President Trump brags about his payroll tax cut. But money-smart employees see it for what it is: a loan.
The tax deferral is to last from Sept. 1 until the end of the year, according to guidance the Treasury and Internal Revenue Service issued last month after the executive order. It spares many employees from paying 6.2 percent of their income toward Social Security, which covers retirement, survivor and disability benefits.
Here’s the problem with this ill-conceived tax holiday.
Employers have to collect all of the deferred payroll taxes between Jan. 1 and April 30, 2021. This means taking out double the normal tax. If, for whatever reason, the money isn’t forwarded to the IRS, interest and penalties begin to accrue on any unpaid taxes starting May 1.
While workers will have extra money now, it’s just a short-term and temporary infusion of cash that needs to be paid back unless Congress eventually forgives the debt. And that’s a bet I would not place given the current political environment. If people are struggling now, how will they be able to afford to pay twice the payroll tax four months from now, and right after the holidays?
Although many private-sector employers have rightly elected to skip this optional tax deferral, the Trump administration has refused to allow federal employees or members of the military to opt out.
“We’re hearing from people who don’t want this,” said Tony Reardon, national president of the National Treasury Employees Union.
Some federal employees are upset and wonder how to make up for the double taxation — which they can’t opt out of — that they’ll be subject to next year.
“All Federal Civilian Payroll Providers will act in unison. As such, no Payroll Providers, Departments/Agencies, nor employees will be able to opt-in/opt-out of the deferral,” according to an email obtained by The Washington Post. The message went to employees of an agency serviced by payroll processor Defense Finance and Accounting Service.
The email also said employees are still liable for the deferred tax should they leave federal civilian employment. The elimination of the withholding takes effect in the pay period ending Saturday, the DFAS email said.
“The payroll tax deferral is mandatory at our agency and affects a huge number of workers,” emailed one federal employee who works at the Defense Department and spoke on the condition of anonymity because of the sensitivity of the topic. “As far as I can see, it is really idiotic, costs a lot of money to the government, and doesn’t help anyone. It is an unnecessary hassle.”
Workers are wondering whether they should increase their withholding so that enough money is taken out of their paychecks to cover the deferred payroll tax. Financial professionals advise against this strategy.
“Increasing federal tax withholding is not necessarily the best idea,” said Eric Bronnenkant, head of tax at online financial adviser Betterment. “The government is loaning individuals money at zero percent and then individuals would effectively be loaning the money back to the government at zero percent."
In addition, when you withhold too much, you have to wait to get the money back as a tax refund.
“You’d have to file your Form 1040 to get the additional federal withholding back, and the timing wouldn’t work,” says Edward Karl, vice president of taxation for the American Institute of Certified Public Accountants. “Additionally, if you stopped working for the employer, the employer may seek to recover the deferred tax immediately."
For federal employees, it wouldn’t be effective anyway since the collection of the deferred taxes will be taken from their wages in the first part of 2021, according to a separate notice from DFAS.
If you can’t opt out, the better strategy is to figure out how much extra you’re getting as a result of the payroll deferral and set that money aside as savings.
“People who cannot afford the extra tax in 2021 out of normal earnings should be setting aside the extra funds received currently in a savings account to be drawn down on during the first four months of 2021 to avoid being in a position to need to fund normal life expenses with high-interest credit card debt or personal loans,” Bronnenkant said.
The payroll deferral is all about the optics of appearing to provide meaningful pandemic-related financial assistance. This directive just shifts a burden forward.
“This scheme is not helpful,” Reardon said. “To the extent that they are helped in 2020, they are hurt in 2021."
Eric Yoder contributed to this report.