Payroll Tax Holiday – Don’t Be Left Holding the Tax Bill
On August 8th 2020, President Trump issued an executive memorandum offering companies payroll tax deferral in an effort to provide relief to workers amidst stalled coronavirus relief legislation. Employees are typically required to pay 6.2% of their salary (up to $137,700 income) toward the Social Security portion of FICA taxes. Under the memorandum, employers can defer the withholding of this Social Security tax portion of the payroll tax. How does it work, who does it apply to, and will you have to pay it back? We’re here to answer some of your biggest questions.
Trump’s payroll tax suspension period runs from September 1st through December 31st 2020. It’s only available to employees with wages of less than$104,000/year. It does not include compensation that’s excluded from FICA taxes – like payroll deductions for employee health savings accounts or flexible spending accounts. Having trouble identifying this number? Look at last year’s Form W-2, Box 3.
Not all employers have opted to participate in this payroll tax suspension. “The Executive Order does not mandate deferral, nor does it outline any penalty as a result of not participating in the deferral,” according to Kevin Brady, the lead Republican on the house Ways and Means Committee.
It’s worth noting that federal agencies have made the deferral mandatory for all eligible federal civilian employees and service members – more than 1 million workers are expected to be affected. Many employers have opted out as they await more guidance. Curious how this works for any employee with variable pay? Since this deferral is available to employees who have wages and compensation of less than $4,000 in a given biweekly payroll period, commission-based employees could be eligible for deferral in one pay period but not eligible in the next payroll period. The same obstacle may arise for employees who receive bonuses during this September-December window. Therefore, as many have noted, payroll systems face a challenge in attempting to switch the deferral on and off as certain employees rise above and below the threshold. Lastly, based on our reading of the memorandum, it does not appear that an employee can require the employer to participate.
What happens after the suspension? Employers that suspend collection of employees’ payroll tax will collect double the amount (12.4%) of Social Security tax from workers’ paychecks from January 1st through April 30th2021 to repay the tax obligation – unless legislation is enacted to forgive the uncollected taxes. Consequently, employees will notice reduced net pay in 2021 equal to any increase in net pay in 2020.
After April 30th 2021, penalties, interest, and additions to tax will begin to accrue on employers for tax amounts that haven’t been repaid, according to IRS Notice 2020-65. So, this brings up another concern, what happens if an employee leaves at the end of the year? Employers can make repayment arrangements with the employee, such as deducting the amount owed from the final paycheck. Otherwise, the employer would have to pay the balance owed. It’s still unclear if the employer has any means to enforce collection.
The payroll tax holiday is designed to put more money in your pocket if you qualify. It’s vital that workers understand that right now this is only a tax deferral, not tax forgiveness. It’s essentially a very short-term, interest-free loan. And the tax holiday could certainly backfire if the deferral is not forgiven and you’re left holding the bill. In the event that your employer participates in this suspension, we strongly recommend you put the extra cash in a savings account to supplement your potential reduced cash flow in early 2021.