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Payroll Tax Credits for Employers

The Devil is in the Details

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Throughout the whole year payroll taxes have been at the forefront of employer’s attention.

When unemployment shook the economy so badly one of the basic types of help designed to support businesses targeted the employees of companies. Employees were badly hurt because many businesses were closed. They were left hanging in the air.

At this point in time everybody is already aware of the many programs directed to help unemployment and businesses but with the tax season close at hand people, employers and employees, need to pay attention to some details that perhaps during the year have been overlooked.

It is convenient that the stakeholders review not only with the CARES Act that was signed in March of 2020 with its many provisions directed to help unemployed people and businesses struggling to survive.

In particular the IRS has been channeling financial help since the 2017 TAX CUTS AND JOBS Act with the changes to the tax code introduced at that time. To mention just very visible actions, taxes were decreased for businesses and new credits were introduced. The Qualified Business Income Credit and higher refundable credits as the Child Tax Credit provide examples.

Let us not review every provision concerning this topic in these lines, but only a few. Mostly because circumstances and differences abound among businesses and their employees. Let us only review very few prominent things that have affected the overall situation and could be interesting for businesses to determine where they stand in their respect.

Payroll Taxes

Let us start with a brief description of the payroll taxes, sometimes called employment taxes. These are Social Security and Medicare.

Payroll taxes are called FICA and MEDFICA, which are acronyms for the Federal Insurance Contributions Act and Medicaid Federal Insurance Contributions Act.

Social Security taxes are 12.4% of every employee's annual gross wages and Medicare is 2.9%, for a total of 15.3%.

This means that if an employee makes $10,000 per year in wages, the full payroll taxes would be $1,513. Undoubtedly a huge expense.

Common law employees vs. independent contractors

A common law employee refers to the employee being in the employer’s payroll. In this case he will be paid with a W2. In the case of a common law employee, half of the employment taxes are paid by the employer and the other half is paid by the employee.

An independent contractor, on the other hand, is somebody who performs a job for the business that hires him, but he does not belong to the company. He is sometimes called a self-employed person.

In the case of a self-employed person, he is both employer and employee and, therefore, he will pay both halves of the payroll taxes. This applies to pass-through companies, as limited liability companies, partnerships, or S Corporations. It also applies to sole proprietors. In all these cases the employee/owner receives a W2 because he is employed by his own company.

There are many nuances involved in combinations of these basic norms. What happens when the owner of a company wants to receive a 1099-MISC and be paid as if he were an independent contractor?

As an aside we could ask why would somebody want to be paid like this? Perhaps because it involves less paperwork? Perhaps he thinks in this case that he is escaping payment of the contributions towards his Social Security pension and Medicare? The fact of the issue is that I have seen people prefer this alternative as if it were something very desirable. In my experience they are not only difficult to persuade of the weakness of their idea but are passionate about it.

Basically, this is not supported by the code. The person in this situation is not and independent contractor because he received direction and is controlled by the company. He has two hats. According to one he is the owner of the company. According to the other, he is an employee. Works for this company, represents this company, and in every respect the relationship is that of a person not placed one step removed from the functioning of the company but fully in the middle of the affairs. He cannot argue that he is an independent contractor whose only relationship with the company is the job at hand.

In any case, the IRS will challenge the assumption.

The regulations state: “In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor.” (Regs. Sec. 31.3306(i)-1(b))

Please note that the latter quote is from the Regulations. Treasury regulations are commonly referred to as Federal tax regulations. They pick up where the Internal Revenue Code (IRC) leaves off by providing the official interpretation of the IRC by the U.S. Department of the Treasury.

In Ewens and Miller Inc. the Tax Court listed a seven-factor test to determine whether an individual is a common law employee or an independent contractor (Ewens and Miller Inc., 117 T.C. 263 (2001)).

• The degree of control exercised by the principal
• Which party invests in work facilities used by the individual
• The individual’s opportunity for profit or loss
• Whether the principal can discharge the individual
• Whether the work is part of the principal’s regular business
• The permanency of the relationship; and
• The relationship the parties believed they were creating

The problem here as in so many other cases with the IRS is that the norm is not applied all the time. Worst than that, it is sparingly applied. But if in the end they catch up with somebody transgressing this regulation that person may face a very steep tax liability. You have to consider that it is not easy to determine who is a statutory employee. In some cases, the quantity of benefits that a person received may be used to determine if he is an employee.

Statutory Employees

On some other cases, the person that the business claims as an independent contractor, is instead a statutory employee. And, as such, the employer will pay half of the employment taxes.

The line between the two is dim, but statutory employees only work for one company, are fully dependent on it for goal definition, use of time and performance. The term “statutory employee” is not used in the Internal Revenue Code. The only definition presented there is that of an “employee”, in general. This is done in Section 3121(d)(3) of the code.

To be an employee the individual must in the first place perform services for remuneration.

Besides, the following are employees:

• An agent-driver or commission-driver who distributes meat products, vegetable products, fruit products, bakery products, or beverages (other than milk), or who picks up or delivers laundry or dry-cleaning for his or her principal.
• A full-time insurance salesperson.
• A home worker who performs work according to specifications of the person for whom the services are being performed, on materials or goods furnished by the person. The work product must be returned to the person or someone designated by him or her.
• A traveling or city salesperson, other than an agent-driver or commission-driver (covered in the first point above), engaged on a full-time basis in the solicitation on behalf of a principal of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments for merchandise for resale or supplies for use in their business. However, the full-time basis rule will not be violated if the salesperson also performs some sideline activities for a person other than the principal. The word “statutory” means in this case legal, contractual.
When the IRS challenges the classification made by the company and stipulates that somebody classified as an independent contractor is instead a statutory employee, the company must pay half of the payroll taxes.

Payroll Protection Program (PPP)

The CARES Act of 2020 brought the Payroll Protection Program (PPP) loans to help employees and businesses. We now know that even if there have been some irregularities surrendering this program, nevertheless many small businesses received timely help.

The PPP loan was directed to keep employees employed, and if a company wants for the loan to be forgiven, more than 60% of the funds must have been used to compensate employees. Employers really need to verify if they still qualify for this program as there have been changes during the year.

But this is not the only program available.

Refundable Payroll Tax Credit

The CARES Act includes a tax incentive in the form of a refundable payroll tax credit. Officially named the Employee Retention Credit, its goal was to incentivize businesses to keep employees on the payroll even if they are not working. This is not the same as the PPP program.

Eligible employers get a payroll tax credit equal to 50% of wages paid per quarter up to $10,000 per person for wages paid between March 13th and the end of 2020. It is important that you verified if you qualified for this credit and act accordingly when filing your taxes.

Deferral of payroll taxes

One of the questions some people have these days refers to the deferral of the payroll taxes. They are intrigued by the provision included in the CARES Act but are unsure of what it means in terms of its duration. Is it for a long time? Is it similar to an Installment Plan? To whom it applies, specifically?

The CARES Act actually allows employers to defer payment of the employer’s share of the Social Security taxes.

Section 2302 of the CARES Act provides that employers may defer the deposit and payment of the employer's portion of Social Security taxes and certain railroad retirement taxes. These are the taxes imposed under section 3111(a) of the Internal Revenue Code (the "Code") And Section 3111(a) of the Code says: “I.R.C. § 3111(a) Old-Age, Survivors, And Disability Insurance:

“In addition to other taxes, there is hereby imposed on every employer an excise tax, with respect to having individuals in his employ, equal to 6.2 percent of the wages (as defined in section 3121(a)) paid by the employer with respect to employment (as defined in section 3121(b)).”

In other words, Social Security taxes do not include Medicare taxes.

Self-employed individuals may defer the payment of 50 percent of the Social Security tax imposed under section 1401(a) of the Internal Revenue Code on net earnings from self-employment income for the period beginning on March 27, 2020 and ending December 31, 2020.

Of the portion corresponding to the employee of the Social Security tax, the employer is not granted any grace periods to deposit those amounts in the name of the employee. The deposits must be made on time as these are funds corresponding to the salaries and wages paid.

The same happens with Medicare, either with the portion of the employer or that of the employee. Both need to be paid on time.

The only portion that is been deferred is the Social Security tax corresponding to the employer. The deposit (if employment tax liability more than $2,500, paid semi-weekly, monthly or day after) or payment (if deposits are made quarterly or annually) of the portion deferred can be done 50% on December 31 of 2021, and 50% on December 31, 2022. Depending on the practices of the employer, these amounts are deposited monthly or quarterly, in most of the cases. If the employer fails to do this on time, penalties and interest will accrue to him.

Filing is made with Forms 941, 943 or 944, and deposits are usually made through EFTPS, the payment module of the IRS.

PPP repayment after payroll credits

If an employer received a loan under the Small Business Administration Act, as provided in section 1102 of the CARES Act that covers the Paycheck Protection Program (PPP), they can defer the deposit and payment of the employer's share of Social Security tax even if the loan has been forgiven or partially forgiven.

Prior to the enactment of the PPP Flexibility Act, from June 5, 2020, an employer was prevented from deferring the deposit and payment of the employer's share of Social Security tax after the employer receives a decision that its PPP loan was forgiven by the lender.

Therefore, an employer that receives a PPP loan is entitled to defer the payment and deposit of the employer's share of Social Security tax, even if the loan is forgiven.

In conclusion

These are not all the provisions in the CARES Act. Use this as an invitation to review all of them and to verify the things you must do to qualify for all its applicable programs. We will remember this year as the time when things changed in a way that hindered our ability to react. The year of inefficacy. Jobs, places, people, routines and reacting practices, all stopped working.

Let us fight this inertia.