New Avenues Open for Employers to Save on Payroll Taxes

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June 18, 2010

Employers should be alert to significant new legislative and judicial developments in the collection and payment of payroll taxes.

Payroll Tax Exemption for New Hires. The Internal Revenue Service has released a new tax form to help employers claim the payroll tax exemption adopted into law by the Hiring Incentives to Restore Employment Act (HIRE Act), signed by President Obama on March 18, 2010.

The HIRE Act exempts employers from their share of Social Security taxes on wages paid to previously unemployed workers after March 18, 2010, through year-end. Specifically, employers are exempt from the payroll tax on Social Security wages paid on or after March 19, 2010, for employees whose start date is after February 3, 2010. The exemption covers wages paid to these employees until the end of this year.

The new Form W-11 places the onus of compliance on the employee. Form W-11 is completed by new employees to certify, under penalties of perjury, that they were unemployed, or did not work for anyone for a total of more than 40 hours, during the 60-day period ending on the day they begin employment with a new employer. The employer does not sign Form W-11, and it is not filed with the IRS. Employers must retain the form in their books and records. The payroll tax exemption will be claimed by employers on their Form 941 quarterly tax returns, beginning with the returns filed for the second quarter of 2010. Payroll taxes for these qualifying new hires paid during the first quarter may be credited against the payroll tax for the second quarter.

The exemption applies for new employees of businesses, agricultural employers, nonprofit organizations, and tribal governments. It also applies for employees previously laid off (even by the same employer) who have been receiving COBRA benefits. The exemption does not apply, however, to federal, state, or local government employees, except for those of public universities and colleges.   

The employer must still withhold and pay over the employee’s share of Social Security payroll taxes and both the employer’s and the employee’s share of health insurance payroll taxes. The requirement that employers withhold income taxes from employees’ wages is also unaffected by this legislation.

Business Credit for Retention of Workers. The HIRE Act also creates a new general business tax credit to persuade employers to retain newly hired workers. Employers may claim the credit for each employee hired after February 3, 2010, and before January 1, 2011. The credit is the lesser of $1,000 or 6.2 percent of wages for the retention of each new hire. For an employer to claim the credit, a worker must remain on the job for 52 consecutive weeks, and the worker’s pay cannot decrease significantly in the second half of the year―that is, the wages in the second half must be at least 80 percent of those paid in the first half.  In the case of a calendar year taxpayer, therefore, the credit can be claimed on the employer’s 2011 income tax return only when satisfaction of the 52-consecutive-week requirement can be ascertained. The credit can be carried forward for up to 20 taxable years but cannot be carried back to a taxable year beginning before March 18, 2010.

FICA Taxes and In re Quality Stores, Inc. In a related development dealing with payroll taxes, a U.S. District Court in Michigan recently held that employer severance payments are not subject to FICA taxes when an employee is terminated because of downsizing or the shuttering of operations. Commenting that federal courts and the IRS have concluded both ways on this issue, depending on the circumstances, the District Court decided that employer severance payments are not classified as wages and so are not subject to FICA, which imposes a tax on employee wages to fund Social Security and health care benefits. In contrast to CSX Corp., Inc. v. United States, which the U.S. Court of Federal Claims decided in the opposite way in 2002, the District Court in Michigan reasoned that because the severance payments are intended to serve the same purpose as Social Security benefits that support workers in lieu of their lost ability to earn wages (in this case, supplemental unemployment compensation benefits), collecting social benefit taxes on wage-replacement social benefits makes little sense. The court therefore concluded that severance payments tied to employees’ separation from employment because of a reduction in force or a plant or operation being discontinued fit the statutory exceptions to FICA and FUTA taxation for supplemental unemployment compensation benefits.  

The Tax Group of Ballard Spahr LLP is able to advise employers on compliance issues arising under the HIRE Act. We also will assist employers in filing refund claims for the overpayment of payroll taxes on employee severance pay. Please contact Nancy M. Lashnits, at 602.798.5413 or [email protected], for additional information and assistance.

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