Part 3: Accounting for the CARES Act Payroll Tax Deferral Program
Updated: Sep 3, 2020
Focus Management Group has discussed creative accounting methods related to the Payroll Protection Program (“PPP”) and the income statement and working capital. In this article, we are turning our attention to the CARES Act’s payroll tax deferral program.
What is a Quick Summary of the Payroll Tax Deferral Program?
Companies will be able to defer payment of employer’s share of payroll taxes incurred from March 27, 2020 to December 31, 2020.
Of the total deferral, 50% will need to be paid by December 31, 2021 and 50% will need to be paid by December 31, 2022.
The quarterly 941 reports will be amended to report the deferrals with the second quarter of 2020.
The deferral is the employer portion of the payroll taxes, or 6.2% of payroll.
Continued clarifications related to the Payroll Protection Program and debt forgiveness are occurring.
What happens if the employer uses a third party to prepare payroll?
If an employer designates an agent to deposit employment taxes, it is the employer who directs the agent to defer the payment of employment taxes that has the liability if the taxes are not timely paid by the deferral date (12/31/21 and 12/31/22).
If a customer has a service contract with a certified professional employer organization (“PEO”) (sometimes referred to as an employee leasing company), the customer who directs the PEO to defer the payment of employment taxes has the liability if the taxes are not paid timely by the deferral date (12/31/21 and 12/31/22).
While these rules allow a deferral of the tax payment, they do not change the personal liability of responsible persons for the trust fund portion of withheld taxes (employee income tax withholding and employee portions of Social Security and Medicare taxes).
How will the accounting for this liability be handled?
Let’s consider an employer or customer of a PEO that has an annual gross payroll of $4 million, and one with $40 million. Using nine months of total payroll, estimated employer portion of taxes of 6.2%, the deferral could be $186,000 at $4 million of gross payroll, or $1.8 million at $40 million of gross payroll.
Depending on the size of the employer and the amount of expenses comprised by payroll, this tax deferral could be a significant number impacting liquidity and availability under a line of credit.
If the company accrues for the liability by debiting payroll expenses and crediting accrued payroll taxes, the balance sheet of the company would report the liability in the accrued liability section of the balance sheet.
If the company does not report the expense until it is due, the liabilities would be understated.
As with other PPP program and CARES Act accounting processes, the year end financial reporting may be different than the internal interim financial reporting.
If a payroll service is used as agent, the method the payroll service uses to invoice the company could affect the financial reporting.
If a PEO is used, the method the PEO uses for invoicing the company would impact how the deferred payroll taxes would be reported at the company level.
Who is responsible for unpaid payroll taxes?
The current guidance from the IRS indicates that employee or the company using the PEO is responsible for paying the deferred taxes.
The question a lender will need to address is the priority position of this tax deferral if the deferred amount is unpaid when due.
What should a lender or reviewer of financial statements watch for?
Relative to the deferred tax program, here is a short list of questions to ask and additional reporting to request:
Ask for a monthly payroll report showing all employees, the amount paid, the taxes incurred, and the taxes deferred.
Ask for the 941 reports filed quarterly.
Track the deferred amount.
Ask for detail to support a single line item for accrued liabilities. Often a company reports a single line item for accrued liabilities on a balance sheet, but is able to print a detailed listing of individual general ledger accounts making up that total accrued liability.
Ask the company to separately identify the deferred taxes, whether in current or long term accruals. Some companies may put a portion of the deferred amounts in current versus long term liabilities because amounts under the program may be deferred to 12/31/21 and 12/31/22.
Lenders should consider reserving an amount equal to the deferred taxes to ensure sufficient availability under a line of credit to make the deferred tax payments when they are due.
What are the next steps?
Lenders and investors are going to hear the Covid-19 excuse for the foreseeable future. We all know there are positive and negative impacts to businesses as a result of the virus and none of us should make light of the seriousness of the virus and the impact on business.
But, as readers of financial statements, we all need to make sure we don’t hear what we want to hear, or make excuses for performance that are unfounded. Ask questions.
Focus Management Group is available to assist in developing tracking mechanisms with businesses that can help clarify performance impacts, and working capital impacts. Call us to discuss what you are seeing and the questions you have.