS wants the employee to self-adjust by increasing their withholding.

If that fails, the IRS sends the employer a letter. An employer has 60 days from the date of the letter to unilaterally adjust the employee’s withholdings.

The employee can quit, but the lock is good for 12 months. The employee will have to go somewhere else for a year before returning if he/she wishes to avoid the lock.

The 60 days has two purposes:

(1)  To allow the employer time to make the changes, and 

(2)  To prompt the employee to contact the IRS. If so – and if the employee can persuade the IRS – the IRS may modify the lock.

If the employee keeps his/her nose clean, he/she can request the IRS remove the lock-in. Figure that it will take about three years of tax returns, however, so it is best to avoid the lock altogether.

The employer is extremely unlikely to buck the IRS, as the employer might then draw surrogate liability. One might be a valued employee, but one is not that valued. 

Let’s look at a case.

Charles G worked for Volvo Trucks North America (VTNA). He submitted a W-4 to VTNA claiming that he was exempt from income tax withholding. He also requested VTNA to stop withholding social security taxes.

VTNA was surprisingly tolerant. It spotted Charles a 99-dependent W-4 (affecting income tax withholding), although it could not do anything about the social security.

Charles went a couple of years or so before the IRS contacted him. He blew it off, so the IRS sent VTNA a lock-in letter.

Charles went ballistic.

Charles accused the IRS and VTNA of “acting in violation of the Racketeer Influenced and Corrupt Organizations Act (RICO).”

Wow. I wonder how it went come employee review time.

The Court of course dismissed Charles’ claim against VTNA. In general, an employer must follow an employee’s request concerning withholding. If the employee asserts that he/she is exempt from withholding, then the employer must comply with such request unless certain situations occur. A lock-in letter is one of those situations.

It sounds rather self-evident, truthfully.

It also sounds like Charles was a bit of a tax protestor. A word of advice: don’t go there with Charles. Your chances of success are between zero and none, and the list of dead bodies on that hill stretches interminably. Several years ago, we represented a business having an officer the IRS considered a protestor. I did not agree with the IRS on this, but I admit that he was getting close to the line.  The audit was … unpleasant. There was no question that school was in session, and the IRS was looking to teach a lesson.

Our case this time was Giles v Volvo Trucks of North America, 551 F. Supp 2^nd 359.

Downside Of Not Issuing 1099s

Let’s be honest: no one likes 1099s.

I get it. The government has conscripted us – business owners and their advisors – into unpaid volunteers for the IRS. Perhaps it started innocently enough, but with the passage of years and the accretion of reporting demands, information reporting has become a significant indirect tax on businesses.

It’s not going to get better. There is a proposal in the White House’s Green Book, for example, mandating banks to report gross deposit and disbursement account information to the Treasury.

Back to 1099s.

You see it all the time: one person pays another in cash with no intention – or ability – to issue a 1099 at year-end.

What can go wrong?

Plenty.

Let’s look at Adler v Commissioner as an example.

Peter Adler owned a consulting company. He had a significant client. He would travel for that client and be reimbursed for his expenses.

The accounting is simple: offset the travel expenses with the reimbursements. Common sense, as the travel expenses were passed-on to the client.

However, in one of the years Peter incurred expenses of approximately $44 thousand for construction work.

The Court wondered how a consultant could incur construction expenses.

Frankly, so do I.

For one reason or another Peter could not provide 1099s to the IRS.

One possible reason is that Peter made his checks out to a corporation. One is not required to issue 1099s to an incorporated business. Peter could present copies of the cancelled checks. He could then verify the corporate status of the payee on the secretary of state’s website.

Nah, I doubt that was the reason.

Another possibility is that Peter got caught deducting personal expenses. Let’s assume this was not the reason and continue our discussion.

A third possibility is that Peter went to the bank, got cash and paid whoever in cash. Paying someone in cash does not necessarily mean that you will not or cannot issue a 1099 at year-end, but the odds of this happening drop radically.

Peter had nothing he could give the Court. I suppose he could track down the person he paid cash and get a written statement to present the Court.

Rigghhhtttt ….

The Court did the short and sweet: they disallowed the deduction.

Could it get worse?

Fortunately for Peter, it ended there, but – yes – it can get worse.

What if the IRS said that you had an employee instead of a contractor? You are now responsible for withholdings, employer matching, W-2s and so on.

COMMENT: You can substitute “gig worker” for contractor, if you wish. The tax issues are the same.

Folks, depending upon the number of people and dollars involved, this could be a bankrupting experience.

Hold on CTG, say you. Isn’t there a relief provision when the IRS flips a contractor on you?

There are two.

I suspect you are referring to Section 530 relief.

It provides protection from an IRS flip (that is, contractor to employee) if three requirements are met:

1.    You filed the appropriate paperwork for the relationship you are claiming exists with the service provider.

2.    You must be consistent. If Joe and Harry do the same work, then you have to report Joe and Harry the same way.

3.    You have to have a reasonable basis for taking not treating the service provider as an employee. The construction industry is populated with contractors, for example.

You might be thinking that (3) above could have saved Peter.

Maybe.

But (1) above doomed him.

Why?

Because Peter should have issued a 1099. He had a business. A business is supposed to issue a 1099 to a service provider once payments exceed $600.

There was no Section 530 relief for Peter.

I will give you a second relief provision if the IRS flips a contractor on you. 

Think about the consequences of this for a second.

(1)  You were supposed to withhold federal income tax.

(2)  You were supposed to withhold social security.

(3)  You were supposed to match the social security.

(4)  You were supposed to remit those withholdings and your match to the IRS on a timely basis.

(5)  You were supposed to file quarterly employment reports accounting for the above.

(6)  You were supposed to issue W-2s to the employee at year-end.

(7)  You were supposed to send a copy of the W-2 to the Social Security Administration at year-end.

(8)  Payroll has some of the nastiest penalties in the tax Code.

This could be a business-shuttering event. I had a client several years ago who was faced with this scenario. The situation was complicated by fact that the IRS considered one of the owners to be a tax protestor. I personally did not think the owner merited protestor status, as he was not filing nonsense appeals with the IRS or filing delaying motions with the Tax Court. He was more …  not filing tax returns.  Nonetheless, I can vouch that the IRS was not humored.

Back to relief 2. Take a look at this bad boy:

§ 3509 Determination of employer's liability for certain employment taxes.

(a)  In general.

If any employer fails to deduct and withhold any tax under chapter 24 or subchapter A of chapter 21 with respect to any employee by reason of treating such employee as not being an employee for purposes of such chapter or subchapter, the amount of the employer's liability for-

(1)  Withholding taxes.

Tax under chapter 24 for such year with respect to such employee shall be determined as if the amount required to be deducted and withheld were equal to 1.5 percent of the wages (as defined in section 3401 ) paid to such employee.

(2)  Employee social security tax.

Taxes under subchapter A of chapter 21 with respect to such employee shall be determined as if the taxes imposed under such subchapter were 20 percent of the amount imposed under such subchapter without regard to this subparagraph .

Yes, you still owe federal income and social security, but it is a fraction of what it might have been. For example, you should have withheld 7.65% from the employee for social security. Section 3509(a)(2) gives you a break: the IRS will accept 20% of 7.65%, or 1.53%.

Is it great?

Well, no.

Might it be the difference between staying in business and closing your doors?

Well, yes.

State Taxation of Telecommuting

The year 2020 has brought us a new state tax issue.

To be fair, the issue is not totally new, but it has taken on importance with stay-at-home mandates.

Here is the issue: You work in one state but live in another. Which state gets to tax you when you are working from home?

Let’s start with the general rule: state taxation belongs to the state where the employee performs services, not the state where the employee resides. The concept is referred to as “sourcing,” and it is the same reason a state can tax you if you have rental real estate there.

Let’s follow that with the first exception: states can agree to not follow the general rule. Ohio, for example, has a reciprocal agreement with Kentucky. The agreement provides that an employee will be taxed by his/her state of residence, not by the state where the employee works.   A Kentucky resident working in Ohio, for example, will be taxed by Kentucky and not by Ohio.

Let’s pull away from the Cincinnati tristate area, however. That reciprocal agreement makes too much sense.

We need two other states: let’s use Iowa and Missouri.

One lives in Iowa and commutes to Missouri. Both states have an individual income tax. We have 2020, COVID and stay-at-home. An employee of a Missouri employer works from home, with home being Iowa.

Which state gets to tax?

This one is simple. Iowa.

Why?

Because both states have the same rule: the state of residence gets to tax a telecommuter.

So where is the issue in this area?

With states that are … less reasonable … than Iowa and Missouri.

Let’s go to Captain Obvious: New York.

New York has a “convenience of the employer” addendum to the above discussion. Under this rule, New York asks why the employee is working remotely: is it for the convenience of the employer, or is it for the convenience of the employee? The tax consequence varies depending on the answer.

* If for the convenience of the (New York) employer, then the employee’s state of residence has the first right to tax.

* If for the convenience of the (nonresident) employee, then New York has the first right to tax.

We for example have a Tennessee client with a New York employer who walked into this issue. He lives and works in Memphis, infrequently travelling to New York. We were able to resolve the matter, but New York initially went after him rather aggressively.

How does New York’s rule work with 2020 and COVID?

It doesn’t.

All those employees not commuting to New York were very much observing the convenience of their employer.

Clearly, this was an unacceptable answer to New York.

Let’s change the rule, said New York: the employee’s “assigned or primary” location will now control. If my accounting office was located in New York, for example, that would be my “assigned or primary” office and New York could tax me, no matter where I was.

How could I avoid that result? I would need to have my employer open a bona fide office where I lived. Some people could do that. Most could not.

Yessir.

There is no evolving tax doctrine here. This is ad hoc and reactive taxation, with much caprice, little constancy and the sense that New York will say and do whatever to lift your wallet.

There are few other states that follow this “convenience” rule: Pennsylvania, Delaware and New Jersey come to mind. It is more convenient for them to tax you than not to tax you, to reword the rule.

COVID introduced us to two more states feuding over the taxation of telecommuters: Massachusetts and New Hampshire. Massachusetts decreed that any employee who began working outside the state for “pandemic-related” circumstances would continue to be subject to Massachusetts income tax.

It is the same issue as New York, one might initially think. New Hampshire will allow a tax credit for the tax paid Massachusetts. The accounting fee goes up, but it works out in the end, right?

Nope.

Why?

New Hampshire does not tax W-2 income.

How do states like Massachusetts or New York justify their behavior?

There is an argument: Massachusetts and New York have roads, infrastructure, schools, universities, hospitals and so forth that attracted employers to locate there. Their tax is a fair and appropriate levy for providing and sustaining an environment which allows a person to be employed.

Got it.

Don’t buy it.

I grew up in Florida, which does not have an individual income tax. Somehow the state nonetheless has roads, infrastructure, schools, universities, hospitals and so forth. The only explanation must be divine intervention, it appears.

Additionally, if I lived in New Hampshire – and worked from there – I might prefer that my taxes go to New Hampshire. I after all would be using its roads, infrastructure, schools, universities, hospitals and so on, putting little – or no – demand on Massachusetts. I might in fact be quite pleased to not commute into Massachusetts regularly, if it all. It seems grotesque that Massachusetts will chase me across the fruited plains just because I need a job.

New Hampshire has filed a complaint against Massachusetts with the Supreme Court. The argument is rather simple: Massachusetts is infringing by imposing its tax on New Hampshire residents working in New Hampshire.  Interestingly, Connecticut and New Jersey have filed amicus (“friend of the court”) briefs supporting New Hampshire’s position. Their beef is with New York and not Massachusetts, but they are clearly interested in the issue.

I personally expect the expansion and growing acceptance of telecommuting to be a permanent employment change as we come out of COVID and its attendant restrictions. With that as context, the treatment of telecommuting may well be one of the “next big things” in taxation.

Changes to 2020 Federal Payroll Taxes

There were two bills passed in March that significantly impacted payroll taxes for 2020. The first – Families First Coronavirus Response Act – expanded employee paid leave, with the intent that the cost of the leave be shifted to the government via refundable payroll tax credits. The second – The Coronavirus Aid, Relief and Economic Security Act - allows employers to defer the deposit of (some) payroll taxes, while also providing a payroll tax credit to encourage employers directly affected by the virus (either through government order or decline in business) to retain employees.

Following is a recap to aid as you work through this new minefield. As always, remember that no recap is exhaustive. Please be advised to review the underlying guidance for specific issues and questions.

The President signed the CARES Act on March 27, 2020.

The CARES act brought us the Employee Retention Credit (ERC).

(1)  Eligible employers include tax-exempt organizations but not government agencies.

(2)  Eligible employers have a refundable credit equal to 50% of qualified wages (including allocable health care expenses) paid employees if the employer …

(a)  Fully or partially suspends operations during 2020 due to orders from an appropriate governmental authority due to COVID-19; or

(b)  Experiences a significant decline in gross receipts during a calendar quarter.

a.    The period begins with the first quarter in which gross 2020 receipts are less than 50% of gross receipts for the same quarter in 2019.

b.    The period ends the quarter after the quarter whose gross receipts exceed 80% for the same quarter in 2019.

(3)  Qualified wages mean wages paid after March 12, 2020 and before January 1, 2021.

NOTE: This means that an eligible employer may claim the credit for qualified wages paid as early as March 13, 2020.

(4) Qualified wages include allocable health care expenses and are limited to $10,000 per employee for 2020.

(5) Qualified wages vary significantly depending on the size of the employer.

(a)   If the employer had 100 or fewer full-time equivalents (FTEs) in 2019, then qualified wages include wages paid all employees.

(b)  If the employer had more than 100 FTEs in 2019, then qualified wages mean wages paid an employee not working because of (a) government orders or (b) a significant decline in gross receipts.

(6) The credit is 50% of qualified wages, meaning the maximum credit is $5,000 ($10,000 times 50%).

(7) Technically, the credit is allowed only against the employer share of social security tax (that is 6.2%), but this is misleading. The credit is fully refundable, so it will continue offsetting employee payroll withholdings and employer payroll taxes until the credit exhausted. If there is still a credit remaining, then the remaining credit is refundable to the employer.

EXAMPLE: CTG Command Center pays $10,000 in qualifying wages in quarter 2, 2020. Employee federal income tax, social security and Medicare withholdings are $4,000. The employer social security is $620 ($10,000 times 6.2%), for a required total payroll tax deposit of $4,620. The retention credit is $5,000. The retention credit will offset all the required payroll tax deposits – employee and employer – and result in a $380 refund to CTG Command Center.

(8) The IRS realized that having an employer make payroll tax deposits, only to have those deposits later refunded, is not prudent cash flow management. The IRS will therefore allow an employer to offset otherwise required payroll tax deposits by anticipated payroll tax credits. The amounts otherwise due or credited are to be accounted for with the filing of the quarterly Form 941. If payroll tax credits are expected to exceed payroll tax deposits otherwise required, there is also a procedure to obtain an advance refund (that is, before filing Form 941) from the IRS.

(9) There is an unusual interaction with the CARES deferral of employer payroll taxes:

·      An employer can defer and still receive the employee retention credit, resulting in, in effect, an interest-free loan from the government.

(10) There is no equivalent of the retention credit for self-employeds.

(11) This credit does not play well with the emergency sick or expanded family leave provisions. In short, one cannot use the same wages for more than one credit.

(12) This credit is not available if the employer receives a Paycheck Protection loan.

 The CARES Act also brought us the deferral of employer social security taxes.

(1) An employer’s payroll tax liability has two parts: social security tax at 6.2% and Medicare tax at 1.45%. The deferral is solely for the employer share of social security taxes (that is, 6.2%).

(2) Unlike the ERC, the deferral applies to deposits (rather than wages paid) otherwise required beginning March 27, 2020 and through December 31, 2020.

COMMENT:  Therefore, payroll taxes accrued before March 27, 2020 would qualify as long as the payroll tax deposit was due on or after March 27, 2020.

(3) All employers are eligible. Unlike the ERC, there is no employer size limitations.

(4) Unlike the ERC, there is no requirement that the employer be affected by COVID-19.

(5) The deferral is as follows:

(a)  50% of taxes deferred are due December 31, 2021

(b)  The remaining 50% is due December 31, 2022

(6) The deferral also applies to self-employeds. The amount deferred is 6.2% of the total 15.3% self-employment tax rate. The is no deferral once the self-employed exceeds the maximum social security wage base.

(7) There is an unusual interaction with the Families First emergency sick and expanded family leave credits.

·      An employer can defer and still receive the emergency sick and expanded family leave credits, resulting in, in effect, an interest-free loan from the government.

(8) There is an unusual interaction with the employee retention credit (ERC).

·      An employer can defer and still receive the employee retention credit, resulting in, in effect, an interest-free loan from the government.

(9) There is an unusual interaction with a Paycheck Protection loan.

·      No further deferrals are allowed after an employer receives notice of Paycheck Protection Loan forgiveness.

·      However, deferrals up to that date remain eligible for deferral and are due December 31, 2021 and 2022.

(10) Note that the deferral affects payroll taxes due on or after March 27, 2020, meaning that one would expect the deferral to be accounted for on the first quarter employer Form 941.

The IRS has clarified that the credit for this stub period will NOT be accounted for on the first quarter Form 941. Rather they will be added to any credits arising during the quarter two and reported on the second quarter Form 941.

The President signed the Families First Coronavirus Response Act on March 18, 2020, introducing two new (and temporary) paid-leave benefits.

Emergency Sick Leave

(1)  Applies to businesses and tax-exempt organizations with fewer than 500 employees 

(2)  Applies immediately to employees of the above employers

(3)  The tax credit is based on qualifying leave provided employees between April 1, 2020 and December 31, 2020.

·      Note that emergency sick leave wages paid in 2021 will qualify if paid for leave taken between April 1 and December 31,2020. 

(4)  Full-time employees can receive up to 80 hours of sick leave. Part-time employees can receive leave based on the average number of hours worked over a two-week period of time.  

(5)  If …

a.     The employee is subject to a federal, state or local quarantine or isolation order related to COVID-19;

b.    The employee has been directed by a healthcare provider to self-quarantine due to concerns related to COVID-19;

c.     The employee is seeking to obtain medical diagnosis when experiencing symptoms of COVID-19

… then the maximum (creditable) paid leave is the employee’s regular rate of pay, up to $511 per day and limited to $5,110 per employee.

(6)  If the employee takes time-off …

a.     To care for a family member who is subject to a federal, state or local quarantine or isolation order related to COVID-19;

b.    To care for a child (under 18 years of age) whose school has been closed or paid childcare provider is unavailable due to COVID-19; or

c.     Because the employee is experiencing any other substantially similar conditions as specified by the Secretary of Health and Human Services

… then the maximum (creditable) paid leave is 2/3 of the employee’s regular rate of pay, up to $200 per day and limited to $2,000 per employee.

(7)  For both (5) and (6), the employer is allowed to increase the credit amount by the allocable cost of the employee’s health insurance coverage.

(8)  Employers are still required to withhold employee federal income taxes and the employee’s share of Social Security and Medicare taxes. 

·      The intent is that this will be covered by the $511/$200 per day allowance.

(9)  Wages paid under the emergency sick leave provision ….

a.     Are NOT be subject to employer social security (6.2%), and

b.    ARE subject to employer Medicare (1.45%)

                                                      i.     However, this employer Medicare requirement is misleading because the credit will be increased by the amount of

1.    The employer Medicare tax, and

2.    The allocable cost of health insurance coverage

EXAMPLE: CTG Command Center pays one employee $200 per day for 10 days. It also pays $100 in health care costs. Employee withholdings are $300 for federal income tax, $124 for social security and $29 for Medicare – a total of $453.Net pay is therefore $1,547 ($2,000 – $453) and total compensation (including health care and employer Medicare) is $2,129. CTG Command Center will receive credit on its payroll tax return for $2,000 + $100 (allocable health care) + $29 (employer Medicare) = $2,129. This means that the cost of the employee (excluding unemployment insurance and workers compensation) has been shifted from CTG Command to the federal government for the covered period.  

(10)        The credit can be offset against all employee withholdings and employer payroll taxes.

·      Any excess is refundable to the employer.

(11)       Any credits utilized will constitute taxable income to the employer.

·      Offsetting the employer payroll tax expense on wages paid emergency leave employees.

(12)       There is a comparable provision for self-employeds

a.     However, the “average daily self-employment income” will not be calculable until year-end, as it refers to 2020 net earnings from self-employment divided by 260 days.

EXAMPLE. Rocket Man is self-employed. He earned $185,000 for 2020, and he spent 10 days taking care of his mom during the crisis. His daily self-employment income is $712 ($185,000 divided by 260). That however exceeds $200, so his allowable paid sick leave is $2,000. His 2020 net earnings from self-employment are reduced by $2,000. He is also allowed to reduce his otherwise-required quarterly estimated tax payments accordingly. 

(13)       There is an unusual interaction with the emergency sick leave credit and the employer payroll tax deferral.

·      An employer can defer and still receive the emergency sick leave credit, resulting, in effect, an interest-free loan from the government.

(14) This credit does not play well with the employee retention credit. In short, one cannot use the same wages for more than one credit.

Expanded Family Leave

(1)  Applies to businesses and tax-exempt organizations with fewer than 500 employees 

(2)  This is a narrow expansion of FMLA to include

… employees unable to perform services (including telework) because of need to care for a child whose school or place of care is closed or whose childcare provider is unavailable due to COVID-19. 

(3)  The employee must have worked for the employer for at least 30 day to qualify.

(4)  The credit is based on qualifying leave provided employees between April 1, 2020 and December 31, 2020

·      Note that emergency sick leave wages paid in 2021 will qualify if paid for leave taken between April 1 and December 31,2020. 

(5)  The provision allows up to 12 weeks of employer-provided protected leave, 10 of which is creditable to the employer.

(6) The maximum (creditable) emergency family leave is the employee’s regular rate of pay, up to $200 per day and limited to $10,000 per employee.

(7) The employer is allowed to increase the credit amount by the allocable cost of the employee’s health insurance coverage.

(8)  Employers are still required to withhold employee federal income taxes and the employee’s share of Social Security and Medicare taxes.

·      The intention is that this will be covered by the $200 per day allowance.

(9)  Wages paid under the expanded family leave provision ….

a.     Are NOT be subject to employer social security (6.2%), and

b.    ARE subject to employer Medicare (1.45%)

                                                      i.     However, this employer Medicare requirement is misleading because the credit will be increased by the amount of

1.    The employer Medicare tax, and

2.    The allocable cost of health insurance coverage

(10)       The credit can be offset against all employee withholdings and employer payroll taxes.

·      Any excess is refundable to the employer.

(11)       Any credits utilized will constitute taxable income to the employer.

·      Offsetting the employer payroll tax expense on wages paid emergency leave employees.

(12)       The example given above for emergency sick leave also covers expanded family leave.

(13)       The discussion about self-employeds given above also covers expanded family leave.

(14)       There is an unusual interaction with the expanded family leave credit and the employer payroll tax deferral.

·      An employer can defer and still receive the expanded family leave credit, resulting in, in effect, an interest-free loan from the government.

(15)       This credit does not play well with the employee retention credit. In short, one cannot use the same wages for more than one credit.

(16)       The FMLA “restoration to position” provision under FMLA does not apply to employers with fewer than 25 employees and meeting certain other requirements.