Personal Finance

Here are 5 key things workers should know about the payroll tax deferral

Key Points
  • Sept. 1 was the first day of President Donald Trump’s payroll tax deferral, a temporary suspension of the 6.2% Social Security tax that employees cover. It’s in effect until the end of the year.
  • Recent guidance put employers on the hook for collecting and remitting the deferred tax, which they must do by April 30, 2021 or else face penalties, interest and additional tax.
  • Not all employers may take up the deferral, so you'll want to talk to your human resources representative or a payroll representative to see how your company will proceed.
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Tough choices are ahead for employers as President Donald Trump's payroll tax holiday goes into effect, but it's never too early for employees to figure out what's coming up.

The payroll tax deferral went into effect on Sept. 1, following an executive order Trump had issued in August. It's effective until the end of the year.

Workers and employers each share half of a 12.4% tax to cover Social Security, plus a 2.9% tax to pay for Medicare. The Social Security tax applies to up to $137,700 of your wages in 2020 — and this number is adjusted every year – but the Medicare tax comes into play beyond this level.

The holiday applies to the employee's share of the Social Security tax, but only if the wages paid to a worker in a bi-weekly pay period falls below $4,000.

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Be aware that this is a deferral of taxes only – not forgiveness. Congress would have to intervene in order to forgive the taxes owed.

Employers must withhold and pay those deferred taxes ratably — that is, proportionally over time — from your pay between Jan. 1, 2021 and April 30, 2021, or else they will face interest, penalties and additions to tax, according to recent guidance issued from the IRS.

For now, the best course of action would be to talk to your human resources representative or your firm's payroll department to get a sense of how your employer might handle the holiday.

Here are five things that employees should know about the Social Security tax deferral, according to Pete Isberg, vice president of government affairs at payroll service provider ADP.

1. Your employer may not offer the holiday

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The onus is on employers, if they participate, to withhold and pay workers' deferred taxes early next year.

Whether it's the magnitude of the responsibility, the rapid rollout of the guidance from the IRS or the complexity of explaining the details to employees, there will be firms that back away from providing the holiday altogether.

"It's the employer's choice to offer it, and if they do, they may ask you if you want to take the deferral," Isberg said.

2. This is only a delay

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Just as all holidays must come to an end, any amounts that you don't pay from September through December will be withheld from your pay in January.

Participating employees will get a 6.2% bump in wages now, but they'll see a decrease early next year as employers recoup the deferred amounts and continue covering the ongoing payroll tax.

Plan ahead by saving the extra bit of cash you get this fall so that you can prepare for a drop off in cash flow early next year.

3. Deferred taxes will be withheld in even amounts next year

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When your employer recoups the deferral next year, you'll see the amount deducted evenly from Jan. 1 through April 30 2021.

However, employers and payroll providers are still hashing out what might happen to seasonal workers and employees who leave prior to the deferral being repaid.

"If you change jobs, your employer may withhold the full amount deferred from your last check," Isberg said. This could be a substantial amount.

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While the guidance allows employers to "make arrangements" to collect taxes from an employee, it could prove challenging if a worker quits abruptly.

"When most people quit jobs, they don't want to be found, especially if you want to collect money from them," said Nicole Davis, CPA and founder of Butler-Davis Tax & Accounting in Conyers, Georgia.

4. Are you getting a bonus? You might not get a deferral for each pay period.

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The deferral applies only if the amount a worker earns is under $4,000 bi-weekly.

However, with bonus season coming up, workers who receive that extra pay in a pay period may end up with bi-weekly wages that are too high for the deferral in that particular paycheck.

Overtime pay during the holidays could also have a similar effect, said Robert Delgado, principal at KPMG in San Diego.

"Individuals could move in and out of the deferral," he said. "In some situations, you could have a pay period where there's deferral and pay periods where there isn't."

5. Just over $4,000 in biweekly pay? No deferral for you

The $4,000 threshold in a biweekly pay period is a "cliff" and not a phaseout.

This means that while a worker with $3,999 in earnings would qualify for the deferral, an employee earning $4,001 would not.

"There is zero deferral beyond the threshold, which might surprise some people," Isberg said.