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Reducing the Social Security Tax Rate Retroactive to January 1 February 18, 2003 The notion of providing employees and employers with a “payroll tax holiday” has garnered support from a number of members of Congress over the last two years as a means to provide a quick boost to the incomes of employees and employers and, thus, a stimulus to the economy. The National Payroll Reporting Consortium (NPRC), American Payroll Association (APA), American Society for Payroll Management (ASPM), and other organizations have analyzed several proposals put forth in the past two years and found that these proposals as a general matter would involve significant administrative issues that would necessitate three to six months of lead-time to ensure that employers would be able to modify systems and the Government would be able to modify forms sufficiently to allow implementation of the proposed tax holidays. Many of the administrative problems associated with these proposals arise because they contemplate a mid-year implementation date. A new idea -- reducing the Social Security tax rate retroactive to January 1 -- would avoid many of the problems associated with previous payroll tax holiday proposals and thus could be implemented, even in the middle of the calendar year, with less required lead-time. NPRC estimates that sophisticated employers and payroll service providers could implement the retroactive Social Security tax rate reduction in four to eight weeks, regardless of the implementation date of the proposal. Up to three months of lead time would likely be necessary, however, to minimize error rates associated with less sophisticated employers. The need for lead time arises primarily because of the administrative burden associated with human communications and coordination of the change with the six million employers and roughly 140 million employees who would be affected. Automatic Features of Payroll Systems Most payroll systems include a feature that calculates Social Security and Medicare taxes owed with respect to an employee on a year-to-date and quarterly basis. Any FICA rate change applied in the middle of a year would be assumed by the various payroll systems to apply for the entire year. While this feature causes significant problems for proposals to implement changes effective in the middle of a calendar year, the same feature can be turned to an advantage by utilizing an effective date retroactive to January 1. Implementation Within the First Calendar Quarter If a Social Security tax reduction effective retroactively to January 1 is enacted and implemented by March 31st, the FICA recalculation feature present in most payroll systems would automatically calculate and refund Social Security taxes previously withheld at the higher rate, in effect generating a lump-sum tax rebate due to employees. Thus, with the input of a new tax rate retroactive to the beginning of the year, the rebate would generally be provided automatically through the payroll process without the need for software development. This type of change would be the easiest to implement, possibly in as little as two weeks. Implementation After Quarterly Returns Have Been Filed Normally a Social Security tax rate reduction would be applied to Social Security taxable wages paid for the current calendar quarter only. If this proposal was enacted after March 31, programming changes might be necessary to separately calculate and apply the rate reduction to Social Security wages for prior quarters in the year. Relative to other Tax Holiday proposals, programming to calculate and apply a rate change to wages reported in a prior quarter is not particularly difficult, but all programming changes require time to implement, test and communicate. It may be necessary for employers to report a correction to their previously filed IRS Form 941 (Employer's Quarterly Federal Tax Return), since these forms will have been filed when the higher rate was in effect. Employers generally file Form 941c to reduce tax liabilities for a prior quarter, and apply the resulting credit to current taxes, noting the credit on the current Form 941. It might be possible, however, for the IRS to adopt special rules to make amending returns unnecessary. In any event, coordination between the IRS and employers may be necessary to clarify whether employers may elect a refund check instead of a credit, and whether the resulting overpayments may be offset against any other outstanding liabilities of the employer. Employer Funding Issue Under this proposal, the initial tax rebate would be paid to employees in the form of increased net pay. Employers would increase employee paychecks and reduce the amount of payroll taxes they would otherwise pay to the Treasury. Most employers (except for larger employers) are not required to transmit payroll taxes to the Federal Treasury until a few days (or even more than a month for employers with smaller payrolls) after the day employees are paid. Thus, to include the rebate as part of the employee's regular paycheck, the employer would have to pay this extra amount at least a few days earlier than the date that they would normally have to transmit taxes to the Treasury. This could potentially cause liquidity problems for some small business owners who might normally rely on the extra few days (or as much as a month, for smaller employers) to come up with the funds to pay employment taxes. A possible solution to this problem might be for employers to run a separate payroll to pay just the rebate amount on the day taxes would be due. Rebate That Exceeds Tax Liability for a Pay Period If the retroactive tax rebate amount exceeds the amount that an employee owes in taxes in a particular pay period, the excess rebate amount would either have to be funded, temporarily, by the employer, or deferred until the next pay period. Former Employees Administering the tax rebate for former employees, who worked for the employer earlier in the rebate year, could be problematic. Some payroll systems may automatically adjust Social Security withholding and generate a rebate check for terminated employees, since employees must typically remain on the payroll system until year-end W-2s are generated and filed with the government. If a check is generated, the employer could mail it to the last known address. One alternative would be to allow employers to credit any tax rebate to federal income tax withheld on the former employee's W-2. Recovery of Government Debts In 2001, the IRS was able to reduce tax rebate checks by any overdue amounts administered by a government agency, such as tax debts, child support, or student loans. The IRS would probably not have the opportunity to recover amounts due from employees in any program administered by employers. 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.