Payroll Tax Holiday – What Business Owners, Employees, and Retirees Need to Know

On August 8, President Trump signed a series of executive orders hoping to stimulate the U.S. economy as Congress remained at odds over an agreement for the next stimulus package. One of the orders signed provides a “payroll tax holiday” for American workers that was implemented as of September 1. Let’s take a quick look at what the executive order does and the potential impact.

The Payroll Tax Holiday    

The executive order directs the secretary of the Treasury to defer some payroll tax obligations.  Under normal circumstances, employees pay 6.2 percent and employers pay 6.2 percent of the total 12.4 percent Social Security tax due for each worker. Under the “holiday,” the employee portion can be deferred, while employers will still have to contribute their own portion for each worker.  There are income limits with who can participate in the program. While this will put more money in employee pockets to spend immediately, the issue at hand is that this is a deferral, not forgiveness of the taxes.  

Based on guidance from the IRS, the deferred payroll taxes must be repaid between January 1 and April 30, 2021 — or they will become subject to interest and penalties. This may mean employees who participate in this program will see their paychecks increase in the fall, only to see a big tax bill in the winter when potentially double the amount of employee-paid payroll tax will need to be withheld to pay back the deferred taxes. Employers may end up becoming enforcers, having to collect those extra taxes and penalties from their employees if necessary, based on the IRS announcement. To further complicate matters, what happens to employees who change jobs during this time frame or are no longer employed?

Those who participate in this payroll tax holiday might find out in the long run that it isn’t quite the holiday they were hoping for. While it may provide a short-term economic boost if employees actually spend their money in the fall, it will likely cause a drag in subsequent economic periods when they have to pay it back.        

How Changes to Payroll Taxes May Impact Social Security Benefits

The payroll tax holiday may also cause concern about corresponding impacts to Social Security benefits. In late August, the Social Security Administration chief actuary issued a memorandum showing the effect of hypothetical legislation eliminating the payroll tax permanently. The results showed the Disability Insurance and Social Security trust funds would run out quickly without any workers paying into them, which is not surprising. While a number of media outlets have seized upon this memo, saying the president wants to terminate Social Security, he has said he doesn’t want to undercut benefits or add to the deficit. He is calling for benefits to be paid out of the general fund rather than the trust fund and has said economic growth will make up for revenue losses.  

While this may be campaign rhetoric, does it mean you should change your approach to Social Security? Not at this point. We don’t believe it is worth considering changing your strategy or approach to Social Security until actual legislation is known, which will not be until after the election. There is zero chance of Congress passing Social Security legislation before the election, and all of this may be a moot point depending on who is elected president and which parties control the House and Senate.  

Bottom Line

While the executive order was designed to provide a boost to a struggling economy and workers during their pandemic-induced economic struggles, there will likely be consequences in 2021 in the form of higher taxes for those who try to boost their income short term this year. Longer term, there are risks to Social Security if the payroll tax was ever on the chopping block, but at this point we see it as an unlikely outcome of the upcoming election. 

If you find yourself concerned with the payroll tax holiday or long-term strategies for Social Security, please give one of our CERTIFIED FINANCIAL PLANNER™ professionals a call to see how we can help.