Deferred Taxes – First Payment Due 12/31/21

Posted December 10, 2021

Many employers took advantage of the deferred tax provisions in the CARES Act to defer payment of employer’s share of Social Security wages paid from March 27, 2020, through December 31, 2020. While the provisions provided some much-needed relief in 2020, the proverbial “bill” is now coming due. The first half or installment of the deferred taxes is due December 31, 2021. Not surprisingly, the IRS’s rules for repayment are confusing, and could entrap employers by imposing a 10% to 15% penalty on the full amount deferred, whether the employer has a small shortfall or misses the deadline entirely. We encourage employers who deferred taxes in 2020 and are unable to make the first installment payment to contact us so we can discuss some options for resolving the liability and preserving your funding relationship(s). 

Overview 

The deferred tax provisions apply only to a subset of payroll taxes. Generally, there are three components to payroll taxes at the federal level (taxes paid to the IRS): 

  • Withholding (amount withheld from employees’ paychecks), 
  • Social Security (the employee pays 6.2% and the employer matches 6.2%), and 
  • Medicare (the employee pays 1.45% and the employer matches 1.45%). 

Senator Grassley summarized Section 2302 of CARES Act (Delay of payment of employer payroll taxes) as follows: 

“The provision allows employers and self-employed individuals to defer payment of the employer share of the Social Security tax they otherwise are responsible for paying to the federal government with respect to their employees.” 

The deferred taxes provision applies only to the employer-matching portion of Social Security (6.2%). Additionally, the provision applies only to Q2, Q3, and Q4 2020 941 returns. The first half of the deferred taxes (the first installment payment) must be paid by December 31, 2021, and the second half (the second installment payment) must be paid by December 31, 2022. 

Example 

To determine the potential amount of the deferral, first look at line 5a – Social Security Wages – on the 941 return(s) for Q2, Q3, or Q4 2020. If we assume the amount reported on line 5a is $100,000, then the employer portion is one half of $100,000, or $50,000 ($100,000 * ½ = $50,000). In this example, the employer could defer $50,000 in 2020, then pay the first installment of $25,000 by December 31, 2021, and second installment of $25,000 by December 31, 2022. Remember, an employer can only defer the employer matching portion of the Social Security taxes, the other payroll taxes should have been paid on time. 

Penalties for Underpayment 

The IRS “clarified” the penalties for failure to pay the deferred taxes on time in a memo issued August 30, 2021 (PMTA 2021-007, Penalty for Failure to Deposit Taxes Deferred Under CARES Act Section 2302(a)(2)).  

If any portion of the deposit is not made by the applicable date, whether December 31, 2021, as to the first installment, or December 31, 2022, as to the second installment, then the deferral is completely invalid. In that event, the deposits were due on the usual deposit due dates provided in Treas. Regs. §§ 31.6302-1and 31.6302-2, which would be the due dates used in determining any penalties under section 6656. 

The IRS memo provides some examples illustrating the rule. Assume that an employer has deferred, under CARES Act section 2302(a)(2), $50,000 of Social Security taxes. Under CARES Act section 2302(d)(3), the employer must deposit $25,000 by December 31, 2021, and the remaining $25,000 by December 31, 2022. 

If, for the 2020 tax year, the employer deposits $5,000 on December 31, 2021, and makes no other deposits before December 31, 2021 [misses the first payment], the 10% penalty under section 6656(b)(1)(A)(iii), for failure deposit tax for more than 15 days, applies to the entire $50,000, and the penalty amount would be $5,000. Because the first installment of $25,000, due on December 31, 2021, was not deposited by that date, the deferral is invalidated as to the entire $50,000. If, on February 7, 2022, the IRS issues a notice demanding payment of the balance of the first installment, and the employer does not pay the full amount demanded by February 17, 2022, the penalty rate increases to 15 percent. 

If, for the 2020 tax year, the employer deposits $25,000 on December 31, 2021 [makes the first payment], and deposits the remaining $25,000 on February 28, 2023 [misses the second payment], the 10% penalty under section 6656(b)(1)(A)(iii), for failure to deposit tax for more than 15 days, applies to the entire $50,000, and the penalty amount would be $5,000. Because the second installment of $25,000, due on December 31, 2022, was not timely deposited, the deferral is invalidated as to the entire $50,000. 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 demanded by February 16, 2023, the penalty rate increases to 15 percent. 

If either installment payment is insufficient – December 31, 2021, or December 31, 2022 – penalties and interest will accrue on the entire amount deferred. The failure to deposit penalty is 10%, and then increases to 15% once the IRS issues the initial notice and demand. 

Practice Pointers 

Deadlines. December 31, 2021, falls on a Friday, which is a federal holiday and means the first half of the deferred taxes is due the following business day – Monday, January 3, 2022. Similarly, December 31, 2022, falls on a Saturday, and Monday, January 2, 2023, is a federal holiday. As such, the second half of the deferred taxes is due the following business day – Tuesday, January 3, 2023. While the deadline may be January 3rd, don’t wait until the last minute to send payment.  

Method of Repayment. Technically, payments can be made through the Electronic Federal Tax Payment System (EFTPS), by credit or debit card, or by check or money order. Our clients have had problems tracking and verifying payments made by credit or debit card. As such, we suggest making payments through EFTPS, or by check or money order.  

  • Separate Payments. IRS guidance indicates that the IRS computer system cannot apply a single payment to multiple quarters. Therefore, separate payments should be made for each quarter where a business deferred taxes. In theory, it’s possible to have the IRS reapply or reallocate payments after the fact. However, it’s not easy and the IRS can always say, “No.” It’s better for employers to make the payments correctly in the first place. 
  • Designate Payments. Payments made through EFTPS are designated to a specific tax form and period. However, there’s no way to designate that the funds should be applied specifically to the deferred taxes. Payments made by check should include a 2020 Form 941-V payment voucher with the circle darkened for the appropriate quarter. Additionally, employers should include their employer identification number (EIN), the words “Form 941,” the corresponding quarter, e.g., “Q2 2020,” and the words “for deferred taxes.” 

Amount of Repayment. In theory, the IRS was supposed to send reminder letters to employers indicating the deferred amounts to be paid at the end of the year (CP256V Notices). These notices were not sent until late October, and many employers have still not received them. If payments were made recently, those payments will likely not be reflected in the notices. 

  • Pay the Larger Amount. If the IRS notice indicates a larger amount owed than the employer believes to be case, pay the larger amount now and reconcile the issue later. If the employer believes it owes more than the amount listed on the notice, pay the larger amount now and reconcile the issue later. Because the relief is all or nothing, employers should err on the side of caution. 
  • Contact the IRS to Confirm Payment. We’ve uncovered a common issue through our monitoring service – an employer makes a subsequent payment (not a timely deposit) in the amount of the deferred taxes, but a portion of the payment is used to pay non-deferred amounts. For example, consistent with the examples above, an employer made a $25,000 payment earlier in 2021 (and probably thinks they’ve paid the deferred amounts in full). However, the IRS applied $5,000 of that payment to non-deferred taxes (there was a shortfall in the amount of the remaining taxes, i.e., withholding, Medicare taxes, and/or employee portion of Social Security). The remaining $20,000 was applied to the deferred taxes, but that leaves a shortfall of $5,000 in the deferred taxes. If not corrected, this employer will be assessed a 10% failure to deposit penalty for the entire $50,000 deferred. 

Shortfalls. Employers that do not pay the first installment in full and/or cannot pay the second installment in full should contact Tax Guard to discuss options. We can reconcile and pursue reallocation of payment, if possible. If not, we can negotiate a repayment plan with an affordable monthly payment, which protects the employer, protects the lender, and preserves funding.