On August 8, 2020, President Trump issued an executive order, directing the U.S. Treasury to grant employers the ability to defer the withholding, deposit and payment of certain payroll taxes as further COVID-19 tax relief. The deferral applies only to the employee portion of Social Security taxes and Railroad Retirement taxes (i.e., 6.2 percent of wages) required to be withheld and paid under Internal Revenue Code (“Code”) Sections 3101(a) and 3201(a) from September 1, 2020 to December 31, 2020.
PRACTICE ALERT: The deferral does not apply to required employee Medicare tax withholdings under Code Section 3101(b) (either the standard 1.45 percent on all wages or the additional 0.9 percent tax on wages in excess of $200,000). Further, the deferral is not available for the employer’s share of Social Security (6.2 percent) or Medicare (1.45 percent) taxes.
IRS NOTICE 2020-65
On August 28, 2020, the IRS issued Notice 2020-65, providing guidance relative to the president’s executive order. It provides answers to several important questions.
Notice 2020-65 defines employers required to withhold and pay Social Security and Railroad Retirement taxes as “Affected Taxpayers.” It goes on to provide that the due date for withholding and payment of the employee portion of Social Security taxes and Railroad Retirement taxes for the period September 1, 2020 to December 31, 2020 is postponed until the period commencing January 1, 2021 through April 30, 2021.
Up until this past Wednesday, the Paycheck Protection Program (“PPP”) loan forgiveness application issued by the Small Business Administration (“SBA”) had not been updated since May. New guidance was issued in the interim (and anyone who has been following this area knows that guidance is constantly evolving). Most taxpayers have some breathing room before they must file their forgiveness applications; so, it may behoove them to wait to file their applications until they digest the most recent guidance.
On Friday, May 22, 2020, the Small Business Administration (“SBA”), in conjunction and consultation with the U.S. Department of the Treasury (“Treasury”), published an interim final rule (“IFR”) containing new guidance on the treatment of bonuses, prepayments, and the loan forgiveness application and process for Paycheck Protection Program (“PPP”) loans.
Loan Forgiveness Process
Loan forgiveness under the PPP is not automatic. Rather, borrowers must apply for forgiveness using the SBA’s Loan Forgiveness Application (SBA Form 3508) or their lender’s equivalent form, if any. The process is somewhat streamlined:
- The application is submitted to the lender for review and approval.
- The lender will review the application and make a decision regarding loan forgiveness.
- The lender has 60 days from receipt of a complete forgiveness application to issue a decision to the SBA.
- The lender is responsible for notifying the borrower of the amount approved for forgiveness.
- The lender will then request that the SBA repay the amount forgiven.
- Within 90 days from the lender’s request for payment, the SBA will pay the lender the amount forgiven, plus any accrued interest. (If applicable, the SBA will deduct the amount of advances under the Economic Injury Disaster Loan program from its payment to the lender.)
In addition to worrying about keeping their business afloat these days, businesses are focusing on whether their Paycheck Protection Program (“PPP”) loan will be forgiven. Without loan forgiveness, many of these businesses will not survive. Consequently, the stakes are high!
The eligibility requirements for PPP loan forgiveness are complex. As we discussed previously, in large part, loan forgiveness is based on the borrower using the loan proceeds within the eight-week period immediately following receipt of the loan on specified expenses, including payroll and rent.
Some landlords have been generous enough to reduce or even abate rent for a period (e.g., three months) to assist the tenant in salvaging its business. Consequently, these businesses may have little or no rent to pay during the eight-week period. If a business owner asks the landlord for advice on what to do in this situation, the landlord will likely say:
Love thy landlord – pay me anyway!
Whether the prepayment of rent (or the payment of rent for a period preceding the eight-week period) applies for purposes of the loan forgiveness computation under the PPP is likely a question being pondered by many businesses and their advisors.
The Department of the Treasury estimates the annual federal “tax gap” (the difference between what taxpayers should have paid and what they actually paid on a timely basis) exceeds $450 billion. IR-2012-4 (January 6, 2012). This figure correlates with a voluntary tax compliance rate of just shy of 86 percent.
Studies conducted by the National Research Program (“NRP”) conclude that the $450 billion “tax gap” is comprised of three components, namely non-filing of tax returns ($28 billion), underreporting of income ($376 billion) and underpayment of taxes ($46 billion).
On September 26, 2006, the Treasury’s Office of Tax Policy published a document titled “A Comprehensive Strategy for Reducing the Tax Gap.” Subsequent updates on “Reducing the Tax Gap” have been published. In these documents, Treasury emphasized its renewed commitment to dramatically reduce the tax gap.
Four key principles are set forth in these documents to guide IRS efforts to improve compliance:
- Address both unintentional taxpayer errors and intentional taxpayer evasion;
- Target sources of noncompliance with specificity;
- Combine enforcement activities with commitment to taxpayer service; and
- Policy positions and compliance proposals should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of a burden on the taxpayer.
To accomplish its goals, these documents set forth several strategies, including:
- Continuing research to unveil common areas of noncompliance;
- Continuing improvements in information technology to enhance detection of noncompliance;
- Continuing expansion of examination and collection efforts;
- Continuing enhancement of taxpayer service to reduce unintentional errors;
- Continuing to seek tax law simplification to reduce unintentional errors, reduce opportunities for evasion, and simplify the Service’s job of administering tax laws; and
- Coordinating efforts with local and foreign governments to enhance compliance and collection activities.
In 2006, IRS Commissioner Mark W. Everson stated, in support of the Service’s increased compliance activity, that “[t]he magnitude of the tax gap highlights the critical role of enforcement in keeping our system of tax administration healthy.” IR-2006-28 (February 14, 2006). Given the size of the tax gap and the fact that federal budget deficits are in the hundreds of billions of dollars, tax compliance should be a renewed priority of the IRS. While we saw a few years ago the IRS begin to increase its audit staff and start auditing taxpayers in greater numbers and more aggressively than in the past years, severe budget cuts have recently derailed this momentum. That said, given that the IRS is virtually the only federal agency that generates revenue, logic suggests lawmakers should work hard to restore the Service’s budget.
On February 4, 2016, Senator Ron Wyden (D-OR), ranking member of the U.S. Senate Finance Committee, alerted IRS Commissioner John Koskinen (by letter) that $67 billion of the tax gap each year is attributable to corporations. He advises the Commissioner that a proper analysis of the causes of the tax gap is necessary in order for lawmakers to be able to create effective tools to eradicate it. Senator Wyden, in a direct and strong manner, alerts the Commissioner to some interesting things, including:
- The IRS tracks the portion of the tax gap attributable to corporations based on audit results, but it has no mechanism to track the specific sources of the corporate tax gap; and
- Without knowing the sources of the tax gap attributable to corporations, lawmakers cannot effectively design policies to reduce this portion of the tax gap.
Senator Wyden requested the Commissioner to provide him with certain information before the U.S. Senate Finance Committee’s February 10, 2016, hearing on the IRS budget and a more full response within 60 days. He specifically requested:
- A specific explanation of the methodology used to estimate the corporate portion of the tax gap;
- Whether the IRS maintains a centralized repository of corporate audit issues;
- A list of top corporate audit issues and each issue’s contribution to the corporate portion of the tax gap;
- A copy of all data and work papers used by the IRS to compute the corporate portion of the tax gap; and
- Any steps the IRS has taken to improve compliance as outlined in the 2006 Treasury Office of Tax Policy study (referenced above).
What is interesting is that Senator Wyden’s robust letter to Commissioner Koskinen was delivered just days before the U.S. Senate Finance Committee held its hearing on the IRS budget. The timing seems to indicate that lawmakers mean business – they want the tax gap addressed. That said, without a sufficient budget, the IRS likely does not have the resources to tackle this major problem.
Of interesting note, the annual tax gap has increased by approximately $150 billion since 2001. Yet, the IRS has had its budget slashed by over $1 billion in the last five (5) years.
According to Commissioner Koskinen, the funding of the IRS this fiscal year ending September 30 is back to the 2008 funding level. He recently suggested the results will be felt by taxpayers and tax advisors, including:
- At least 46,000 fewer business and individual audits will conclude this fiscal year;
- Taxpayers will encounter about a thirty (30) minute wait when calling a service center to reach an IRS representative;
- 3,000 to 4,000 IRS employees will lose their jobs, and there is the possibility that employee furlough days will be implemented this fiscal year, reducing the ability of the IRS to provide taxpayer service;
- Approximately 280,000 fewer collections will be made this fiscal year;
- IT systems will not be replaced or updated this fiscal year as scheduled; and
- Implementation of taxpayer identification theft protections will have to be delayed until a future fiscal year.
Commissioner Koskinen predicts these most recent IRS budget cuts will ultimately result in a loss of $2 billion or more in tax revenue that would have otherwise been collected this fiscal year. Lawmakers need to work with the IRS to help eradicate this major problem. Without an adequate budget, however, the IRS will make little, if any, progress. Hopefully, lawmakers will properly fund the IRS. Time will tell.
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.