With many businesses operating under constrained financial circumstances because of the coronavirus pandemic, finding available cash to pay current operating expenses can be difficult. Although the Coronavirus Aid, Relief and Economic Security Act (Cares Act) provides assistance to cover expenses such as payroll, rent, and insurance through both the Economic Injury Disaster Loan program and the Paycheck Protection Program, many businesses are finding that these sources of funding aren't adequate to meet their current needs and they are facing a cash shortfall.
One source of cash that a business owner should not tap is funds in accounts earmarked for the payment of federal payroll taxes. Although this is not an acceptable practice, some businesses may believe that it is given the provisions in the Cares Act that delay the payment of 50 percent of a business's 2020 employer payroll tax liability until December 31, 2021, and the other 50 percent until December 31, 2022. To understand why this practice is unacceptable and what is intended by this Cares Act provision, the basic rules governing federal payroll and withholding taxes must be considered.
Employers incur several expenses and are subject to certain liabilities imposed upon them by the federal government as a result of hiring employees. The most common of these are payroll withholding taxes. Typically, an employer is obligated to withhold federal income taxes from an employee's pay and remit those amounts to the Internal Revenue Service on the employee's behalf. These amounts often represent a significant portion of an employer's total federal payroll tax remittances. In addition, an employer is required to withhold the employee's tax due under the Federal Insurance Contributions Act, used to fund both the Social Security and the Medicare programs. For 2020, an employee must pay a tax of 6.2 percent on the first $137,700 of their earnings toward the Social Security program. They must pay another tax of 1.45 percent on all of their earnings under $200,000 along with an additional 0.9 percent (2.35 percent total) on earnings over that amount toward the Medicare program. Although these income tax withholding and FICA tax amounts are collected and paid by the employer, they actually represent taxes due from the employees themselves. These amounts are not payroll taxes that are subject to deferred payment under the Cares Act.
So, what payroll taxes qualify for deferred payment under the Cares Act? In addition to payroll withholding, an employer is obligated to match both the 6.2 percent paid by the employee for FICA tax related to the Social Security program and the 1.45 percent paid by employee on their first $137,700 of earning related to Medicare. These payroll taxes, assessed at a combined rate of 7.65 percent and paid to the IRS, are the sole obligation of the employer and it is these payroll taxes that are the subject of the Cares Act deferral provisions. All employers, regardless of size, can avail themselves of the payroll tax deferral rules. There is no need-based eligibility and the ability to extend the payment of an employer's payroll tax liability should provide some short-term liquidity to businesses. Also, there is no interest charge for the deferral. However, the payroll tax deferral is not available to a taxpayer that obtains a PPP loan under the Cares Act if the loan is later forgiven.
Since withholding taxes are not subject to the payroll tax deferral provisions under the Cares Act, it's critical that employers pay these amounts when due. There is no relief from their timely payment. Furthermore, the IRS views these items as trust fund taxes. The Internal Revenue Code is very clear that any person who in their business capacity is required to collect and pay trust fund taxes and who fails to do so is personally liable for the amounts not paid. The IRS can, and often does, pursue individuals to collect unpaid withholding taxes from the assets they own in their own name.
Because there can be subtleties involving payroll taxes and withholding along with the various liabilities associated with them, it is strongly recommended that businesses seek professional advice before availing themselves of the payroll tax deferral provisions of the Cares Act and develop a clear understanding of what taxes are covered by the legislation.