Delayed But Not Forgiven: Examining Deferred 2020 Payroll Taxes in M&A Transactions
November 09, 2020
Due diligence is an essential activity for both buyer and seller success in an M&A transaction. The process allows parties to identify and assess risks, liabilities, and business problems before finalizing a transaction. Tax due diligence is just one aspect of the overall process. It typically requires an examination of a business’s historical tax records, current and future tax obligations, potential worker classification issues, compliance risks, as well as other types of tax issues. Payroll tax compliance, particularly the obligation to pay 2020 payroll taxes deferred during the pandemic, has become a vital checklist item for any M&A transaction.
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES” Act), signed into law on March 27, 2020, contains a wide range of pandemic-related economic relief provisions. One of these provisions, Section 2302, permits employers to defer the deposit and payment of the employer’s portion (6.2% of employee’s wages) of Social Security tax due on wages paid during the period beginning March 27, 2020, and ending December 31, 2020. Cash-strapped businesses may defer such deposits and payments to free-up cash for other purposes, without any immediate threat of having to pay penalties or interest. See IRS Notice 2020-20. These deferred deposits and payments, however, are not forgiven. Deferred amounts are due to the government in two installments: (1) one-half (50%) at the end of 2021, and (2) the remaining one-half (50%) at the end of 2022.
On August 8, 2020, the President also signed four executive orders, including the Presidential Memorandum to allow employees to defer certain payroll tax obligations. Shortly thereafter, on August 28, 2020, the Department of Treasury and Internal Revenue Service issued guidance implementing the memorandum. As per Notice 2020-65, deferral is now also permitted on the employee portion of Social Security tax due from September 1, 2020, through December 31, 2020. Employer participation is optional and deferral is only available for employees whose wages or compensation are generally less than $4,000 per bi-weekly pay period (typically workers making less than $100,000 a year). If an employer offers this option to its employees, the employer remains responsible for remitting these taxes to the Internal Revenue Service, on behalf of employees, no later than April 30, 2021. This means that employers will need to collect and pay the Social Security tax due for September 1 through December 31, 2020, in addition to the collected Social Security tax from January 1, 2021, through April 30, 2021. Notice 2020-65 places the responsibility for payment of the deferred amounts on the employer. If the employer does not withhold and remit the deferred employee amounts due by April 30, 2021, the employer (and quite possibly its responsible parties) will very likely be subject to penalties and interest, including the onerous trust fund recovery penalty (the “TFRP”). Internal Revenue Code (IRC) § 6672 provides for assessment of the TFRP against those deemed responsible persons who willfully failed to withhold from employees and remit to the IRS income taxes, employment taxes (which include Social Security taxes), and certain types of excise taxes, which are referred to as the “trust fund” taxes. A responsible person can generally be an officer of a corporation, a partner, a sole proprietor, or an employee of any form of business.
Although representative of only two of the many government relief provisions enacted in response to the COVID-19 pandemic, these payroll tax deferral actions require consideration in the M&A context. The actions provide liquidity, but the deferrals of such obligations also raise liability concerns that need to be addressed. Consider the following:
- What if a business is sold before one or both of the required installment payments or tax remittances are due?
- What if the deferred amounts due are never paid? Who will be liable?
To avoid any confusion, M&A parties should confirm that deferred payroll taxes are included in net indebtedness or otherwise considered. They should include the deferred payroll taxes in the definition of pre- or post-closing taxes, and determine who is obliged to pay such amounts. If the seller is responsible, a buyer (as well as any deemed responsible persons with respect to any employee portion) will want to make sure that the seller has sufficient liquidity to cover the liability because ultimate responsibility will fall back to the company (and such responsible persons). If the buyer is responsible, the purchase price may be adjusted, especially in equity transactions. Lastly, tax representations and warranties, as well as tax indemnifications, should be utilized as necessary to ensure the transaction – as it relates to such deferrals – is fair to both buyer and seller.
If you have any questions about payroll tax deferral, payroll tax liabilities, and/or the importance of tax due diligence, please do not hesitate to contact me or another attorney here at Farrell Fritz, P.C.