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CARES Act Payroll Tax Deferral: Pay Now or Later?

November 16, 2020

Did you take advantage of the payroll tax deferral under the CARES Act? If you did, time to start doing some tax planning.

The payroll tax deferral under the CARES Act provides a great opportunity for employers to defer payment of the Employer share of social security taxes incurred through December 31, 2020. Employers who have elected this deferral have until December 31, 2021 to pay 50% of the deferred amount, with the remaining balance due by December 31, 2022. This works out to be a nice interest free loan for the employer.

Although waiting until the due dates to pay the deferred employer taxes may seem appealing, you may want to pay the deferred taxes sooner.

What is the payroll tax deferral?

Check out our blog, How Does the CARES Act Impact Tax Deferral and Credit Programs? Essentially, the CARES Act provides employers and self-employed individuals the option to defer payment of employer social security taxes (6.2% tax rate) incurred from the date of enactment through December 31, 2020.

Why would you want to pay them sooner?

This allows you to time when you receive the related tax deduction.

Let’s take a look at how both cash and accrual taxpayers can time their deductions for tax purposes.

Cash Basis Taxpayers

For cash basis taxpayers, it’s very simple. You get the deduction the year in which you pay the tax. For cash basis taxpayers they will need to look at what they estimate their taxable income will be for 2020 vs 2021. Depending on your business’ taxable income situation, you may not want to lose out on the deduction for employer payroll taxes on your 2020 return. If this is the case, you need to make plans to pay the deferred taxes before December 31st, 2020.

Accrual Basis Taxpayers

For accrual basis taxpayers, it’s a little more complex, but they (almost) get the benefit of hindsight to make their decisions. Although you may be thinking that an accrual basis taxpayer automatically gets the deduction the year the employer payroll tax liability was incurred, that is not actually the case.

IRS revenue ruling 2007-12 establishes that payroll taxes are only deductible in the year incurred for accrual basis taxpayers if the taxes are paid by September 15th of the following year or the date the return is filed with extension. In other words, as long as you pay the deferred taxes prior to the date you file your tax return (including extension period), these taxes are deductible on that tax return. If you pay after the date the return is filed or after the September 15th deadline, the taxes will be deductible the year in which they are paid.

Therefore, an accrual basis taxpayer may want to extend their 2020 income tax return filing date through September 15th, 2021 and wait to see the results for the first 8 months of 2021 before deciding whether to take the deduction in 2020 or in 2021. Also, assuming the taxpayer only pays 50% of the deferred employer taxes, this same strategy can be applied for the 2021 income tax year.

If you took advantage of the employer payroll tax deferral under the CARES Act, now is the time to start working with your KLR advisor on what tax strategy works best for you.

Navigating through all of the information and programs available to impacted businesses may be overwhelming. KLR advisors are available to help you navigate the best path forward during this unprecedented crisis.

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