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Implementation Problems Related to a “Payroll Tax Holiday”
in December 2001 or January 2002
This paper responds to requests from Congress to analyze tax administrative issues raised by Senator Domenici’s “Payroll Tax Holiday” proposal, suggested for inclusion in a compromise economic stimulus package. In considering this proposal, the Congress should understand the significant implementation issues that, in large part due to the near-term effective date, make the proposal infeasible, and therefore ineffective.
In short, it is likely that employers, software developers, and payroll service providers would not be able to make the necessary adjustments to payroll systems quickly enough to be able to properly implement the proposed tax holiday by December 2001, or January 2002. Generally, changes that impact calculation and reporting of taxes and tax bases require 6 months or more to ensure successful implementation. Such changes would be costly and burdensome to employers. The following addresses some critical points related to the implementation of this proposal.
The Domenici tax holiday proposal is based on the following elements:
Wages paid in December 2001 will have a tax rate of zero for Old Age Survivor and Disability Insurance (OASDI) payroll taxes (normally 6.2%).
Both the employee and employer (and self-employed) OASDI tax rates will be zero.
The tax holiday applies to all employees and all employers who would otherwise be liable for Social Security (OASDI) tax.
The Medicare (HI) rate component (1.45% employee and employer) is not affected.
FICA Recalculation
Internal Revenue Service (IRS) and Social Security Administration (SSA) programs require employment tax returns and W-2 forms to report OASDI strictly based on a calculation of OASDI-subject wages multiplied by 6.2%. If the reports received by either agency do not meet this criteria, either the reports will be rejected, or additional taxes will be immediately assessed. Because of this, virtually all payroll processing systems include programs that calculate taxes due based strictly on Social Security wages paid multiplied by 6.2%. This happens at every level of the process, including:
The calculation of each paycheck;
The determination and deposit of employment taxes due;
The creation of applicable payroll reports;
The calculation and printing of the quarterly employment tax return (Form 941);
The creation of Forms W-2 for employees; and
The preparation of Forms W-2 for filing to the Social Security Administration.
Each such program would have to be changed by both the private sector (employers, software developers, and payroll service providers) and the IRS and SSA to implement this proposal. Just as significantly, all of the affected IRS and SSA systems and tax forms would have to be changed. For example, Forms W-2 and 941, the Employer’s Quarterly Federal Tax Return, may need separate lines for reporting Social Security wages that are not subject to OASDI tax. These changes would require a significant amount of time to implement.
We are concerned that a Social Security “tax holiday” could result in significant software and processing errors and late and/or rejected W-2 reports, on the part of both the private sector and government agencies. In addition, it is likely that both the private and government sectors would incur years of reconciliation effort.
Time Required to Implement Computer System Modifications
Employers who process their own payroll using in-house systems; payroll software developers; and payroll service providers who process payrolls for employers would all have to design, code, implement, and test complex system changes to accommodate the proposal. Tax-rate changes alone normally require a minimum of 30 to 60 days to implement. More significant changes, such as a tax holiday, would require 6 months or more to ensure successful implementation. Depending on the design of each existing system, more time may be required.
The end of the calendar year is one of the busiest times for employers, payroll processors, and software developers, because most payroll-related changes (e.g., federal, state, and local tax tables) are effective January 1. The month of December is typically spent testing and implementing such changes, as well as distributing the changes to employers. In addition, quarterly employment tax and wage reports, W-2 and 1099 forms, etc., must be filed with the various agencies and/or provided to employees by January 31. Thus, even very minor tax-law changes made with little advance-notice around this time of year are extremely difficult to implement.
Would Wages Paid in the Holiday Period still be Considered Social Security Wages?
One issue that must be addressed with respect to Senator Domenici’s proposal is whether Social Security (OASDI) wages would continue to be accrued and reported. Because doing so would be necessary in order to avoid reductions or losses of individuals’ Social Security benefits, it is perhaps a safe assumption that these wages would continue to be counted and reported as Social Security wages paid, even if they are not subject to tax during the holiday period.
There are two general ways to allow continued accrual of wages despite a zero tax rate:
One way is to add new lines to the affected tax forms to separately report OASDI wages paid in the “holiday” month, and wages paid in other months of the year. This approach would require the government agencies and the private sector to accommodate the tax form changes (e.g., Forms 941, W-2, and W-3). Further, all payroll systems would need to add new database fields to separately track such wages. New database fields typically require six months to a year to implement.
The alternative is to change all private sector and government programs that currently require OASDI wages and OASDI taxes to balance. This would require approximately six to nine months to implement. More importantly, without strict tax reporting and payment requirements, Social Security taxes could become subject to inadvertent underpayment.
Wage Tracking
Senator Domenici’s proposal does not attempt to target relief to those whose annual wages are below the OASDI tax base. In this respect, it is less complicated than more targeted proposals. This means, however, that a January 2002 tax holiday under the Domenici proposal would provide a benefit to all wage earners, including those with incomes expected to be far above the OASDI wage base.
Some in Congress have promoted more targeted tax relief. Although the undersigned organizations express no opinion herein on whether to provide broad or targeted tax relief, it can be stated that revising the Domenici proposal to target the tax holiday to those with wages under a certain level would significantly add to the administrative burden of implementation. To target the proposal in this way, a process would have to be developed to identify the targeted individual wage earners, which would impose significant new administrative and record keeping tasks on employers. If the basis were determined by earnings, Congress would have to choose whether “earnings” would be based on a forecast of annual earnings, or wages paid as of a specific date.
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The undersigned organizations are all very supportive of Congressional efforts to pass an economic stimulus package, even if some administrative inconveniences result. This proposal, however, would create administrative problems that go far beyond inconvenience. Because more than several months would be necessary to ensure successful implementation, its primary purpose of near-term economic stimulus would not be achieved.
We appreciate the opportunity to comment on this matter, and remain available to assist in any way possible as Congress works to enact an effective economic stimulus mechanism. If you have any questions, please call Peter Isberg at (973) 974-5779 or Scott Mezistrano at (202) 682-4786.
American Payroll Association
American Society for Payroll Management
National Payroll Reporting Consortium
Society for Human Resource Management