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NPRC Concerns With New Tax-Relief Proposals
October 10, 2001
The Honorable William H. Thomas
Chairman, Committee on Ways and Means
1101 Longworth House Office Building
Washington, D.C. 20515
Dear Chairman Thomas:
We are writing to express our concerns with respect to various technical issues arising under tax-relief proposals being considered as part of an economic stimulus package. In particular, some forms of federal payroll tax and income tax relief that have been proposed could create significant administrative burdens for U.S. employers and payroll service providers.
Our organizations represent employers and payroll service providers that, combined, pay or transmit a substantial portion of tax dollars received annually by the U.S. Treasury. While we applaud the Congress' and the Administration's efforts to help stimulate the economy through tax relief, we believe it is very important to select a method of such tax relief that does not create significant administrative burdens.
Simply put, if targeted or retroactive payroll tax relief is provided in a stimulus package, we believe that this would be best achieved by distributing U.S. Treasury rebate checks directly to taxpayers. The same holds true with respect to withholding reductions to effect retroactive income tax relief. The tax rebate check method would achieve the goal of encouraging an immediate stimulus to the U.S. economy, without imposing undue administrative burdens on taxpayers and payroll service providers.
In contrast, targeted payroll tax relief, or retroactive payroll or income tax relief, implemented through a reduction in tax rates, would create a significant administrative burden for employers and payroll service providers. Realistically, employers and payroll service providers would need six months or more to implement new tax systems to accommodate some of the changes that have been proposed. For such proposals, achieving the goal of providing an immediate stimulus through payroll tax or income tax withholding reductions is unrealistic when the administrative burden is considered.
The attached paper explains in more detail the administrative issues relevant to these payroll tax and income tax relief proposals. We appreciate your consideration of our views as you work on an economic stimulus package. Please feel free to contact Pete Isberg at (973) 974-5779 or Scott Mezistrano at (202) 682-4786 if you have questions or if we can be of further assistance.
Sincerely,
American Payroll Association
American Society for Payroll Management
National Payroll Reporting Consortium, Inc.
ADMINISTRATIVE ISSUES RELEVANT TO TAX RELIEF PROPOSED AS PART OF A STIMULUS PACKAGE
I. TARGETED / RETROACTIVE PAYROLL TAX RELIEF PROPOSALS
Targeted Payroll Tax Relief
If a payroll tax rate reduction was to affect only a subset of employees (for instance, based on income levels), administering eligibility for the reduced rate would impose a difficult new responsibility for employers. In addition, the Social Security tax calculation would be made more complex, in effect becoming a graduated tax. It could take 6 months for employers and payroll software and service providers to implement such a change.
If the subset of employees receiving such a rate reduction is determined based on earnings, the complexity for employers to determine who may be eligible for a reduced rate would be significant. This would be difficult if wages subject to Social Security tax were used, and even more difficult if wages subject to federal income tax (FIT) were used. Many types of compensation, such as 401(k) contributions, are excludable from FIT but not Social Security taxes. Requiring employers to perform an eligibility calculation using one set of definitions, and a separate calculation of the tax rebate amount using different definitions would vastly complicate the task.
Recommendation
Payroll tax rate changes affecting only a subset of employees create significant administrative burdens and should be avoided. Employers and payroll service providers would need at least 6 months to implement such a change. If such rate changes for a certain subset of employees are implemented, the determination should be based on wages subject to Social Security tax, not wages subject to federal income tax.
Retroactive Payroll Tax Relief
A retroactive change effective January 1, 2001, at this late date, would be extremely risky, because most employers, payroll service providers and software developers would not be able to implement such a change prior to the end of the year. If a retroactive change is adopted, it would be better if the change is handled by sending a rebate check directly from the Treasury to individual taxpayers, similar to the method employed by the Economic Growth and Tax Relief Reconciliation Act of 2001.
Recommendation
Congress and the Treasury should avoid making any retroactive changes to payroll tax wage or tax calculations.
Effective Date of a Payroll Tax Cut
Any prospective payroll tax cut should not be made until the first day of 2002, as virtually all payroll systems calculate Social Security taxes based on wages paid beginning on the first day of the calendar year. To effect such a change, it will be necessary to design, develop, and test programming changes, to issue updates to customers, and to allow time for employers to implement the new programming. The new calculations should apply only to Social Security wages paid after 12/31/2001.
Recommendation
Any going-forward changes to payroll tax calculations should not be made effective until the beginning of the year, i.e., January 1, 2002.
Employer/Employee Social Security Tax Rate Parity
Congress should carefully consider the implications of reducing Social Security tax rates for employees without reducing the Social Security tax rates for employers. Such a change would break a longstanding tradition of employer / employee payroll tax parity.
Changing the employee Social Security rate or wage limit without also changing the employer's rate or limit will also introduce complexities to the programming, balancing and reconciliation, and reporting of Social Security wages and taxes.
Different employer/employee FICA rates would have a major impact on the reporting of third party sick pay. Currently, most payroll systems can accommodate a third party provider because the rates are the same for employer and employee. If they are different, payroll systems would have to identify which rate applies (employer or employee) for the taxes deposited by the outside party for the Line 9 adjustments on the Quarterly Employers Federal Employment Tax Return (Form 941). Balancing the tax return would present major complexities and obstacles.
Recommendation
Congress and the Treasury should avoid upsetting the employer/employee Social Security tax parity that exists today.
Social Security "tax holiday" proposal
Any change to Social Security taxes and/or withholding requirements associated with a sub-calendar year time period would create significant confusion and employer burden.
It would be necessary to clarify whether employers should continue to record Social Security wages paid during the period. If a different rate applied (e.g., zero), new database fields would need to be established to separately track wages earned during the time period.
Employees might try to accelerate wages into any 'holiday' period, i.e., by requesting advance vacation pay, or advance bonus or commission pay.
Important employment tax reconciliation programs would be affected. Employers currently reconcile each payroll's Social Security wages and taxes to the quarter-to-date and year-to-date Social Security wage and tax totals for the purposes of ensuring timely deposits. Employers also reconcile Forms 941, Employer’s Quarterly Employment Tax Return, to payroll totals, and to year-end Forms W-2 and W-3. In addition, the IRS and SSA each administer reconciliation programs to compare W-2/W-3 totals to Forms 941. All of these programs would require costly and burdensome changes. To properly craft and administer such a provision would require many special calculations on the part of employers, the Social Security Administration, and the Internal Revenue Service.
Recommendation
Congress and the Treasury should avoid ‘temporary’ changes to Social Security wage or tax calculations.
II. RETROACTIVE INCOME TAX RELIEF PROPOSALS
Requiring the U.S. Treasury to make "exaggerated" reductions in withholding table rates to provide for a retroactive tax cut
Making changes in withholding tables to effect a tax rebate retroactive to the beginning of the year could result in significant tax under or over-payments. This is because the reduced withholding will apply with respect to taxes on wages going forward, when the tax rebate should be calculated based on wages and taxes that were already paid.
For individuals who were unemployed or earned a substantially lower salary for the portion of the year before the new withholding tables are applied, significant under-withholding would result if tables were changed in a manner that assumed that taxpayers earned the same salary throughout the year. Significant under-withholding could result in taxpayers facing large tax bills, and even penalties, at tax-return filing time. In addition, employees would perceive a tax increase when an exaggeratedly low withholding rate reverts to the actual rate.
For individuals who earned a substantially higher salary for the portion of the year before the new withholding tables are applied, significant over-withholding could result.
Recommendation
New withholding tables should reflect a decrease in withholding that is no more than the decrease in the tax tables, without attempting to effect any "catch-up" decrease (for the part of 2001 before new withholding tables go into effect). To the extent a rebate for taxes already paid is authorized, this rebate should be provided by issuing U.S. Treasury checks to taxpayers.
New withholding tables for tax cuts going forward should have an effective date that is four to six weeks after the signing of the bill into law, to allow time for service and software providers to produce and issue updates to customers and to allow time for employers to implement new calculation programming
New withholding tables should have an effective date that coincides with the first of a quarter, as many payroll systems are programmed to reflect withholding table changes taking effect on such dates.
Requiring employers to change employee withholding to provide for a retroactive tax cut based on total wages earned and taxes withheld by the employer during 2001
Some have proposed that employers be required to calculate and implement an ’exaggerated reduction“ in employee withholding going forward, to provide employees with an effective rebate for taxes already paid. This would require employers to calculate the amount in taxes that employees have "overpaid," based on wages already earned, and reduce withholding an extra amount so that the employee is provided this rebate over the remainder of the year (in addition to reducing withholding to reflect a tax cut going forward).
This proposal would be virtually impossible to implement with respect to employees who begin new jobs in the middle of the year, and, even for other employees, the proposal would impose significant burdens on employers and payroll service providers.
The actual impact of any tax cut can only be determined with knowledge of a taxpayer’s total income situation – a much larger set of personal information than that to which any employer has, or wants, access.
In order to properly calculate reduced withholding to provide employees with a rebate for a portion of taxes already paid since the beginning of the year, an employer must know the employee's cumulative wages paid and taxes withheld since the beginning of the year. If the employer does not have this past wage and taxes-paid information, (e.g., because the employee worked for another employer earlier in the year), the proper withholding amount cannot be calculated. If employers have to make assumptions regarding prior wage and tax amounts, it would create significant risk of over-withholding or under-withholding for employees. Over-withholding would work against the whole idea of the tax cut, and under-withholding could result in substantial tax bills, or even penalties, for employees. In addition, employees would perceive a tax increase when an exaggeratedly low withholding rate reverts to the actual rate.
Even if the employee had worked for the employer since the beginning of the year, the employer has no way of knowing whether or not the employee is also working concurrently for another employer. If both employers reduce withholding on wages in the new lowest wage bracket, the employee would be under-withheld at the time of filing the personal income tax return and possibly subject to penalties.
In making income tax withholding calculations, today’s payroll systems consider only the wages earned in the current pay period and apply them against the current withholding tables – the same process for each employee. Any proposal that would require a tax recalculation based in part on prior 2001 earnings and/or withholding may require a customized withholding approach for each employee, which could take months to design, program, test, distribute, and implement.
Recommendation
Any legislation requiring employers to adjust employee withholding should take effect on a “go-forward” basis only.