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How a Payroll Tax Cut Could Affect Your Finances, Now and Later

·9 min read
How a Payroll Tax Cut Could Affect Your Finances, Now and Later

On Aug. 8, President Donald Trump signed an executive memorandum that would defer payroll tax obligations “in light of the ongoing COVID-19 disaster.” The memorandum is set to defer the Social Security portion of payroll taxes from Sept. 1 until Dec. 31. Currently, both employers and employees pay a 6.2% Social Security payroll tax on the first $137,700 of annual earnings.

“This modest, targeted action will put money directly in the pockets of American workers and generate additional incentives for work and employment, right when the money is needed most,” the memorandum states.

But how exactly would the deferment work? And who would benefit from it — or possibly be harmed by it — the most? Here’s what financial experts say the repercussions of a payroll tax cut would be on Americans’ finances now and in the future.

Last updated: Aug. 21, 2020

The Tax Break Applies To Those Making $100,000 or Less Per Year

Not everyone would get a tax break under Trump’s plan: “The deferral shall be made available with respect to any employee the amount of whose wages or compensation, as applicable, payable during any bi-weekly pay period generally is less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods,” the memorandum states.

That means the tax cut does not apply to anyone who makes more than $100,000 annually.

It's Unclear What This Means for People Who Make More Than $100,000 Annually

Although the memorandum clearly waives the payroll tax for those making $100,000 or less, it isn’t stated if there will be benefits for those making more.

“It is somewhat unclear whether workers who make more than this will be ineligible, or if that portion of wages for any worker is eligible,” said Nate Smith, director of the CBIZ MHM National Tax Office.

It's Also Unclear What This Means for People Who Are Self-Employed

Self-employed workers and contractors typically pay their Social Security taxes with their income taxes, so it’s unknown if and how the payroll tax cut would apply to these workers, CNET reported.

It Does Not Benefit People Who Are Unemployed

Critics of Trump’s tax cut say that it does nothing to help the Americans who are in most need of financial relief.

“The tax cuts will not benefit the approximately 38 million jobless Americans, which are arguably those that are affected the most by the pandemic,” said Daniel J. Laginess, CPA, managing partner at Creative Financial Solutions in Southfield, Michigan. “Opponents to the tax cuts argue that there are more effective ways to benefit this population, including another round of stimulus checks and a continuation of banning evictions.”

It Doesn't Benefit Small-Business Owners

Although employees would not have to pay a Social Security income tax, employers would still be responsible for paying their share under Trump’s proposal.

“To extend relief to small businesses, we should consider extending the suspension to employers to put money back into the hands of small businesses,” said Chad Parks, founder and CEO of Ubiquity Retirement + Savings.

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Employers Might Even Be Liable for Employees' Unpaid Taxes

A payroll tax cut could possibly be an additional financial burden on small-business owners.

“Right now there has not been any guidance provided on whether the employer will be responsible for the deferred amounts from the employee,” said Mike Savage, CEO of 1-800Accountant. “This is a major concern for employers because if the employee’s portion of the payroll taxes are deferred, and the employee does not pay back the amounts, the employer may potentially be liable for the employee’s portion.”

Some Employers Might Choose Not To Participate

Even if you are an employee who makes $100,000 or less, you might not get the tax break if your employer opts to hold onto the 6.2% to pay it back to the government at a later date, CNET reported. The memorandum leaves it up to the employer to determine whether or not the 6.2% savings is passed onto the employees.

For Those Who Do Benefit, the Amount Saved Could Be Negligible

Trump believes the tax cut could help stimulate the economy by putting more money in workers’ pockets — but some say the extra earnings might not be enough to make a real impact.

“The payroll tax order covers wages paid during September through December, or one-third of annual wages. Hence, a maximum of $34,667 appears to be eligible,” Smith said. “At 6.2%, a maximum of $2,150 of the worker’s Social Security taxes would be deferred, or $269 on a biweekly basis. But the U.S. median wage is closer to $50,000, and so the more common biweekly deferral amount would be closer to $129. Many workers may not perceive $129 on a biweekly basis as much of a benefit, especially if they must pay it back later.”

But Even a Small Savings Could Be Impactful for Some

Although an extra $50 or so a week isn’t much — and could eventually have to be paid back — some people will be able to make productive use of these funds in the short-term, said Paul Miller, CPA and managing partner at Miller & Company LLP. Miller suggests putting the money into an interest-earning savings account.

“You get a little interest and wait and see what happens. It’s a no lose situation,” he said. “You could even pay down some debt, provided you could borrow it back and save a couple of bucks in interest.”

There's a Possibility the Tax Could Be Forgiven

“President Trump would like to see the deferred taxes eventually waived, and if Congress made that a reality, it would at least solve the repayment conundrum,” Smith said.

As it stands, the memorandum only calls for the deferment of payroll taxes as the president does not have the power to waive taxes. However, Trump proposes in the memorandum that the “Secretary of the Treasury [Steven Mnuchin] shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum.”

But There's Also a Possibility the Tax Will Have To Be Paid Back

“To date, neither political party in Congress has coalesced behind an initiative to cut payroll taxes,” Smith said. “Without Congressional action, the deferred taxes must be repaid.”

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Deferred Taxes Now Could Mean More Taxes Owed in 2021

As it stands, the 6.2% extra that’s going into employees’ paychecks would have to be paid back, though it has not been stated how or when this payment would be due.

“Forthcoming guidance should clarify whether the deferred taxes would be repaid all at once, or gradually over a payback period,” Smith said. “Either way, these taxes would be repaid on top of normal payroll tax withholding, which means worker paychecks would be less than normal during 2021.”

Major business groups — including the U.S. Chamber of Commerce, National Retail Federation and the National Association of Manufacturers — said they won’t participate in the payroll tax cut because of the future burden it could place on employees, Politico reported.

“Many of our members consider it unfair to employees to make a decision that would force a big tax bill on them next year,” the organizations said in a letter to Senate Majority Leader Mitch McConnell, Speaker of the House Nancy Pelosi and Mnuchin.

If the Payroll Tax Is Deferred and Not Waived, It Should Not Have Long-Term Consequences

“Currently this is a deferral. Trump doesn’t have the authority to reduce payroll taxes, so this doesn’t affect Social Security or Medicare,” Miller said.

If the Payroll Tax Is Waived, It Could Deplete Social Security Funds Sooner Than Expected

Waiving four months’ worth of payroll taxes could have a significant effect on the Social Security reserve if no action is taken to make up for these losses. Currently, Social Security funds are estimated to be depleted by 2034.

“At that point, Social Security payments will only be made from the money coming in rather than from the reserves,” Parks said. “Terminating contributions for the next four months will accelerate the timeline for the depletion of Social Security funds.”

This Could Affect Your Finances in the Future

If the Social Security reserve runs out, the amount of benefit you receive could be smaller than expected.

“The greatest negative effect [of a payroll tax cut] is that the reduction of future benefits will come sooner than Social Security trustees are reporting right now,” Parks said. “Social Security has already been massively impacted by the pandemic as the 30 or 40 million people who are not currently working are not paying into Social Security. Essentially, this tax cut would be a double whammy to Social Security.”

However, the Government Could Intervene To Prevent This From Happening

Even if the payroll tax is waived, the government could explore other avenues to fund Social Security.

“President Trump stated that the U.S. government’s general fund would fund any tax deferrals that would not have to be paid back so that Social Security funding will not be affected,” Laginess said. “However, according to USDebtClock.org, the government is running a deficit of almost $3 trillion thus far for 2020 and the national debt stands at approximately $26.6 trillion. The New York Times reported that deferring and forgiving the Social Security payroll tax from August through December would cost the government approximately $400 billion in tax revenue. Using those estimates, suspending the tax from September through December would cost the government $320 billion, driving our country even deeper into debt.”

The Government Could Increase Taxes at a Later Date To Make Up for the Cuts

A lack of payroll tax now could mean more taxes down the line.

“If the amounts are forgiven, then the government may potentially try to make up the shortfall in other areas, such as future increased income taxes or other additional taxes in the future,” Savage said.

The Long-Term Effects of a Payroll Tax Cut Are Still Unknown

“If President Trump is reelected next year, there is a possibility the payroll tax cut could stay past 2020,” said Tony Zabiegala, CRPC, vice president and COO of Strategic Wealth Partners. “If this happens, it could result in a lack of funding to government programs or a general tax increase to make up for lost revenue. Something has to give. There could very well be negative long-term effects, especially as it relates to the unknowns of how this tax cut will be made up in the future.”

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This article originally appeared on GOBankingRates.com: How a Payroll Tax Cut Could Affect Your Finances, Now and Later