On August 8, 2020, President Donald Trump issued a Memorandum to the Secretary of the Treasury with the subject of: Deferring Payroll Tax Obligations. This memorandum directed the Secretary of the Treasury to defer withholding Social Security payroll taxes from September 1, 2020 through December 31, 2020 for workers that make under $104,000 per year. The IRS recently put out guidance regarding the Social Security tax deferral.
If you’re unsure what the payroll tax is, it is the FICA Social Security deduction. It is the 6.2% of your income that is withheld for social security, up to certain income limits. The income limit in 2020 is $137,700. For example, if you make $50,000 per year, you’ll have $3,100 in social security taxes taken out of your paycheck throughout the year.
Now, to be clear, this is a temporary deferral of Social Security taxes, not a temporary elimination of Social Security taxes. Whatever taxes you don’t pay for the next four months, you will pay in the first four months of 2021.
As far as the deferral goes, some employers are opting to not have the payroll taxes suspended, others are giving employees the choice, and some will require all employees have their Social Security taxes deferred. For any federal government employees and military servicemembers, you will be required to have your Social Security taxes deferred if you are under the income limit. For military, the threshold is an O-5 over 16 years of service. Anyone junior to an O-5 with 16 years of service (except W-5’s over 26 years) will have their Social Security taxes deferred until 2021.
What will happen?
If your social security taxes are deferred, you will start getting paychecks that are a little higher for the next four months (September, October, November, and December). However, starting in January, you will have to start paying the deferred Social Security taxes back, so you will likely start getting smaller paychecks. With the deferral, you will be required to pay the deferred taxes back between January 1, 2020 and April 30, 2021.
What should you do?
It may be nice to have a little extra money in your paycheck over the next four months, but if you don’t need that extra money for essential spending like rent, utilities, debt payments, food, gas, or insurance, you should not spend the money and you should put it aside in a savings account. By putting this extra money aside now, you’ll be able to ‘weather the storm’ when January comes and your paychecks shrink considerably. For the person making $50,000 per year and paying $3,100 in social security tax, the deferment will have them see $119 more per check if they are paid every two weeks, and $129 more per check if they are paid twice per month.
However, the challenge may come in January when the Social Security payroll tax is reinstated. The reduction in your paycheck would be nearly double to $238 for those paid every two weeks or $258 for those paid twice per month. The normal tax will be reinstated ($119 or $129) and you’ll be paying back your deferred taxes (another $119 or $129).
If you have the choice and don’t need the money right now, I would just keep having your Social Security taxes taken out of your paycheck. If you don’t have a choice, you need to prepare for your paychecks to be lower after the new year.
Note: I thought this topic was important enough to cover. In the next post, I’ll get back to retirement nest eggs. Specifically, I’ll be covering what happens if you have a fairly large nest egg in a tax-deferred retirement account.
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