What To Expect From the Payroll Tax Holiday
Christmas came early this year. Well, sort of. In an effort to provide financial aid to millions of Americans in dire economic straits, President Trump declared a payroll tax holiday between September and the end of the year. Available to workers who earn $104,000 a year or less, this means that no FICA taxes will be taken out of paychecks by employers that opt into the program.1 This enables workers to take home more income.
Unfortunately, while that may help households whose hours have been reduced, are burdened with health care bills or other expenses that have cropped up during the pandemic, it doesn’t help the 27 million people who actually lost their jobs.2
The payroll tax is noted as a FICA tax on paycheck stubs. It refers to the Federal Insurance Contributions Act, which deducts taxes before wages are paid allowing the government to pay for the Social Security and Medicare programs. This means 6.2% of your salary up to the first $137,700, is deducted from your take-home pay.3 According to the Social Security Administration, 95% of U.S. workers make less than $137,700 a year. The 5% who earn more pay no additional FICA taxes on their income above $137,700.4
To put this into perspective, if you make $100,000 a year, 100% of your income is subject to FICA taxes. If you make $500,000 a year, less than 28% of your income is subject to FICA taxes.
Be aware that FICA taxes are different from federal income taxes, which will still be deducted from paychecks and are not part of the payroll tax holiday.
It’s important to understand that a president cannot impose a tax cut, he can only defer taxes on a temporary basis. When Trump announced his executive order, he declared that if he were re-elected that he would forgive the payroll taxes due this year, and make permanent cuts to payroll taxes going forward. It’s worth noting that only Congress can actually enact these two measures.
Also, recognize that workers can’t opt into or out of whether they’d like to suspend their payroll taxes. These taxes are collected by the employer and therefore the employer makes the decision. The military and many federal government agencies have opted in, so approximately 1.3 million federal workers are projected to have their payroll taxes deferred. This could result in approximately $36 million in lost interest earnings for the Social Security Trust Fund, which is used to pay income benefits to retirees.5
If Congress does not pass legislation to “forgive” this year’s payroll tax holiday, workers will have twice as much — 12.4% of their wages — deducted from their paychecks starting in January. According to the IRS, those payroll taxes must be repaid in full by the end of April or they will be subject to interest and penalties. However, employers will be on the hook to pay those penalties. Should an employee leave the company before those taxes are recouped, the employer would have the option to take the full outstanding payroll tax amount out of his final paycheck.6
The full consequences of the payroll tax program are yet unknown, but they could be problematic. For example, if payroll taxes were permanently eliminated, and another funding source was not created to replace it, it is estimated that the Social Security fund would be depleted by mid-2023 — meaning that this source of income for America’s retirees could be entirely eliminated in three years.7
A further downside is that for cash-strapped employers, the cost of implementing the payroll tax changes may outweigh the benefit to employees. When you consider how long it takes Congress to pass tax legislation, the payroll holiday may simply be a short-term “loan” that is due in full about the same time that 2020 tax returns must be filed.
The payroll tax holiday is designed to give struggling Americans more money right now. However, since there is no way of knowing the likelihood of those taxes being forgiven, the more prudent action may be to save that excess money to repay the taxes early next year. In that case, the payroll tax isn’t very useful for households at all.
It’s also worth noting that the Government Accountability Office (GAO) has indicated that Congress has the power to overturn Trump’s payroll tax holiday.8
1 Shannon Liao. CNN. Aug. 31, 2020. “Here’s what the payroll tax deferral action means for you.” https://www.cnn.com/2020/08/29/economy/trump-treasury-new-guidance-tax-holiday/index.html. Accessed Sept. 18, 2020.
3 Ryan Guina. Forbes. Sept. 8, 2020. “Payroll Tax Holiday – Will You Have To Repay The Taxes That Are Not Withheld?” https://www.forbes.com/sites/ryanguina/2020/09/08/payroll-tax-holiday-will-you-have-to-repay-the-taxes-that-are-not-withheld/#7af6375365d1. Accessed Sept. 18, 2020.
4 Social Security Administration. Aug. 31, 2020. “Wage Statistics for 2018.” https://www.ssa.gov/cgi-bin/netcomp.cgi?year=2018. Accessed Sept. 18, 2020.
5 Shahar Ziv. Forbes. Sept. 16, 2020. “Social Security Could Lose $36 Million As Military Forced Into Payroll Tax Deferral.” https://www.forbes.com/sites/shaharziv/2020/09/16/trumps-payroll-tax-deferral-start-irs-notice-2020-65-could-cost-social-security-20-million/#50f6a15a544d. Accessed Sept. 18, 2020.
6 Darla Mercado. CNBC. Sept. 14, 2020. “Why Trump’s payroll tax holiday may be a lose-lose for workers and their firms.” https://www.cnbc.com/2020/09/14/why-trumps-payroll-tax-cut-may-be-a-lose-lose-for-workers-and-firms.html. Accessed Sept. 18, 2020.
7 Nicholas Reimann. Forbes. Aug. 24, 2020. “Social Security Fund Would Be Empty By 2023 If Payroll Taxes Were Cut, Actuary Estimates.” https://www.forbes.com/sites/nicholasreimann/2020/08/24/social-security-fund-would-be-empty-by-2023-if-payroll-taxes-were-cut-actuary-estimates/#47aea338a3b2. Accessed Oct. 5, 2020.
8 Lisa Rowan. Forbes. Sept. 16, 2020. “Trump’s Payroll Tax Holiday, Already Unpopular, Could Be Overturned By Senate.” https://www.forbes.com/advisor/personal-finance/payroll-tax-holiday-could-be-overturned/. Accessed Sept. 18, 2020.
Neither our firm nor its agents or representatives may give tax advice. Be sure to speak with a qualified professional about your unique situation.
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