What is the Payroll Tax Deferment?

by John Cooney on Oct 18, 2020

Taxes, Tax Planning, retirement

What Is It?

On August 8th, President Trump issued a memorandum directing the Treasury Department to defer the collection of certain payroll taxes. The Secretary of the Treasury then authorized employers to defer withholding their employee’s portion of Social Security taxes until 2021. It is not mandatory for employers to do this, they still have the option of withholding the tax. The purpose is to relieve some of the economic impact the Coronavirus has had and continues to have on employees.

What Does This Mean For Me?

If you are an employee who has their Social Security withheld from their paycheck, makes less than $4,000 bi-weekly, AND your employer elects to defer withholding, then from 1 September until the end of 2020, this amount will not be withheld from your paycheck and your net take-home pay will be higher. It is important to recognize though, that this is a deferral not a relief from paying the tax. It is being deferred until 2021. The taxes you should have paid in 2020 will instead be taken out of your paycheck starting in January of 2021. The current Social Security withholding percentage is 6.2%. Let’s take a look at an example.

John earns $1,000 every two weeks at his job. With each paycheck, $62 is withheld as part of John’s Social Security taxes. Under the Presidential memorandum, this $62 will not be withheld and instead will be deferred. So for September, October, November, and December, John will take-home an extra $124 per month or a total of $496. Nice, right? Well here is where the deferral comes in. Starting in January, John will have the $62 per-paycheck withheld AND an extra $62 of what should have been withheld in September through December. That is not a bad thing, but is something you should be aware of and planning for.

What Should I Do?

You should have a plan on how to deal with the change in your cash flow. Here are three options on what to do and my recommendations on each.

  • Option 1 – Save it! If you are living check to check, you have to be planning for how you will handle the lower income levels in 2021. Your best bet would be to put the extra income in 2020 aside, so that when your income dips in the first quarter of 2021, you have the money you saved in your checking account to compensate.
  • Option 2 – Fund your goals. If you aren’t living paycheck to paycheck, you may be in a position to use the extra money in 2020. If you are confident you can meet your living expenses on the lower income amount, funding your financial goals is a worthy option. Here is my hierarchy of goals that I would put the extra money towards:
    • Pay off debt. This could be a credit card or an extra car or mortgage payment.
    •  Retirement. If you haven’t maxed out your retirement accounts, put the extra money towards your future self.
    •  Tax-Advantaged Accounts. No debt and maxed out your retirement accounts? Look to other tax advantaged saving opportunities. Both an HSA or an Educational Savings Account would be good options here.
  • Option 3 – Spend It! If you are in a good financial position, then use it on yourself or towards your Christmas shopping this year.

Ultimately, what is best for you will depend on your individual situation. What is most important though is understanding how you the deferral affects you. With this knowledge, make a plan that allows you to take full advantage of it in 2020 without putting yourself at a disadvantage for 2021.