Tax holiday: Next hot stimulus idea? Or big headache for you?

A proposed tax holiday, if enacted, is bound to be popular with employees but not so popular with employers and recordkeeping people. Here’s why.
While some workers would receive fatter paychecks because, under the proposal, they wouldn’t pay Social Security or Medicare taxes for six months (and their employers wouldn’t have to make matching deposits), Payroll could get stuck with a messy, tight timetable.
The bill, sponsored by Reps. Aaron Shock (R-IL) and Walt Minnick (D-ID), would apply to employers, and employees of companies with 50 or fewer workers. Similar holidays were proposed during recessions in 2001 and 2003, but ended up on the cutting room floor.
While the idea sounds good on paper (and every proposal is just a bit different), just about all tax holidays have several potential pitfalls:
1. Employers probably wouldn’t get enough lead time. The timeframe to implement a payroll tax holiday could rival the one given for the new COBRA premium subsidy program – a few months at best, because lawmakers want to get money back into Americans’ pockets fast so they can spend, spend, spend. However, employers use a wide variety of payroll systems and while some with simpler payrolls could implement changes in a few weeks, it would take others much longer – even months.
Plus, employers that don’t process in-house would be at the mercy of others. For instance, the companies relying on off-the-shelf software would have to wait for the manufacturers to provide software updates for all different versions of their products. Those using payroll service providers would have to wait for their vendors to design, code, implement and test complex system changes to accommodate the proposal. Tax-rate changes, for example, normally require a minimum of 30 to 60 days to implement, so it’s no wonder that more complicated changes can take longer.
Bottom line: Taking all these details into consideration, employers would need a minimum of three to six months to prepare for a tax holiday. Chances are, though, that lawmakers would push to make this particular stimulus happen faster.
2. Recordkeeping and reporting requirements would change. How would Payroll report Social Security and/or Medicare wages that aren’t subject to taxes? Would IRS change both the Form W-2 and 941? The agency might have to add separate lines for things like Social Security wages paid in tax holiday period, or exempt from tax; Social Security wages subject to tax; Social Security tips paid in tax holiday period, or exempt from tax; Social Security tips subject to tax; and Medicare wages/tips paid in tax holiday period, or exempt from tax.
IRS regs require employers to provide terminating employees a Form W-2 within 30 days of their request, so most tax form changes would have to be made immediately.
3. Potential for abuse. Unless lawmakers define exactly which types of wages qualify for a tax holiday (and that seems unlikely), there’s an opportunity for employees to artificially shift income into any time-based holiday period. For instance, say a tax holiday’s in effect for the third and fourth quarters of 2009. Someone entitled to a large bonus based on business results and normally paid after the first of the year might arrange to have the check cut at the very end of the fourth quarter to take advantage of the “tax free” status. Payroll might also field requests for advance vacation pay or commissions.
Right now, the payroll tax holiday is only proposed. But, with the economy still far from recovering, it could easily gain more support. We’ll keep you posted.