In a memo from the Chief Counsel office (PTMA-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 Act (CARES Act) by the applicable installment due date will result in a penalty under IRC Section 6656 that runs from the original due date and applies to the entire deferred amount.

The CARES Act delays 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 December 31, 2020 (see Tax Alert 2020-1974). The CARES Act treats these amounts as timely paid if 50% of the deferred amount is paid by December 31, 2021, and the remainder by December 31, 2022.

Because these dates fall on the weekend, the Chief Counsel memo confirms that the deadlines are actually January 3, 2022, and January 3, 2023, under the weekend/holiday rule of IRC Section 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 IRC Section 3111(a), which is 6.2% of wages up to the wage base ($137,700 in 2020)
• The portion of the employer's and the employee's representative share of Tier 1 Railroad Retirement Tax Act (RRTA) tax under IRC Sections 3211(a) and 3221(a), which corresponds to the 6.2% Social Security tax rate due

Under IRC Section 6656, the penalty is 10% of the underpayment if the failure is 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 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 anticipating refundable credits allowed under COVID-relief provisions.

As explained in the Form 941 instructions and FAQs posted on the IRS website, 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 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 IRC Section 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 IRC Section 7503 gives employers income-tax-planning opportunities. Employers may generally deduct employment taxes in the tax year they are paid. Thus, an employer may choose to delay its payments until January 3, 2022, and January 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-year tax year might benefit from paying its first installment of deferred employment tax on January 3, 2022, rather than in 2021. Because taxpayers are not required to apply IRC Section 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-year 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 8 ½ months after the end of the tax year may be deducted in the prior tax year if the recurring item exception under IRC Section 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 January 3, 2022. That is, 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 January 3, 2022, and the remaining $10,000 by January 3, 2023. The IRS has not indicated whether this rule applies quarter by quarter or to the entire amount deferred in 2020. For example, if an employer owed $50,000 in tax for Q2 2020, and $50,000 in tax for Q3 2020, and deferred no tax in Q2 and the entire amount in Q3, it is unclear whether the employer owes $0 or $25,000 by January 3, 2022. Given the IRS's interpretation on applying deposit penalties, this ambiguity carries a heavy weight as a taxpayer might properly repay the correct amount but allocate incorrectly amongst the quarters, resulting in an overpayment for one quarter but an underpayment for another quarter. It appears that this allocation error could result in a 10% penalty applied to all employer Social Security taxes deferred in 2020.

Although the IRS did not amend Form 941 for the first quarter of 2020 to allow for reporting the deferral, the IRS has informally confirmed that taxpayers should designate repayments of tax due from March 27, 2020 through March 31, 2020, as a Q1 2020 payment. Employers that deferred for the first quarter should have received a notice from the IRS, though this has not been universally true and some transcripts do not show the Q1 liability. Because allocation failures could trigger significant penalties, this uncertainty may be problematic.

In addition, the IRS appeared to suggest during an industry call that penalties under IRC 6651 (for failure to pay) could also apply, and further, that the IRS would apply any deferral repayments to outstanding liabilities before applying the repayment to the deferral.

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