Requirements for all employees to submit a new federal income-withholding form by October 2020 and for employers to assist workers with this process were among the recommendations made Nov. 20 to the Internal Revenue Service by the agency’s advisory council.
The Internal Revenue Service Advisory Council, in its 2019 report to the IRS, also recommended that guidance for on-demand pay services be developed as soon as possible.
Clarifying 2020 Form W-4
With a new Form W-4, Employee’s Withholding Certificate, required starting in 2020, the IRS has published early drafts of the form as well as new instructions in Publication 15-T, “Federal Income Tax Withholding Methods.” The final version of the 2020 Form W-4, with possible revisions, is expected to be released in November and a final version of Publication 15-T is expected by year-end. The withholding form and instructions are being revised to reflect the elimination of personal exemptions in the tax code overhaul (Pub. L. 115-97) that took effect Jan. 1, 2018.
However, the advisory council said the IRS should clarify the rules and procedures for federal income tax withholding in 2020. The rules are complex and confusing, especially to employees, said the report, which listed concerns about Form W-4 as the advisory council’s top issue.
“In the past, employers and payroll professionals have been instructed not to assist employees with Form W-4 submission to avoid being put in the role of tax adviser,” the report said. “The complexities of the new Form W-4 will add additional pressure on employers to take a more active part in the taxpayer education process.”
For example, the 2020 Form W-4 has a check box to withhold at a higher rate in Step 2, the report said. The line instructions state: “Consider checking the box on line 2 if there are only two jobs in the household. The standard deduction and tax brackets will be divided equally between the two jobs.”
“Nowhere do the instructions explain what this language means,” the report said. “Only in Publication 15-T is this explained. The IRSAC believes this will increase confusion for taxpayers and employers and recommends more detailed explanation and examples of increased withholding if the Step 2 box is checked. At the least, the instructions should reference Publication 15-T for more information on this point.”
Employer payroll systems would need to identify at the employee level which Form W-4 method is being used—one of the methods for 2020 or a method that was in use before 2020 but is still permitted in 2020 for Forms W-4 filed by Dec. 31, 2019, the report said.
“Having the employer maintain dual withholding calculation systems/processes causes unnecessary administrative burden and costs to employers and payroll service providers (in addition to being confusing to employees and payors),” the report said. “This burden will go on for years until an employee with a Form W-4 issued prior to the new 2020 W-4 either files a changed W-4 or quits working for the employer.” Additionally, if employees find in 2020 that they are underwithheld based on a pre-2020 Form W-4, a new Form W-4 would need to be filed.
Adding to the confusion is the online IRS tool that is used to estimate withholding, the report said.
“Taxpayers remain confused about their federal income tax withholding,” the report said. “The new withholding estimator that appears on the IRS website is using the old marital status and allowance routine (for all but spousal and dependent allowances) because it applies for 2019. It also requires taxpayers to come prepared with their prior year tax return and a current paystub to properly use the estimator.”
In 2020, the report said, the estimator would need to be replaced with one based on the new Form W-4 method of withholding, which is different than what has been used for the past three decades.
The council “believes that many employees will not complete and submit a new Form W-4 or W-4P to their employers due to the changes and the confusion the employees will have in completing the new form and using the estimator,” the report said.
In addition to updating the withholding estimator, the council recommended that the IRS further clarify the rules and procedures for 2020 and require employees to submit a new 2020 W-4 by Oct. 1, 2020. The agency should encourage employers to distribute the 2020 instructions to all employees or provide them with the link to the document’s location on the IRS website.
Guidance for Quick-Pay Programs
On-demand pay services are gaining in popularity as technological advances propel such programs. Large payroll-service providers, including ADP LLC, are participating in the on-demand pay trend. Other service providers participating in the trend include DailyPay, FlexWage, Gusto, Rapid! Paycard, and SurePayroll.
“There is no one model for on-demand pay,” the report said. “Essentially, it’s an umbrella definition. It’s not necessarily a loan, though it might be; it’s not necessarily an advance against already earned payroll, though it could be; it is not necessarily payroll, though it could be. Basically on-demand pay allows employees to access some or all of their earned wages on a shorter pay cycle than the normal pay period for their employer. There may or may not be costs and fees which may be paid by the employee, though not necessarily.”
The growth in on-demand pay programs is likely driven in part by employees and independent contractors, and by companies wanting to sell computer software and subscriptions, the report said, adding that lenders may offer such services as a way to increase revenue.
After meeting with members of the advisory council, the IRS asked the group to develop questions that need to be considered in creating a regulatory environment for on-demand payroll. Some of the nearly 40 questions included:
• When is on-demand pay considered a payroll payment for tax purposes? Must it be paid by the employer? If a third party pays, can it be payroll?
• How do the concepts of actual and constructive receipt affect on-demand pay?
• How should payroll deductions be calculated?
• When is on-demand pay considered an advance for tax purposes?
• When on-demand pay is considered a payroll payment, how are taxes calculated?
• Is the payment included on the day of receipt or when the rest of the payroll for that period is paid?
• How would tipped employees be affected?
The American Payroll Association sent a letter in June to the IRS, asking the agency to publish guidance on how to apply income tax withholding, deposits, and reporting requirements to fast-pay options. A copy of the letter was obtained by Bloomberg Tax.
Guidance was needed to define the principal of constructive payment as it applies to on-demand pay and the payroll process, the association said. Among the association’s questions: Under what circumstances does an employee’s access to accrued earnings trigger actual or constructive payment of wages? Can withholding, depositing, and reporting of taxes associated with on-demand pay be processed on the employee’s next regular payday?
The request for guidance was included in a letter that the association sent in response to an IRS solicitation for comments about its 2019-2020 priority guidance plan.
In its report, the IRS advisory council recommended that the agency create guidance for on-demand payroll as soon as possible. The IRS should include discussions with the Labor Department, Social Security Administration, Consumer Financial Protection Bureau, and state agencies.
‘The longer the wait for guidance from the IRS and other stakeholders, the more difficulty there will be in modifying existing practices to bring them into compliance with any such guidance,” the council said.