Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, employers can defer payment of certain 2020 payroll taxes until 2021 and 2022.
But this provision introduces a key question: If a taxpayer defers its eligible payroll taxes, are they deductible on the taxpayer’s 2020 income tax return? The answer depends on a taxpayer’s method of accounting and when the deferred taxes are actually paid.
CARES Act Provision
The CARES Act allows employers to defer payment for the employer portion of payroll taxes—6.2% for Social Security taxes—due from March 27, 2020, through December 31, 2020.
If deferred, the employer owes 50% of the deferred amount by December 31, 2021, and the remaining 50% by December 31, 2022. Employers report the deferred taxes on their Form 941 for the period when the taxes would have otherwise been deposited.
For cash-basis taxpayers, payroll taxes are deductible when paid. Cash-basis taxpayers can determine the year when they apply the tax deduction against income. To claim the deduction in the year the employee provides the services to which the taxes relate, taxpayers would need to make an earlier payment than the CARES Act requires—but they could still receive a significant tax-payment deferral.
A calendar year-end taxpayer may deduct the taxes on their 2020 return if they’re paid by December 31, 2020. Fiscal year-end taxpayers can delay payment until their 2021 year-end, but they need to assess the implications of any amounts due between March 27, 2020, and their 2020 fiscal year-end if it occurs after that date.
The answer isn’t as straight-forward for accrual-basis taxpayers. In general, liabilities are deductible when the liability is fixed and determinable—commonly referred to as the all-events test—and economic performance has occurred.
For payroll taxes, the amounts will generally be fixed and determinable when the employee performs the services to which the compensation relates, and economic performance will be satisfied when the taxes are paid.
For a taxpayer using the recurring-item exception, a liability is deductible in the tax year in which all of the following are true:
- All-events test is met by year-end
- Economic performance occurs by the earlier of when the return is filed or eight-and-a-half months after year-end
- The liability is recurring in nature
- The liability is either immaterial or better matching results—the matching requirement is deemed met for taxes
Accrual-basis taxpayers could benefit from the recurring-item exception for these payroll taxes.
If calendar year-end taxpayers pay their payroll taxes by September 15, 2021, or the return filing date—whichever is earlier—the amount paid can be deducted on the 2020 return using the recurring-item exception. The deduction would be deferred for amounts paid after September 15, 2021.
Accounting Method Changes
If an accrual-basis taxpayer applies the recurring-item exception and hasn’t previously adopted this provision for their payroll taxes, they may be required to file a method change. This change is eligible for automatic consent under Revenue Procedure 2019-43.
It’s important to note that if a taxpayer is required to capitalize payroll taxes for uniform capitalization (UNICAP), it can only apply the recurring-item exception if the taxpayer is either:
- Currently capitalizing these taxes for UNICAP
- Concurrently changing its method to capitalize these taxes for UNICAP
A taxpayer must also meet normal terms and conditions for automatic method changes—as outlined in Revenue Procedure 2015-13.
Taxpayers that took advantage of the payroll-tax deferral permitted by the CARES Act may see a higher income tax bill in 2020 due to the disallowed payroll tax deduction. However, with careful tax planning, taxpayers can preserve the 2020 deduction and still obtain significant payroll tax deferral.
Taxpayers must consider their overall method of accounting—cash or accrual—to determine when payment must be made to claim the deduction. They should also consider this matter when computing any estimated tax payments.
Compared to those using the cash method, accrual-basis taxpayers will generally be able to obtain a longer deferral and still claim a 2020 deduction for deferred payroll taxes if they use—or change to—the recurring-item exception. Taxpayers should evaluate if an accounting method change may be necessary to change to the recurring-item exception method.
Cash-basis taxpayers that are considering a change to accrual in the near term may want to do so now to obtain a longer deferral while preserving the 2020 deduction. Taxpayers that need to request advance consent to change to the accrual method—for instance, because they changed to the cash method in the last five years—must do so before their tax year-end.
We’re Here to Help
To learn more about CARES Act-related deferrals and how your business can benefit from the provisions, contact your Moss Adams professional.