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How the Payroll Tax Holiday Could Affect You

The extra money you receive will have to go back next year.

President Trump’s executive order that temporarily eliminates the 6.2% Social Security tax became effective on Sept. 1. It will affect all federal employees, and potentially millions of other workers nationwide.

If you’re employed and your employer participates, you’ll get an increase in your take-home pay for the rest of the year. But you’ll have to give back the entire tax savings early next year – creating a problem for you if you spend the money and can’t repay it.

Here’s what you need to know.

Who is affected by the executive order?

People who earn up to $4,000 on a biweekly basis and less than $104,000 annually.

Is your employer required to stop withholding the tax from your paycheck?

It doesn’t appear so – unless you work for the federal government. The president has ordered the government to stop collecting Social Security taxes for all 1.3 million federal employees starting in mid-September.

At this writing, no other employer is being required to participate in the program. So, until the Department of Labor or another government agency says otherwise, employers apparently can continue to collect the tax from your paycheck. Whether they can keep the money or still must send it to the U.S. Treasury is unclear. (More on that later.)

What happens at year-end?

The executive order expires Dec. 31. Therefore, on Jan. 1, your employer will resume debiting your paycheck for the Social Security tax. Also, between Jan. 1 and April 30, your employer will collect from your paycheck all the Social Security taxes you owed but did not pay in the months of September, October, November and December.

In other words, your 2021 gross pay will again be reduced by the 6.2% Social Security tax. And your 2021 paychecks will be further reduced by an additional 6.2% during the first four months of 2021 until the government collects the Social Security taxes it isn’t collecting for the rest of 2020. Thus, the increase in take-home pay you’ll get now will be offset by an equal decrease in take-home pay in 2021.

What happens if a worker quits?

The executive order is silent on this question. How will the government collect the tax you owe if you are no longer working for the same employer in January as you were in October?

This is why many employers will choose to continue collecting the Social Security tax – so they won’t be liable for the money you owe if you leave employment before they can collect the tax from you in 2021. But if they do keep collecting the tax, your take-home pay won’t rise – thwarting the president’s goal.

What happens if your employer (a) continues to collect the tax from your paycheck, (b) doesn’t forward the money to the government – and then (c) goes out of business?

This could happen a lot. Small-business owners struggling to keep their businesses open could treat the executive order as an opportunity to improve their cash flow: Collect that 6.2% from your pay and divert it to other bills. Inappropriate and dangerous? Yes, but worry about that later, they figure.

If their tactic fails and their business closes anyway, will the government turn to you for the tax? If so, you could end up paying the tax twice. The government has issued no guidance on this matter.

What if your employer didn’t change its payroll system by Sept. 1?

There has been no guidance offered yet by the federal government regarding this question.

How does the executive order help the nation’s financial crisis caused by the pandemic?

It helps some U.S. households a lot, some a little and others not at all.

The average U.S. worker pays more in Social Security taxes than federal income taxes, according to the Tax Policy Center. Nearly half of all households pay no income tax, but 60% pay Social Security tax. Others have an effective tax rate on income that’s lower than the 6.2% rate they pay to Social Security.

If the president’s executive order is implemented as he envisions, all workers earning less than $104,000/year will enjoy a significant increase in take-home pay for the next four months. This additional income will certainly be of help to those struggling to pay bills.

Other workers don’t need the extra income to pay expenses. They’ll be able to spend the money freely or add it to their savings and investments – either of which will help the economy recover (spending helps businesses and saving helps the capital markets).

Unfortunately, those most in need of help are completely left out by the president’s order. The tax waiver only applies to those who pay taxes – meaning those who have earned income. But if you were laid off or furloughed during the pandemic, you have no income at all – and thus you’re not currently paying any Social Security taxes. You get no relief from the president’s order.

How will this affect the health of Social Security?

Social Security benefits are funded by Social Security taxes and money in the Social Security Trust Fund (which is comprised of excess Social Security taxes collected over the years). In 2020, taxes cover 75% of the benefits paid to retirees; the trust fund covers the rest.

By waiving Social Security taxes from September through December, the Social Security Administration could collect significantly less than expected this year. That would force the SSA to withdraw more than expected from the Social Security Trust Fund. The fund was already projected to be depleted by 2029; if President Trump’s executive order was permanent, Social Security Chief Actuary Stephen Goss recently told Congress that the trust fund would be depleted in 2023.

What should I do?

If you are working and your paycheck rises 6.2% due to the executive order, add that money to your cash reserves – because you’ll likely need to send it to the government early in the new year. And if you have any questions, contact us at Edelman Financial Engines and we can help.

Neither Financial Engines Advisors L.L.C. nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.

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