November 9, 2021
IRS clarifies how to calculate installment payments for deferred employment taxes
The IRS has begun sending informational CP256V notices to employers that chose to defer paying certain Social Security taxes under the CARES Act. The IRS has informally confirmed to EY that the calculation of the tax due will follow a quarterly approach.
CARES Act Section 2302 delays the timing of required federal tax deposits for (1) the employer's share of the Old-Age, Survivors, and Disability Insurance Tax (OASDI or Social Security) under IRC Section 3111(a), and (2) the portion of the employer's and employee representative's share of Tier 1 Railroad Retirement Tax Act tax under IRC Sections 3211(a) and 3221(a) that corresponds to the 6.2% Social Security tax rate that was due between March 27, 2020 and December 31, 2020. The deferred tax will be considered timely paid if 50% is paid by December 31, 2021, and the remainder by December 31, 2022 (see Tax Alert 2020-1974). Due to weekends and holidays, these installments will be due on January 3, 2022, and January 3, 2023, respectively. The IRS previously released a Chief Counsel memo indicating that any failure to pay the proper amount by either deadline will cause all deferred tax from 2020 to be treated as ineligible for the deferral, resulting in an IRC Section 6656 failure-to-deposit penalty (see Tax Alert 2021-1624).
As explained in the instructions to the Form 941, Employer's QUARTERLY Federal Tax Return, 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 has announced in payroll industry calls that it has begun issuing an informational notice, CP256V, which lists the tax due to be repaid in the first installment. A separate notice will be sent for each quarter in which Social Security tax was deferred. The IRS, on its website (Understanding Your CP256V Notice), makes clear that a separate payment must be made for each quarter and cautions that the payment should not be combined with any other payment.
It was previously unclear whether the IRS would treat the tax to be repaid in the first installment as 50% of the total tax that could have been deferred for all of 2020 (that is, an annualized approach), or instead 50% of the tax that could have been deferred for each quarter. For example, under an annualized approach, an employer with $4,030,000 in deferrable Social Security tax liability would owe $1,705,000 by January 3, 2022; under a quarterly approach, the employer would owe a different amount depending on what was deferrable and actually deferred in each quarter, as the example in the following table demonstrates.
As noted previously, the IRS expects employers to use the quarterly approach. Thus, in the example, if the employer were to use the annualized approach instead and pay only $1,705,000 by the January 3, 2022 deadline, it seems the IRS would treat the entire $4,030,000 that was deferred from 2020 as ineligible for deferral and assert a $403,000 failure-to-deposit penalty under IRC Section 6656 (10% of $4,030,000), even though the employer's payment fell short of the tax due under the quarterly approach by only $155,000.
Given the significant penalty that could be imposed, employers should consider reviewing the tax shown on the CP256V notice for each quarter. If the tax shown is greater than the expected repayment liability, it will be important to understand the reason for the discrepancy, which may entail confirming that the calculation employed a quarterly approach and reviewing IRS transcripts to understand whether the tax shown on the notice reflects recent payments.