Treasury’s On-Demand Pay Proposal Shows IRS’s Concern with Constructive Receipt, Says Tax Services Director
For the second year in a row, the Treasury Department has issued a revenue proposal to clarify the tax treatment of earned wage access (EWA) pay arrangements.
A tax services director in Washington D.C. says that the Treasury Department’s proposal to clarify the tax treatment of on-demand pay arrangements makes it “clear” that the IRS is concerned with the constructive receipt issue of this trending employee benefit.
Earned wage access
According to the Treasury, employers and third-party payors increasingly allow employees to receive payment of earned wages before their regularly scheduled pay dates. In the payroll industry, such arrangements are generally referred to as earned wage access or EWA. For more than a decade, this type of early pay program has become a more popular benefit offering by employers to their workers as a financial wellbeing tool.
Benefit to employees
“It appears to be a pretty valuable benefit from the perspective of employees since so many employees live paycheck to paycheck,” said Tim Daum, a managing director at Crowe LLP’s National Tax Services. An April 2023 report from PYMNTS and LendingClub found that at least 60% of United States consumers lived paycheck-to-paycheck as of March 2023. Daum added that for individuals with certain immediate financial concerns, “the ability to access their wages prior to their normally scheduled payday could be a big deal.”
Back in 2021, the American Payroll Association (APA) produced a report on understanding EWA, noting that such “programs have moved from the early adoption phase to become a more established business practice and part of the benefits package offered to employees.” The report, titled “Understanding Earned Wage Access and Payroll,” explains that “employers are also interested in whether employee benefits will help them attract and retain talent.”
Employer benefits too
A survey from 2022 showed that workers in the U.S. would stay longer at a job if they could get immediate access to their earned pay after each day’s work at no cost (56% of those surveyed). Also, during a workshop on financial wellbeing at APA’s 2022 Congress event in Las Vegas, Felicia Cheek, Director, HCM Product Strategy at Oracle, said that concern with an employee’s financial wellbeing is a way to help employers acquire and retain talent as a way to “combat” the Great Resignation, which occurred during the height of the coronavirus (COVID-19) pandemic.
EWA issues
Although this popular benefit is potentially advantageous for employers and employees, EWA is not without its issues. First, in December 2020, the Consumer Financial Protection Bureau (CFPB) published an advisory opinion in the Federal Register to resolve regulatory uncertainty regarding the applicability of the definition of credit under Regulation Z, which implements the Truth in Lending Act (TILA), to certain EWA programs. Specifically, the opinion said that a covered EWA program does not involve the offering or extension of “credit.”
Daum said that people concerned with federal credit and fair lending laws “didn’t like the decision because they viewed it as a loophole around having to comply with Regulation Z.” He added that from the employer’s point of view, “it helps them by not having to deal with Regulation Z, pursuant to that guidance, but it hurts them from the employment tax perspective.”
Constructive receipt
This employment tax viewpoint was initially brought to light when the Treasury Department issued its fiscal year 2023 “Green Book” of revenue proposals in March 2022, with a measure on page 106 to clarify the tax treatment of on-demand pay arrangements. Employment tax regulations provide that wages are considered paid when they are constructively received by the employee. This means that the wages are set apart or otherwise made available so that the employee can access that amount at any time. “You’re in constructive receipt as soon as you’re able to access them, whether you access them or not,” Daum noted.
As such, the Treasury says that employees with access to an on-demand pay arrangement may be in constant constructive receipt of their wages as they are earned and advises employers that offer EWA to maintain either a daily or a miscellaneous payroll period where they withhold and pay employment taxes on employees’ earned wages on a daily basis.
Treasury again proposes constructive receipt rule
The effective date of this proposal was to be January 1, 2023. However, 2022 ended without any such legislation being signed into law. However, the Treasury’s FY 2024 “Green Book” again includes the on-demand pay arrangement employment tax clarification on page 207. “It’s an Administration proposal, but I think it’s clear how the IRS views these arrangements is that there’s a constructive receipt issue,” Daum stated.
Specifically, the Treasury’s proposal would amend several sections of the Internal Revenue Code as follows:
- Code Sec. 7701to provide a definition of an on-demand pay arrangement as an arrangement that allows employees to withdraw earned wages before their regularly scheduled pay dates.
- Code Sec. 3401(b)to provide that on-demand pay arrangements are treated as a weekly payroll period, even if employees have access to their wages during the week.
- Code Sec. 3102, Code Sec. 3111, and Code Sec. 3301to clarify that on-demand pay arrangements are not loans.
- Code Sec. 6302to provide special payroll deposit rules for on-demand pay arrangements.
Proposals show how IRS views EWA
“From an employer’s perspective, these proposals should make them aware that…if the IRS ever looks at their particular arrangement, they may be asking why have you not been remitting taxes more frequently than you have?” Daum said. He provided an example where an employer might pay its employees on a monthly basis, implement an EWA program, and then find that the IRS may view the change as if the employer is paying its employees using the EWA benefit as a daily payday. “I think this proposal should put employers on notice that that’s the way the IRS views things,” Daum added regarding the potential exposure employers may be opening themselves up to.
Proposal could provide certainty
Regarding if the proposal was enacted sometime this year and effective in 2024, Daum believes that it might be welcomed by employers and tax professionals. “It would give some certainty as to how all of this should be treated,” he began. “I think if they did enact legislation like this, I think it would give everybody a better road map of exactly how to handle it.”
State EWA laws and proposals
While there is currently not a specific rule in effect regarding EWA and constructive receipt for federal employment tax purposes, some states have enacted legislation regarding on-demand pay arrangements. Others are in the process of adding or amending existing rules or regulations. For example, California’s Department of Financial Protection & Innovation has extended the comment period to May 17 for proposed regulations pertaining to EWA.
A proposed bill from earlier this year in Georgia would cap the mandatory fees EWA service providers are allowed to charge at 10%. Other states like Kansas, Missouri, New York, and Vermont have proposed legislation to require EWA providers to register with the state.
EWA’s future
Although Congress does not have any pending legislation at the moment regarding Treasury’s EWA proposal, EWA continues to trend in a positive direction. While Daum prefers not to predict the future, he said said that without guidance, EWA is currently “overtly difficult to work with” which can prove to be an obstacle to implementation as EWA will become “more prevalent…as [the] technology just continues to get better and better.”
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