Did Your Paycheck Just Get 6% Bigger? Plan to Pay More Come Tax Time

Photo to accompany story about the new tax deferral. consumerfinance.gov

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Keep an eye on your paycheck for the next few weeks — it may be quite a bit bigger. 

Six percent bigger, to be exact.

A payroll tax deferment in effect from the beginning of September until at least the end of the year could provide a little bit of financial relief to millions of working Americans. 

But there’s a catch. You’ll only get the tax break if your employer has decided to opt in. And because the break is only temporary, you may have to pay that money back next year. 

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Payroll Tax Deferral – HELP!⠀ ⠀ FIRST: if you are military or a federal employee 🇺🇸 making less than $104K/yr ($4.33K semi-monthly), as of now this is mandatory with no ability to opt out. 😡⠀ ⠀ Private sector employers can choose whether or not to participate in this program. The same income guidelines apply, but even if your employer chooses to participate, you should have the choice to opt out.⠀ ⠀ For federal employees, it’s a FORCED LOAN. Make no mistake, if you spend it now, you may find yourself in BIG trouble later!⠀ ⠀ For the pay periods between Sep 1 and Dec 31, 2020, the 6.2% Social Security tax withholding will be suspended.⠀ ⠀ HOWEVER, for the pay periods between Jan 1 and Apr 30, 2021, not only will that 6.2% deduction resume, but you will ALSO HAVE TO PAY BACK all the withholding that was suspended from Sep – Dec. ⠀ ⠀ EXAMPLE:⠀ ⠀ • You make $50,000 per year (gross)⠀ ⠀ • You are a federal employee (military), so you are not able to opt out of this deferral⠀ ⠀ • Your gross semi-monthly (twice a month) pay is $2,083⠀ ⠀ • Your tax deductions look like this:⠀ ⠀ ■ $212 Federal Tax⠀ ■ $90 State Tax⠀ ■ $30 Medicare Tax⠀ ■ $129 Social Security Tax⠀ ⠀ • Your net take home pay is currently $1,622 twice per month 🙂⠀ ⠀ • During Sep-Dec 2020, the $129 per pay period Social Security deduction will be suspended. Your “new” take home pay for the last 8 pay periods of the year is $1,751 😎⠀ ⠀ • BUT WAIT. For the next 8 pay periods (Jan-Apr 2021), not only will that $129 per pay period deduction resume, but you will also have ANOTHER $129 per pay period deducted to pay back what was not withheld from Sep-Dec 2020 😱⠀ ⠀ • Your take home pay from Jan – Apr 2021 is now $1,493 semi-monthly 😭⠀ ⠀ LESSON: If you get used to and SPEND that extra money for the rest of this year, you will have a BRUTAL wake up call come January, as your monthly take home pay will drop by OVER $500 per month. (If you make more than this example, the effect will be amplified.)⠀ ⠀ If you have no choice but to participate in this plan, or you choose to participate with your private sector employer, please SAVE THAT EXTRA WINDFALL so you don’t find yourself in a bad place starting 2021.

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If you’re a tax-paying employee, whether your firm is big or small, here’s what you need to know.

What Is the Payroll Tax?

Employers and employees both pay taxes to help fund programs like Social Security and Medicare. Under the new deferral, introduced by a presidential memorandum in August, usual Social Security taxes would not be taken out of employees’ paychecks.

Normally, 6.2% of an employee’s gross pay is taken out for this purpose and another 6.2% is paid by the employer. During the deferral period, lasting through December 31, 2020, this tax isn’t taken out of the paychecks of employees at companies that have decided to participate in the deferral, which is not mandatory.  

How Can I Tell If I’ve Been Affected? 

There’s an easy way to see if you’re participating in the program: Your paycheck. 

Look for the field on your pay stub called “FICA SS Tax” or “OASDI” (from Old Age, Survivor and Disability Insurance). 

The program went into effect September 1, so check a recent pay stub. If your paycheck is 6.2% bigger than normal, and there’s no tax listed in the FICA SS or OASDI field, it’s safe to say you are participating in the deferral program.

If you’re not still sure if your employer is participating in the program, get in touch with your company’s human resources or payroll team. Only employees making less than $104,000 per year, or less than $4,000 in a bi-weekly pay period, are eligible to receive the tax benefit, as the IRS notes.

How Does the Payroll Tax Deferment Work?

If you are eligible and your company opts to participate in the program, those taxes will be withheld through the rest of the year. 

Come 2021, though, your employer must pay those deferred taxes.

They have not been canceled. Instead of paying them in the last four months of 2020, you’ll end up paying them in the first four of 2021. It’s possible that Congress may pass a law forgiving payment of those back taxes, but no bill on the subject is currently being discussed.  

The decision whether to participate is up to employers, says Alice Jacobsohn, director of government relations at the American Payroll Association.

“If an employer decides to offer the tax deferral in President Trump’s memo, that employer can decide whether to allow employees to opt in or opt out, or whether to make the decision companywide,” she adds.

If your employer participates in the program, more money will be taken out of your paycheck in the first four months of 2021 in order to retroactively pay back those taxes.

While the federal government has adopted the deferral for its employees, no major U.S. employer has decided to participate, the Wall Street Journal reported.

Pro Tip

Check with your employer ASAP to find out whether it’s participating in the tax-deferral program, and start to plan your finances accordingly.

Sarre Baldassarri, a CPA and Principal at LTA US Advisors in New York, says there is a risk of “legal issues between employers and employees” if there isn’t clarity on what the company’s policies on the deferral are. Guidance from the government has been somewhat unclear, says Baldassarri, whose company provides tax advice to foreign firms wanting to invest in the U.S.

If given the option, Baldassarri would participate in the program “to get a bigger paycheck today instead of in four months,” he says. “If you can wait four months to give money to the government, why not?”

But accountants have differing opinions on the matter. “In my opinion it’s not a good idea because people don’t realize they need to pay that money back,” says  Michele Levy, a CPA and senior accountant. “Come tax season, they might not have that money available to do so,” she adds. 

And if someone who was getting the deferral quits their company between now and December 31, employers might be the ones responsible for paying taxes back to the Treasury, unless they recoup the money from the employee. 

“You’re still on the hook for the money,” Levy says‚ and “the government can go after the employer if the employee doesn’t pay it back.”  

What to Do With The Extra Money 

If your employer decides to participate in the tax deferral and you end up with extra money in your paychecks, you’ll want to be strategic about where you put the funds.

“Normally, tax withholding is taken care of by your employer and you don’t have to think about it,” says Rachel Elson, an associate financial planner at Perigon Wealth Management in San Francisco. But this new policy “pushes the personal finance responsibility onto the employee.”

Elson recommends looking at your paycheck and getting a sense of what the normal deposit is. Then, “take the extra amount and transfer it to a savings account — somewhere off to the side where you won’t be tempted to spend it.”

Levy suggests the same, recommending people set the money aside to ensure they have it readily available to repay back taxes come 2021. “It could end up being a couple of thousand dollars,” she says.

If you need the money urgently, you can put it towards paying off your essentials, including bills and minimum payments on any debts. 

You could also use the opportunity to pay off high-interest debt. “If you have a credit card where you’re paying 15-20% interest, use that extra money [from your paycheck] to knock that down, and reckon with the fact that you’re going to have a lean period from January to April,” Elson says.

Lastly, if you’re able to cover all of your bills and needs, it’s worth thinking about investing further in your retirement. For example, salaried workers can and should take advantage of their employer’s 401(k) or 403(b) plan. It’s a good idea to chat with a Human Resources representative to see what your options are.

You can also decide to open a Roth IRA account, which is managed independently of your employer. While there’s a contribution limit of $6,000 per year, experts say it’s all right to start with baby steps.Take NextAdvisor contributor Jully-Alma Taveras as an example. She is on track to save $1.6 million in a Roth IRA by the time she’s 67 — and she started with only $50 when she was 19.

The bottom line is that it’s important to remember the tax deferral isn’t free money; it’s merely that—a deferral. If you’re participating in the program, you’ll want to take a look at your finances and make sure you’ll be able to cover the back taxes come 2021. Once that’s squared away, you can use the extra funds to help bolster your financial safety net.