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The Payroll Tax Deferral And How To Budget For It

Payroll tax deferral? What’s that?

Well, due to the ongoing COVID-19 pandemic, the people in charge at the White House thought it might be a good idea to defer federal tax collections from our paychecks. 

Note that I said defer, but we’ll come back to that later. 

Anyhow, this brilliant plan came about with the idea to put money in American’s pockets NOW when they need it and to provide incentives for employment.

But what does this mean for you?

2020 Payroll Tax Deferment

The Secretary of the Treasury is hereby directed to use his authority pursuant to 26 U.S.C. 7508A to defer the withholding, deposit, and payment of the tax imposed by 26 U.S.C. 3101(a), and so much of the tax imposed by 26 U.S.C. 3201 as is attributable to the rate in effect under 26 U.S.C. 3101(a), on wages or compensation, as applicable, paid during the period of September 1, 2020, through December 31, 2020, subject to the following conditions:

Memorandum on Whitehouse.gov

This will apply to the Social Security tax or the railroad retirement tax equivalent. Social Security is taxed at 6.2%, so someone making $8,000 per month would get to keep $496. It seems great now, but if you don’t budget for it next year, you could end up in a financial snafu.

The thing about this “tax holiday” is that to defer means to postpone, which means that you’ll end up paying back that money next year. For September through December, you will have no Social Security taxes taken out, then January through April, paychecks will have double the amount (12.4%) deducted. (IRS Guidance)

In a U.S. Coast Guard bulletin, it states that civilian employees making $4000 or under per pay period, and all military members making $8,666 per month and under will be affected. It also says that if you separate prior to full collection, the amount due will come out of your final pay.

UPDATE: DFAS has released information that it will indeed apply the payroll tax deferral to military members who make under $8,666.66 per month for basic pay and civilian employees with $4,000 or less of taxable wages in a pay period.

Key takeaways:

  • Collection of Social Security taxes will be temporarily suspended.
  • It affects those who make a pretax amount of under $4,000 bi-weekly.
  • It applies to military members making below $8,666.66 per month; this can include ranks E-1 to O-6 based on taxable income. Tax-exempt allowances such as BAS and BAH are not included in the calculation.
  • It will affect your paychecks from September 1, 2020, to December 31, 2020.
  • This “extra” money will have to be paid back by April 30, 2021, consider it a loan.
  • Military members and federal employees cannot opt-out of the tax deferral. Other employers have the option to enact this or not.

How to budget for this

Don’t fret! We can deal with this. The key is to pretend that the extra money isn’t there. Though if you do need the extra money now, you should use it, just be prepared for the lower paychecks in early 2021.

Here’s my plan of what to do: 

  1. Calculate the taxes that won’t be taken out each month
  2. Put the money aside in a savings account (it will build a little interest as well).
  3. Use the money saved to make up for the smaller paychecks January through April. 

To know how much you need to save, calculate 6.2% of your paycheck.

Bi-Weekly PaycheckSocial Security taxes
$1,000$62
$2,000$124
$3,000$186
$4,000$248

Or, if you’re an active-duty military member, check your LES to see how much is usually deducted every month.

FICA social security taxes on a LES

This deferral should be effective for eligible military members on the next military pay dates: September 12th for Navy Federal members, and September 14th for USAA.

Unanswered Questions

It all seems straightforward, but this executive order lacks clarity and leaves questions unanswered. We know that the social security taxes won’t be taken back in a lump sum on taxes, but how exactly is still up for debate.

What happens if your income increases in 2021? Will they still take out 12.4 percent for social security, or only what you owe?

This also becomes confusing if you make different amounts for each paycheck due to overtime, bonuses, etc.

Hopefully we’ll gain more information soon and it does not negatively affect anyone’s finances.

Payroll tax deferral

FAQ

What is the payroll tax deferment?

A postponement of the collection of social security taxes and the railroad retirement tax from Sept. 1 to Dec. 31, 2020.

Will payroll tax deferral be forgiven?

As of now, this deferral is not a forgiveness; the taxes will have to be paid back before May 1st, 2021. The presidential memorandum does say, “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.” Nevertheless, only Congress can forgive taxes.

Who is eligible for payroll tax deferral?

Employees who make less than $4,000 bi-weekly, or the equivalent in respect to their pay period, are eligible for the payroll tax deferral. However, the employer does not have to defer payroll tax and first has the choice to opt-in.

Should I adjust my tax withholding?

Changing your tax withholding will not negate the 12.4% tax on paychecks Jan. – April 2021. It will only result in a larger tax return or less money owed.

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