Posted on June 4, 2020
Summary
- It appears that a small share of firms are taking advantage of the provision of the CARES Act that allows them to defer, for an extended period, remitting to the Treasury their share of Social Security payroll taxes.
- The Congressional revenue estimates produced when the legislation was under consideration assumed, we infer, that most all firms would utilize the provision.
- Even though the allowed deferral provides, in effect, an interest free loan to firms, there are reasons why firms may not utilize the provision.
- Evidence from quarterly financial statements, along with observed growth in overall withholding, suggests that a small amount of payroll taxes are being deferred.
Here’s a long, rather technical post, intended perhaps for tax economists or true renaissance individuals, about one of the lesser discussed provisions of the CARES Act that was enacted in late March. The provision provides potential liquidity to all firms by allowing them to defer remitting to the IRS their share of Social Security payroll taxes. The deferral applies to such taxes that the firms would otherwise have to pay throughout the course of this year; instead, they can remit half by December 31, 2021 and the other half by December 31, 2022. (A firm is normally required to quickly pay to the Treasury 6.2 percent of wages and salaries paid to its employees, an amount representing the firm’s share of Social Security payroll taxes, and the firm also remits an additional 6.2 percent of wages and salaries for the employee portion of the tax. The deferral provision only applies to the employer portion. The wage base for the Social Security payroll tax is limited to $137,700 per worker this year.)
The allowed remittance delay amounts to an interest free loan by the government. However, there is early evidence that the the large bulk of firms, or at least the firms who pay the bulk of wages and salaries in the economy, are not deferring those payroll taxes. Why might that be and what is the early evidence?
Before addressing those questions, first let me say that I believe it was expected at the time of enactment that most or all firms would take advantage of the provision. The estimates of the Congressional Joint Committee on Taxation (JCT), produced at the time of consideration of the legislation, were that the provision would reduce federal revenues by $352 billion in fiscal years 2020 and 2021, presumably representing the amounts deferred for the rest of calendar year 2020, which spans the two fiscal years; JCT then estimated that those reductions would later be largely recouped, by a total of $339 billion. (It does not net to zero presumably because some firms will go out of business and be unable to remit the amounts deferred.) By my reckoning, that revenue estimate assumes that pretty much all firms take advantage of the deferral, perhaps a reasonable assumption at the time–at least under the considerable time constraints for producing the estimate–because the provision is effectively an interest free loan, and who doesn’t like those? Because Social Security employer payroll taxes are about 17 percent of total tax withholding (which also includes income tax withholding, Medicare payroll taxes, and the employee share of payroll taxes, none of which can be deferred), that means that 17 percent of total withholding would be deferred. That’s a lot.
Why might firms not take advantage of the allowed deferral? I see three possible reasons:
- The penalties for not remitting payroll taxes when due are steep. Certain individual employees of businesses are personally liable for such failure to remit, in the amount of the unremitted amounts plus interest and penalties. There are protections in the CARES Act for a non-paying firms’ payroll processors, but management might be concerned about their own personal liability if their firms are unable to remit the amounts in 2021 and 2022. They must appreciate that much could happen to their firm by the end of 2022.
- Firms have other things to worry about than setting up the process for deferring the payment of the payroll taxes, and even in normal times all too often individuals do not take advantage of voluntary, beneficial government programs. First, given those steep penalties for not paying the payroll tax amounts when ultimately due, the firms would need to set the funds aside in very safe investments that are cordoned off from being used for other purposes. That necessity reduces the benefits and increases the implementation costs. In addition, even if a government program is clearly beneficial to a firm or individual and the implementation costs are low, there are always many who do not utilize the program. The so-called “take-up rate” of voluntary government programs set up to help certain individuals and firms is all too often disappointingly low.
- Firms may have an economic reason to pay the payroll taxes in 2020 rather than in 2021 or 2022, which relates to when the associated income tax deduction gets booked. If the firm remits the payroll tax in 2020, it gets the corresponding income tax deduction in 2020. For many firms, that will increase their losses for tax purposes (that is, negative taxable profits, of which there will be a lot) in 2020. For firms with such losses in 2020, they can now use those losses to obtain refunds of a portion of the income taxes that they paid for a period of up to the past five years. (They in effect refile their past tax returns with the new losses incorporated, and they get a refund by how much their taxes for those earlier years get reduced.) That so-called “carryback” provision is specially allowed by the CARES Act for years 2018 to 2020 –otherwise firms can only carry the losses forward to offset profits in future years. And the corporate tax rate was 35 percent before 2018 (compared to 21 percent since then), so a 2020 deduction carried back by an unprofitable firm could be much more valuable than if the deduction were taken in a future year. So, to recap, pay the payroll taxes this year, get the deduction and increase the firm’s losses by that amount, then carry back the bigger loss and get a refund of up to 35 percent of the payroll tax deduction–rather than paying the payroll tax at the end of 2021 and 2022, getting the deduction then at the 21 percent corporate tax rate, or, if the firm is still in a loss position in those years, waiting even longer to use the deduction.
Note that there is a caveat to the deduction timing strategy: Certain firms may be able to get a 2020 deduction under the “recurring item exception” of the tax law even if they remit the taxes in 2021, although it has to be within the first 8-1/2 months of the year. That treatment would apply to accrual basis taxpayers and if they elected that exception for other such payments. Consult your tax attorney. Future IRS guidance may address this. And firms could certainly pay the deferred amount before the end of 2020 and get the income tax deduction this year, but such a short deferral period may not be worth undertaking given the costs of setting up the system.
What evidence is there that firms are generally not utilizing the opportunity to defer their payroll taxes?
First, firms are starting to issue financial statements that cover periods after enactment of the CARES Act. Firms need to account for deferred taxes in such statements. I have found recently-filed financial statements for 16 of the 500 largest U.S. firms, which cover a quarter ending in late April or the first part of May, thus after the CARES Act was enacted in late March. (Most firms file on a quarterly basis for a quarter ending at the end of March and every 3 months thereafter, so at this point we are looking at a small group of firms with unusual reporting periods.) Only one of those 16 firms say that they are utilizing the deferral opportunity (Best Buy, the electronics retailer, in case you’re interested). Five of the firms say that the provisions of the CARES Act have no material effect on their financial statement, so I consider those firms to not be deferring. The other 10 have no mention of the CARES Act, and though I cannot see any obviously unusual activity in deferred tax liabilities for those 10 firms, that doesn’t preclude that they are utilizing the deferral provisions and just not saying so. In any event, it looks like low utilization of the payroll tax deferral provision. I also searched the financial statements of all firms for the quarter ending March 30, so after the enactment of the CARES Act but largely before it went into effect, and I found only one of the largest 500 firms (Starbucks, the coffee place, in case you’re interested) says that they plan to utilize the payroll tax deferral. Again, the firms don’t have to say, but I don’t see affirmative evidence for many firms utilizing the provision.
Second, if firms were fully taking advantage of the payroll tax deferral, total tax withholding should be much lower than it has been in recent weeks. For example, before any adjustment for tax law changes, we estimate that total tax withholding fell by about 11 percent in May (which is calculated relative to May of a year ago). If the remittance delay were reducing total withholding by 17 percent (the percentage described above), then that would imply that total withholding would have been higher by 6 percent if the remittance delay had not been enacted. And that doesn’t even take into account other payroll tax credits of the CARES Act and other recent legislation that reduce withholding. Such an implied 6 percent increase in withholding without any law changes is nowhere near reasonable given the current economic conditions and how high unemployment has risen. That calculation is an indirect indication of the lack of a significant response by firms to the allowed payroll tax delay.
Much more information will be available in the future on the amount of deferral of payroll taxes. Most importantly, firms will, as usual, file form 941 with the Treasury Department for each of the last three quarters of 2020, detailing the components of their withholding payments, including how much they deferred. The next such form is due by July 31, 2020, for activity during the April to June quarter. (And, by a special rule, any amounts deferred in the short available period before April 1 will also show up on that filing.) Then it takes time for Treasury to process the forms. The information from Treasury on form 941 amounts won’t be made public, but we expect to be able to make some inferences from other Treasury releases, such as the Monthly Treasury Statement. Note that it is possible that some firms could wait until they file the form 941 to start deferring the taxes, but I’m not sure what they would gain by doing that; we’ll need to monitor that. Also, additional information from future financial statements may help elucidate the issue. In any event, I’d rather not wait until the end of December 2021 and December 2022 to see if withholding remittances get an unexpected boost!