Personal Finance

These workers won’t be able to opt out of the payroll tax deferral

Key Points
  • Sept. 1 marked the first day of the payroll tax deferral, a temporary suspension of the 6.2% tax employees pay toward Social Security. It’s in effect through the end of the year.
  • Not all employers will participate, but the federal government, including the military, is in. Lawmakers are calling on Treasury Secretary Mnuchin to allow federal employees and service members to opt out.
  • Employees who are participating in the tax holiday can expect larger paychecks this fall, but their take home pay will decline in early 2021 as the IRS recoups the deferred taxes.
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While private companies decide how to proceed with the payroll tax holiday, one major employer has decided that it's in: the federal government.

President Donald Trump's payroll tax deferral, which he issued via executive order, took effect on Sept. 1.

It's a temporary suspension of the 6.2% tax employees pay toward Social Security, effective until the end of the year, and it applies to individuals who earn no more than $4,000 per bi-weekly pay period.

The key issue is that this is only a deferral of the tax — not outright forgiveness, which would require legislation from Congress.

That means participating employees would enjoy a 6.2% bump in their take-home pay for the remainder of the year, but the deferred tax will be recouped from their paychecks  — along with the ongoing payroll levy known as FICA taxes — in the first few months of 2021.

Why businesses are sounding the alarm on the payroll tax proposal
Why businesses are sounding the alarm on the payroll tax proposal

"When the FICA is deferred, they generally receive 6.2% more now, and then 12.4% less for January through April," said Anne Bushman, partner, Washington national tax compensation and benefits at RSM US.

Though private employers are largely expected to be lukewarm toward the tax holiday, due to its rapid rollout and the difficulty of explaining lower paychecks to workers in the new year, the federal government — including enlisted military servicemembers — will be participating with no way to drop out.

"Military members are not eligible to opt out of the deferral if their Social Security wages fall within the stated limits," the Defense Finance and Accounting Service said on its website. The entity provides payroll services for the Department of Defense.

Pushback in Washington

Sen. Chris Van Hollen, D-Md.
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Lawmakers are now pushing the federal government to allow their employees to choose whether they want to participate.

"We urge you to let federal workers and uniformed service members choose whether to defer their payroll tax obligations under IRS Notice 2020-65, rather than forcing them to participate," wrote Sen. Chris Van Hollen, D-Md., in a Sept. 8 letter to Treasury Secretary Steven Mnuchin and Office of Management and Budget director Russell Vought.

"While some federal employees may want to defer their payroll tax payments, unions representing federal workers have made clear that many others do not," he wrote.

Other efforts are also underway to block Trump's executive order.

Rep. John Larson, D-Conn., recently introduced a bill to overturn Trump's payroll tax deferral. This arrives on the heels of Senate Democrats' push for an expedited Congressional Review Act ruling on the tax holiday — a step toward undoing the suspension.

Reassess your finances

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Whether you're a federal employee who's locked into the deferral or you're at a private company that's enrolling an entire workforce into the tax holiday, you'll need to budget now to avoid a cash shortfall in 2021.

"People who recognize it may be an issue for them next year might want to set aside the additional funds they're getting right now into a high-yield savings account in recognition that their paycheck is going to be lower for the first four months of next year," said Eric Bronnenkant, CPA and head of tax at Betterment.

This also means you should be conscious of how your expenses might stack up next year, because they could fluctuate.

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"Changes that may occur between now and April may include benefit changes for 2021, holiday expenses, additional childcare expenses if schools don't reopen and potentially others," said Bushman of RSM US. 

"If employees plan only in terms of today's expenses, and not the expenses through April, their planning would not be sufficient," she said.

What remains murkier for both federal and private workers is what might happen if they part company with their employer prior to 2021.

Military members or civilian federal employees who separate from their employer or retire before the taxes are recouped are still responsible for the tax payment, according to the Defense Finance and Accounting Service.

Private employers may make arrangements with their employees to collect the taxes, according to an IRS notice. However, companies are subject to penalties, interests and additions to tax if they don't remit the deferred taxes by April 30.

"There is some flexibility for employers to collect deferred tax amounts from employees other than proportionally for January through April, if necessary," said Bushman.

"Certainly, leaving a job is sometimes voluntary and sometimes not, but either way employees need to know that this could come up and it may affect their final pay or otherwise."