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The IRS and U.S. Treasury Department recently issued guidance on how the Trump administration’s payroll tax deferral will work.
But questions remain. Will employees be required to take the holiday if their employers elect to participate? And how painful might it be for workers and employers to pay the deferred tax in early 2021?
Read on to learn what we know about the payroll tax cut, what questions linger, and how you’ll have to navigate the holiday carefully if you want to avoid a big tax bill in 2021.
- What is the payroll tax holiday?
- Who’s eligible to defer payroll taxes?
- How does the payroll tax holiday work?
- How much could the payroll tax holiday save me?
- When do I have to pay the deferred tax?
What is the payroll tax holiday?
The executive action signed by President Donald Trump in early August creates a payroll tax deferral, not a true “tax holiday.” During a tax holiday, a government either reduces or entirely waives a certain type of tax.
Both the original executive action and the subsequent IRS guidance make it clear the affected taxes are postponed, not eliminated. This means that unless something changes, anyone who takes the payroll tax holiday will have to pay the tax eventually.
The deferral applies only to the employee’s portion of Social Security taxes (6.2% of a worker’s wages or compensation) that would be paid between Sept. 1 and Dec. 31, 2020.
Who’s eligible to defer payroll taxes?
Only employees who earn less than $4,000 (before taxes) per biweekly pay period can defer their Social Security taxes.
If you work for a company that decides not to participate in the deferral (neither the executive action nor IRS guidance specifically says companies must), you won’t be able to defer the tax, even if you’re within the income limit.
How does the payroll tax holiday work?
Despite the IRS and Treasury Department guidance, many details remain unclear.
Companies could stop withholding employees’ share of Social Security taxes from their paychecks as of Sept. 1, 2020. But they can also decide not to take part. And they must withhold and pay all the deferred tax no later than April 30, 2021.
If you meet the income limit and work for a company that’s participating in the holiday, can you choose to continue having tax withheld and paid? The IRS guidance doesn’t address this.
How much could the payroll tax holiday save me?
Savings will vary, but higher earners, who pay more in Social Security payroll taxes, would likely see a significantly bigger increase in take-home pay than lower earners.
For example, if you take home about $3,800 per biweekly paycheck after taxes (roughly corresponding to a $99,000 annual salary), you might see a take-home pay increase of about $236 per pay period. If there are nine pay periods during that time, that could translate into more than $2,100 or so extra in your pocket between September and December. Someone whose biweekly take-home pay corresponds to about a $24,000 per year salary would see a bump of about $57 per paycheck, or $515 total in pocketed pay.
When do I have to pay the deferred tax?
Keep in mind that the bigger paychecks at the end of the year in 2020 would mean smaller ones at the beginning of 2021.
That’s because you must pay those deferred taxes by April 30, 2021, according to the IRS and Treasury guidance. Unless Congress acts to change things, if the deferred taxes aren’t paid by then, interest, penalties and additional tax will begin adding up on May 1, 2021.
IRS guidance says employers must withhold the delayed taxes or make other arrangements to collect the tax from employees. But it doesn’t address whether the employers can choose to do it in a lump sum or spread out over the paychecks that employees will get between Jan. 1 and April 30.Learn about IRS penalties
What’s next? It’s complicated.
By all measures, 2020 is an unusual tax year. If you were laid off in the pandemic and have since been re-employed, your tax situation next year may already be complex.
If you received the $600-per-week federal unemployment benefit, as well as state unemployment benefits, and didn’t have federal income tax withheld, you may already be facing a tax bill for 2020. Add into that the extra bite deferred payroll taxes could take out of your paycheck in the first four months of next year, and 2021 could shape up to be a challenging tax year.
The payroll tax holiday is now officially in effect, so it’s probably a good idea to ask your employer what it plans to do. If you have a choice to make about whether to participate, calculate how much the deferred tax could really help you, and if it could cause you financial pain later when you do have to pay it.
In the end, you may decide that you can get by without the extra few bucks a month if forgoing the deferral could spare you some tax complications or a big tax bill in 2021. And if you do take the tax holiday, consider putting the extra money aside in an interest-bearing account to bolster your finances early next year, when you’ll have smaller paychecks as you pay the deferred tax.