President Trump’s payroll tax holiday went into effect this month. Several prominent media outlets covered the news, describing it as a “payroll tax cut.” It’s not a tax cut, and the distinction could result in a very expensive surprise for many in just a few months.
Here’s what you need to know.
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President Trump’s Payroll Tax Holiday
On August 8, 2020, Mr. Trump signed an Executive Memorandum directing the Treasury Secretary to initiate a payroll tax holiday. The title of the memorandum itself makes clear that it’s not a tax cut: Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster. The key word is “deferring,” no cutting, but we’ll come back to that. The payroll tax deferral applied generally to those making less than $100,000 a year.
The Executive Memorandum did direct the Treasury Secretary to explore tax forgiveness options. The memorandum states that the “Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.” Thus far, however, no such legislation has been passed.
Related: 6 Reasons Not to Celebrate the Payroll Tax Holiday
It’s Not a Payroll Tax Cut
On August 28, 2020, the IRS issued guidance “Deferring Certain Payroll Tax Obligations.” Again, the guidance was on “deferring” the payroll tax obligations, not cutting or forgiving them.
Significantly, the guidance “postponed” the payment of payroll taxes, but did not relieve employers from the obligation to pay them. Specifically, it shifted the due date for payroll taxes by four months from September-December 2020 to January-April 2021. In other words, employers do not have to withhold and pay the payroll taxes for the rest of this year, but will have to make up these payments in the first four months of 2021.
And if there was any doubt, which there isn’t, the guidance made it abundantly clear that the deferred payroll taxes must still be paid:
“An Affected Taxpayer must withhold and pay the total Applicable Taxes that the Affected Taxpayer deferred under this notice ratably from wages and compensation paid between January 1, 2021 and April 30, 2021 or interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid Applicable Taxes.”
The “Affected Taxpayer” reference above refers to employers. The guidance makes clear that they must withhold and pay this amount, but can wait to do so until the first four months of 2021.
Some Employers May Still Collect Payroll Taxes Now
While the above may sound like a problem for employers, not employees, it’s not so simple. The Treasury guidance notes the following: “If necessary, the Affected Taxpayer may make arrangements to otherwise collect the total Applicable Taxes from the employee.” (emphasis added). In fact, many employers have said they will continue to withhold payroll taxes now to avoid getting stuck with the bill if an employee quits early next year.
The decision by an employer whether to defer withholding of payroll taxes is discretionary. There is nothing in the IRS guidance that requires an employer to defer the withholding. The WSJ recently reported that “many employers seem unlikely to adopt” the new policy. United Parcel Service, for example, will continue to collect payroll taxes, according to the WSJ report.
For many employees, they may be better off if their employer keeps withholding the tax. For the average worker, it will provide relatively little additional income, will last just four months, and then result in twice as much being taken out for Social Security in early 2021.
In short, the payroll tax holiday is not a tax cut. It’s better to think of it as a short-term interest-free loan that must be repaid in a few months. For those employers who defer withholdings, employees will see their Social Security payroll taxes jump from 6.2% to 12.4% for the first four months of 2021.