Payroll Tax Deferral: How Will It Affect You?

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In August, President Donald Trump signed an executive order allowing employers to suspend payment of a 6.2% tax that's normally deducted from workers' paychecks from September 1 to December 31, 2020.

Many large employers, including state governments and the U.S. House of Representatives, have chosen not to implement the deferral, because the executive order calls for all deferred taxes to be repaid in full by April 30, 2021. Employers implementing the deferral in the final quarter of 2020 will effectively need to make up for it with extra payroll taxes from January through April of 2021—and the order allows them to do so by withholding extra funds from paychecks during that period.

Which Employees Does the Deferral Affect?

The deferral applies to all employees whose bi-weekly wages fall below $4,000 (or who make less than about $104,000 annually) and involves funds that are normally paid toward Social Security benefits. Normally, the 12.4% Social Security tax obligation is split between employer and employee, with each paying 6.2%. Employers withhold the employee portion and pay it to the IRS on their behalf, as part of the deduction that's typically labeled "FICA tax" on employee pay stubs and tax documents.

Under the payroll tax deferral, employers can choose not to withhold the employee portion of the Social Security tax through the end of 2020. Participating employees may allow their employees to opt out of the deferral. If taxes are deferred, the amount must be repaid in full by April 2021. (Self-employed workers are permitted to defer 50% of their Social Security tax obligations for the period from March 27, 2020, to December 31, 2020.)

The White House has characterized the tax deferral as a form of relief for workers under financial stress from the COVID-19 pandemic and economic recession. Employers opting out of the deferral and others have challenged the effectiveness of the measure, however. Detractors say the plan will do more harm than good, by giving employees a temporary boost in pay, only to follow it up with a temporary pay cut that could sting.

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How Much Extra Will I See in My Paycheck?

If you're an employee who earns less than $4,000 every two weeks and your employer has opted to take the tax deferral, you may be seeing a 6.2% increase in your paycheck through the end of the year. But be aware that you could wind up with a temporary reduction in your paycheck from January to April of next year—a cut that could reduce your paycheck by nearly the same amount as the current increase. Once the deferral is paid back, your paycheck will go back to pre-deferral levels.

What About Personal Income Taxes?

Because the IRS collects payroll taxes from employers, the tax deferral will not require eligible wage earners to do anything differently when filing their tax returns. Any reductions in withholding for the fourth quarter of 2020 will be reflected in the Form W-2 employers provide in January 2021, and additional withholding from January through April 2021 will be reflected in W-2s issued in January 2022. Neither adjustment will affect procedures for filling out individual tax forms for 2020 or 2021.

President Trump has indicated a desire to end all federal payroll taxes. The executive order implementing the tax deferral orders the federal government to explore options for eliminating them, but doing so would require Congressional support the president doesn't currently have. Critics charge the move would cripple the already strained Social Security system.

How to Handle the Deferral

If your employer enacts the deferral, you may want to consider setting aside some of the extra money you're receiving in your paycheck to help you cover the temporary pay reduction that's likely to follow after the New Year. It's looking unlikely that the president will meet his goals of abolishing payroll taxes or getting deferred taxes forgiven altogether, but if he does, you can consider these savings a windfall. Otherwise, they can help when it's time to pay back the deferral.