The coronavirus pandemic is a big problem, and requires equally-big solutions. On August 8, the President tried another tactic to help the average American, by directing the Department of the Treasury to hit a temporary “pause” button on payroll taxes for employed workers (i.e., people who work as W-2 employees).
Although it sounds like a helpful move, it’s plagued with problems. Even if all of these snags are cleared up in the upcoming weeks, the effect might not be that life-changing for many people.
Still, it’s worth keeping an eye on.
To understand how the payroll tax pause might affect you, it’s worth recapping how payroll taxes work in the first place.
How Do Payroll Taxes Work?
Each time you get paid, the government demands a cut in the form of payroll taxes.
Normally, you and your employer split the payment. You’ll pay 6.2% of your paycheck toward Social Security and 1.45% for Medicare. This is called the “employee portion.” Your employer also pays the same amount, called the “employer portion.”
The employee portion of your tax liability is automatically withheld from your paycheck by your employer, so you don’t really “see” it unless you look at your pay stub.
Recently, Congress passed the CARES Act which gave employers the option of deferring (i.e., putting off) their employer portion of payroll taxes. Now, with the recent Presidential Memorandum, you might have the same option, too.
What the Payroll Tax Deferment Changed
A Presidential Memorandum is similar to an Executive Order in that they’re used to tell government officials how to do their jobs. The difference is that an Executive Order requires the President to cite a constitutional or legal basis to justify the order.
In this case, the President issued a memorandum directing the Secretary of Treasury to figure out a way that employees can defer their share of payroll taxes.
Here’s a brief rundown of what you need to know:
- It only affects employed people (specifically, W-2 employees)
- Unless Congress passes new legislation, you’ll have to pay these taxes back later
- The deferral only lasts for three months — from September 31, 2020 to December 31, 2020
- There are a lot of unanswered questions about how this would work in practice
- It only applies to people earning less than $4,000 every two weeks (i.e., $104,000/year)
- It temporarily lets employers off the hook from collecting Social Security taxes — not all payroll taxes — from employees
Questions with the Payroll Tax Deferment
There are a lot of unknowns right now. The Department of Treasury will be issuing “guidance” — i.e., rules about how this would work — any day now, but until it does, the memorandum raises a lot of questions.
Is it Legal?
Normally, Congress is in charge of making laws about taxation. That’s not something that traditionally the President can change. That’s why a lot of legal scholars expect that this Memorandum might be challenged in court. It’s possible that this Memorandum will be ruled unconstitutional. If it is, it won’t be legal unless Congress passes legislation on it.
How Much Will it Help You?
Since the deferment will only last for three months, only affects people making under $104,000/year, and is limited to just Social Security taxes, it might not be the boon that you’d expect.
For someone making the maximum ($104,000 annually, pre-tax), that would translate into an extra $1,488 total over the next three months (in other words, an extra $124/week). Most people don’t earn that much, though. In 2018 the median household income was $60,293, and for these folks, you can expect about an extra $862 over the course of the next few months (or, an extra $72/week).
Will You Owe a Big Tax Bill, or Will It Be Forgiven?
The biggest unknown right now is what’ll happen to the taxes you put off paying today.
Congress can pass legislation to forgive these deferred taxes, but there’s no guarantee that they’ll do it. And unless Congress does, you’ll have to pay those taxes back, which could be as soon as your next tax return. This means that you could end up owing a big tax bill when you file your taxes at the beginning of 2021.
As it stands now, this payroll tax deferment isn’t really anything more than a short-term, interest-free loan that you’ll need to repay in a few months anyway. This hardship support doesn’t make a huge impact, since workers who are having a hard time making ends meet today, are unlikely able to fully repay the debt in three months’ time.
Can You Opt Out?
Given all these uncertainties, many tax experts are advising business owners just to keep taking out and paying payroll taxes as normal. There’s just too many unknowns at this point. But that also brings up another question — can workers decide to opt out of the program entirely? Do employers have to impose payroll tax deferment? Unfortunately, even that’s not clear at this point.
What Happens If You Leave Your Job?
The entire country isn’t going to stay in a time-freeze employment bubble over the next three months. Businesses will close down, people will be fired, hired, or they’ll quit. It’s messy, and right now, it’s not clear what’ll happen if your employment changes midway through this three-month pause on payroll taxes.
For example, let’s say you’re currently working for a grocery store that’s not taking out your payroll taxes, and you’re let go and unemployed for a few weeks. Then, you start working for a landscaping company that does withhold your payroll taxes.
In this scenario, you went through a period where you didn’t pay payroll taxes, then were unemployed, and then employed again and paid payroll tax. Right now, it’s not clear how all of that messiness will be handled at the end of the year.
We’ll Know More Soon
Right now there’s so much we don’t know. The Department of Treasury should be releasing more information about how this might work in the upcoming days. After that, it’s up to Congress to decide whether to forgive these back taxes or not.
More importantly, all of this assumes you even still have a job. If you’re one of the 10% of Americans who were unemployed in July, this won’t help you at all. Unfortunately, we still have a long way to go.
Next Steps
In the meantime, it might be a good idea to check with your employer’s payroll department to see how they’ll handle your paycheck. The payroll deferral is meant to put more money in your pocket so that you can spend it over the next few months. But remember — unless Congress says otherwise, you’ll still have to repay the deferred amount during tax season.
If you’re not facing financial hardship right now, it’s a good idea to set aside these deferred taxes in a savings account so you have the money to pay taxes back when it’s due. You can check with your payroll department to see how much this would be based on your paychecks.
