President Trump’s payroll tax holiday started last week. But what does this mean for the average worker? And more importantly, is this really a tax cut, or will you have to repay the taxes that are not withheld?
The answers to these questions depend on several factors. Let’s start by explaining the payroll tax holiday, how it works, who it applies to, and most importantly, will you have to repay it?
The Payroll Tax Holiday is a Deferral Not a Tax Cut
The Trump administration has been lobbying for a payroll tax cut for several months now. However, President Trump does not have the power to unilaterally create a tax cut—only Congress has the ability to pass a law to change the tax code.
President Trump does, however, have the power to defer taxes, which is what he did last month when he signed the Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster to create the payroll tax holiday.
How Does the Payroll Tax Holiday Work?
Payroll taxes are also referred to as Federal Insurance Contributions Act (FICA) taxes. These payroll taxes include Social Security and Medicare taxes which are used to fund these programs.
The payroll tax holiday applies to the Social Security tax portion of your payroll tax, which amounts to 6.2% of your salary, up to the first $137,700.
Employers withhold FICA taxes from the worker’s paycheck and pay an equal amount to the federal government. If you are self-employed, you will pay both portions of this tax.
The payroll tax holiday defers Social Security payroll taxes for eligible workers from September 1, 2020 – December 31, 2020.
Who Does the Payroll Tax Holiday Apply To?
This is where things get interesting. There are two factors at play, eligibility and participation. The presidential memorandum is not the same thing as a change in the law. So not all employers have opted to participate in the payroll tax deferral program.
Payroll tax holiday income eligibility:
The presidential memorandum states the “deferral shall be made available with respect to any employee the amount of whose wages or compensation, as applicable, payable during any bi-weekly pay period generally is less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods.”
In short, this applies to basically anyone who earns $104,000 per year, or less (there are 26 bi-weekly pay periods per year).
Payroll tax holiday employer participation:
This isn’t a decision that most workers can opt into. Payroll taxes are collected by the employer and the nature of their payroll systems generally makes this an all-or-nothing decision.
Many federal government agencies are participating in the payroll tax deferral program, as is the U.S. military. However, many large corporations have opted out of this program due to the lack of concrete guidance, the complexity of changing their payroll systems, and the added uncertainty surrounding this program.
Will I Have to Repay the Payroll Tax Deferral?
This is unknown at this point. Again, let’s return to the presidential memorandum, which, under Section 4, states,
Tax Forgiveness. The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.
As you can see, there is no language stating the payroll tax will be forgiven—only that the Secretary of the Treasury will “explore avenues” for forgiveness.
It would take an act of Congress to pass legislation to forgive the deferred payroll taxes. This is something Congress is unlikely to act upon in the near future. Right now, consider this is an unknown that will not be resolved soon.
What Happens if Payroll Taxes Are Not Forgiven?
If payroll taxes are not forgiven, you will be on the hook for any taxes that have been withheld by your employer, most likely in the form of being taxed at double the rate at the end of the deferral period.
That means instead of paying 6.2% now, you would be required to pay 12.4% starting next year.
The payroll tax holiday defers Social Security taxes from September 1, 2020 – December 31, 2020. These payroll taxes would need to be repaid between the period of January 1, 2021 – April 30, 2021. If the payroll taxes are repaid within this time frame, the taxes would be deferred without any penalties, interest, additional amount, or addition to the tax.
According to the IRS Notice 2020-65, payroll taxes not repaid by this time will be subject to interest, penalties, and additional amounts on the tax.
How Can You Be Prepared For Either Outcome?
The payroll tax holiday is designed to put more money in your pocket. If you meet eligibility requirements and your employer is participating, then you should start seeing a 6.4% increase in your paychecks. The government wants everyone to spend this money to spur along the economy. But this could backfire if this payroll tax deferral is not forgiven—and you would be left holding the bill.
Until we know more, your best course of action is to save these additional payments in a savings account so you have access to additional cash early next year when your paycheck may be smaller than expected.