Back in late March, as much of normal life closed down, businesses got a boost in the form of an immediate tax break. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, employers were allowed to defer their share of payroll taxes for the rest of 2020.
Employees making less than $4,000 every two weeks received a similar deal under a presidential executive action issued in August. These employees can skip their share of the Social Security tax from September 1 through December 31, and instead pay it in 2021.
The goal of these two legislative actions was the same: to provide a quick boost to the economy by letting businesses and workers keep—and spend—a little more of their money. But the tax was temporarily forgiven, not deferred, and the exact details of how this would work and when it must be paid back were not immediately clear.
Internal Revenue Service guidance released July 30 filled in the fine details for employers. The big picture: employers may defer required deposits or payments of their share of the payroll tax from March 27 through December 31. Half of the deferred taxes must be paid by December 31, 2021; the other half is due by the end of 2022.
This amounts to an interest-free loan from the government for 21 to 33 months, and for large businesses with big payrolls, the cash retained can be substantial.
The Employee Share
For employees, the benefits are more limited. The deferral is only for four months and the taxes owed must be paid back by April 30, 2021. A worker earning the 2019 median salary earns about $2,430 pretax in every biweekly paycheck. Adding back the 6.2% normally withheld means an extra $150 every two weeks, or $1,200 by the end of the year.
Starting January 1, however, employers will resume normal withholding and take out extra to recoup the deferred taxes. Basically, employees get to skip the tax for the last quarter of 2020 and pay double tax in the first quarter of 2022.
Year-end bonuses or overtime could kick employees above the earnings threshold for eligibility. Because the deferral is based on biweekly earnings, employees could move in and out of deferral status. And employees who leave a job are still responsible for repaying the full amount of any remaining deferred taxes. Employers may face difficulties trying to recover taxes owed but not withheld from ex-employees.
Deferring the payroll tax is optional for private businesses. It’s up to employers to modify payroll systems to pause withholding, then increase it and deal with these variations. Employers are advised to collect the deferred taxes evenly over the repayment period. It’s unclear how this will work for seasonal employees with variable income.
Any deferred taxes not withheld and paid can be subject to interest, penalties and additions to the tax, which employers can try to collect from the employee. The IRS has provided scant guidance on withholding, depositing and paying the employee portion here.
All this may lead to uncertainty for workers and accounting headaches for employers. Small employers especially may conclude that it’s not worth the costs of reconfiguring payroll systems. Small firms who laid off most workers when business dried up may find that it’s not worthwhile to claim the employer deferral for any remaining staff either.
What about the Self-Employed?
What about the self-employed, who pay the full freight of the Social Security and Medicare payroll taxes? Under the CARES Act, self-employed individuals may defer payment of 50% of the Social Security tax—the portion equivalent to the employer’s share—on net earnings from self-employment income from March 27 to December 31. That means when making estimated income tax payments, they can reduce the Social Security payments to 6.2% of income without penalty.
However, the self-employed were left out of the executive order deferring the employee’s share. The order explicitly references the section of the tax code that authorizes the 6.2% employee share of the tax but omits any mention of a separate section that established payroll taxes for self-employed individuals. That said, payroll taxes for self-employed workers are, in a sense, already deferred until 2021, because fourth-quarter taxes are not due until January 15, when regular employee deferred taxes begin to come due anyway.
Some have questioned the legality of President Trump’s order, since the Constitution gives the power to tax (or not) to Congress. The order directs the Treasury Department to investigate forgiving the deferred payments permanently. Permanent forgiveness seems politically unlikely. If payroll taxes were eliminated without a new source of funding for Social Security, the fund could be depleted by mid-2023, according to a recent letter from Stephen Goss, Chief Actuary for Social Security.
—Toni L. Shears
Andrew Keshner, “What does Trump’s Payroll Tax Deferral Mean for Your Paycheck? Not Much, Experts say,” Marketwatch, Aug. 15, 2020, https://www.marketwatch.com/story/what-does-trumps-payroll-tax-deferral-mean-for-your-paycheck-not-much-experts-say-2020-08-10.
Doug Sword, “Self-Employed Won’t Get to Defer Taxes Under Trump’s Payroll Break,” Roll Call, Aug. 10, 2020.
Deferral of employment tax deposits and payments through December 31, 2020, Internal Revenue Service, https://www.irs.gov/newsroom/deferral-of-employment-tax-deposits-and-payments-through-december-31-2020.
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