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Weeks after President Donald Trump authorized a payroll-tax deferral to try to free up cash for Americans dealing with the coronavirus pandemic, the Internal Revenue Service now has specifics about what the order means for companies cutting paychecks and the workers receiving those checks.
For a worker whose employer chooses to defer the tax obligation, the upshot is simple: slightly bigger paychecks now and slightly smaller paychecks next year, according to payroll-processing experts who have analyzed the IRS guidance .
Workers don’t have to worry about saving money for a lump sum of unpaid taxes, said Pete Isberg, vice president of government relations with the payroll-processing company ADP /zigman2/quotes/207661132/composite ADP -0.49% .
Employees’ ‘only obligation is to sort of understand that starting in January, their net pay is going to be a little bit less. So don’t be surprised when that happens.’
Pete Isberg, ADP
“Their only obligation is to sort of understand that, starting in January, their net pay is going to be a little bit less. So don’t be surprised when that happens.”
Starting next year, “your check very well will go down, if the tax isn’t forgiven, which is a giant unknown,” said Laura Melville, who heads Wiss & Co.’s outsourced payroll services.
Trump’s order instructs Treasury Secretary Steven Mnuchin’s staff to consider crafting a bill that would forgive the payroll taxes deferred from September through December, with Trump up for re-election on Nov. 3 and trailing in national and battleground polls.
In normal times — when the economy isn’t staggering under a public health crisis — federal payroll taxes take a bit off the top of every paycheck.
Specifically, 6.2% of an employee’s gross earnings go toward Social Security, and 1.45% goes to Medicare taxes. The employer pays the same rate, and that combines for a 12.4% Social Security tax and a 2.9% Medicare tax. (Under the CARES Act, employers don’t have to pay their side of the Social Security tax through the end of the year. They can repay half by next year and the other half by 2022.)
With federal lawmakers at loggerheads over another stimulus bill, Trump signed the executive order deferring the employee’s 6.2% tax obligation for pay between Sept. 1 and the end of the year. He also signed memos that, among other things, greenlighted $300 in supplemental unemployment benefits.
When it came to payroll taxes, Trump’s order said, “This modest, targeted action will put money directly in the pockets of American workers.”
The tax deferral doesn’t do anything for millions of unemployed who aren’t on payrolls to begin with, according to critics. Others questioned how to put the order into effect. In addition, the negative short- and long-term impacts on the Social Security system of pausing payroll-tax collection have frequently been raised as objections, particularly with Trump on more than one occasion saying the suspension could be made permanent should he be re-elected.
The new IRS guidance isn’t a rebuttal to the skeptics, but it sketches out the order’s implementation.
Here are three key takeaways:
Employers are on the hook to pay
It’s up to employers whether they’ll participate in the tax deferral, Mnuchin has said .
But until the guidance came out Friday, there was a question as to who would be responsible for getting the deferred taxes to the feds, Isberg said. Would it be workers reporting the deferral next tax season, or would it be companies doing the deferral?
The guidance makes it clear that’s a job for employers, according to Isberg. “They are going to hang on to the liability and the responsibility for repaying all those taxes,” he said.
Of course, workers still have to pay their taxes, just later on. If a company is deferring payroll taxes, the paychecks from January 2021 to April 2021 are going to include two deductions: one for the postponed 6.2% payments and one for the payroll-tax payments that resume in January.
Isberg didn’t know how many ADP clients are going to suspend payroll tax collection; Melville said her company’s clients have been leaning away from the deferral.
‘In my opinion, to be more conservative, I say continue to hold and remit.’
Laura Melville, Wiss & Co.
“In my opinion, to be more conservative, I say continue to hold and remit,” said Melville, a manager at the accounting and consulting firm headquartered in Florham Park, N.J.
“By taking that conservative approach, it’s less of a headache down the road, I think.”
What are eligibility rules and when does the tax deferral start?
Suppose your company decides to defer the tax. If you make less than $4,000 gross on a biweekly basis, you’ll see a bump for now in your paycheck. On an annual basis, someone meets the deferral threshold if they make less than $104,000.
There are nine more biweekly pay periods between now and the end of the year, Iseberg said. That comes to $36,000 in before-tax earnings for someone making $104,000. The 6.2% portion comes to $2,232. Commissions and year-end bonuses are also subject to the deferral, he noted.
The deferral is forward-looking, Isberg said. For example, he confirmed, if a company pauses payroll-tax collection in October, it can’t retroactively lump money from September tax payments.
The IRS guidance is also noteworthy for what it doesn’t say
The guidance doesn’t say one way or another what happens if a company decides to participate, but its employees don’t want to, Isberg said. “Employees are going to have an opinion, right? There’s some that will want to do it and some who will absolutely not.”
Companies going with the deferral are going to have to explain to staff how the arrangement will work, Isberg and Melville said. An IRS spokeswoman declined to comment beyond the guidance issued last week.
Even though the IRS guidance is silent on the matter, companies should be able to explain to staff which course they are taking, Melville said. “They should be ready to answer questions, because they are going to get them.”