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COVID-19, Social Security, Income Taxes

Steps to Take if You Have Been Impacted by the Employee Payroll Tax Deferral

By Bruce McClary | Thursday September 17th, 2020

President Trump’s recent executive actions have impacted millions of Americans. We have already written about the actions on evictions, the student loan payment suspension, and increased unemployment benefits. However, one more executive action signed in August is beginning to have an impact on some American workers: the employee payroll tax deferral. If you have been affected by this deferral (also called a tax “holiday”), here is what you need to know and what you need to plan for in the coming months.

Background

President Trump had been floating the idea of a payroll tax holiday for a while, but Congress did not include it in the CARES Act, nor has Congress taken any further action to put such a holiday in place. As a result, President Trump acted on his own via an executive action. The executive memorandum states that the payroll tax holiday or deferral will take place from September 1 through December 31, 2020. It covers employees who make less than $104,000 in annual gross wages.

How does it work? Normally, “payroll taxes” are deducted from your wages on each paycheck that you receive. These include a tax for Social Security, which is 6.2 percent of your gross wages. Under the executive action, employers can opt not to have this 6.2 percent withheld from your check.

As a result, if you work for a participating employer, your paycheck will effectively increase by 6.2 percent. As Kiplinger explains, this amounts to an extra $446 in earnings this year for someone making $10 an hour. And the maximum amount in savings for the year would be $2,232 (for someone making $50 per hour, or the maximum salary level at which you can take the deferral).

While this may be a helpful change for some, there are two major caveats to keep in mind. First, many employers are not participating. And, if they do not participate then their employees cannot defer the payroll taxes. The federal government, as an employer, is participating. This includes the military. The Department of Defense has published special guidance for service members.  If you are not a federal employee or in the military, then you will need to check with your employer to make sure you know whether they have elected to participate.

The second caveat is that the money that is not withheld must be paid back within the first four months of next year, unless there are more legal changes. In other words, you need to remember that this is a holiday or deferral and not a tax cut or tax forgiveness. This means that participating employees will see bigger checks for the remainder of this year, but next year will see smaller checks.

Steps to Take

#1 Know if your employer is participating

This should be fairly easy to do: speak with your employer to see if they are participating in this program. By now, you may have already received a paycheck since September 1, so you could check your pay stub to see if Social Security was withheld. If your employer is not participating, then your pay will continue to be taxed as normal, and you will not need to take further action.

#2 See where you stand and then budget for the change

If your employer is participating then your income will essentially grow by 6.2 percent for the remainder of this year. You need to budget for that increased income, right? Well, not so fast. First, take a good close look at where you stand. Are you financially stable? If so, you may be able to increase some of your budget items and use the new money coming in.

On the other hand, if money is tight then it is probably best to keep your budget where it is. You almost want to pretend this “new money” does not exist. Try to keep your spending level where it has been and do not count on the new funds to go toward purchases. Just put them in your emergency savings and leave them there.

Why? Because remember you will have to pay this money back. Right now, you are getting a 6.2 percent pay increase, essentially. But next year you will experience a 6.2 percent pay reduction for the first four months! You will want to hold onto this money now because you may need it later when your paychecks are smaller.

#3 Stay Informed

There is a chance that this tax holiday could turn into a permanent tax cut. This would mean that the Social Security tax you avoid this year could be forgiven. For that to happen would require another executive order or other legislation. This is far from a certainty, and many commentators think it is very unlikely. So, do not expect the money to be forgiven, but stay informed on the issue so you can make the appropriate choices as time goes on.

Many people are not affected by this executive order. If you are one of the people affected, be sure to remember that—as of now—you will owe the deferred tax next year. If there’s any question as to whether you can afford the tax hike next year, then just save the money now. That will make things much simpler and easier to manage.

If you need additional assistance managing your personal finances and credit, contact a credit counselor for free help.

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