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Plan Smart for the New Payroll Tax Deferral

Have you seen a change in your paycheck? Normally, a slice of 6.25% is taken from your pay as part of your typical payroll tax withholdings. That money is customarily used to pay your Social Security tax—which covers retirement, survivor and disability benefits. However, some people are receiving larger or increased pay over the tail end of 2020. That’s because of an August presidential memorandum calling for employers to temporarily stop the Social Security tax withholding during the period September 1 to end of the year.

The purpose of the action is fiscal relief—specifically to help those still working, but dealing with COVID-19 financial stress.

Not everyone’s tax is being deferred
The deferral isn’t being applied to everyone. Private companies have been allowed to opt-out of this deferral, but many workers don’t have that option, including most federal employees and uniformed service members. Of those, only people making under $104,000/year will see the deferral. People making more than that amount are not eligible.

What you need to know
At first glance, the tax deferral program may sound like a windfall of extra cash. You do get a larger paycheck—for now. But there’s a catch. This is only a delay in tax payments—not forgiveness. Eligible taxpayers are still expected to pay applicable taxes. The executive order indicates tax payments will resume beginning January 1, 2021. Employers will have until April 30, 2021 to collect and repay your outstanding taxes.

What does it mean? While as a worker, you’ll have extra money now, it’s just a short-term and temporary cash infusion. Come January 1 through April 30, 2021, your employer will be taking out double the normal tax.

Another catch: tax penalties
In addition to the 2021 double tax whammy, if any deferred taxes are not paid between January 1 to April 30, 2021, you’ll need to pay even more—as interest, penalties, and additions will begin to accrue on May 1, 2021.

What you need to do
The tax deferral doesn’t appear to provide you any real net benefit in terms of dollars. The president’s effort doesn’t so much change what people pay in taxes —just when they pay it. If you have a repayment obligation, know that your 2021 finances may be impacted. The money is going to start being repaid around a time that holiday bills come due.

A lot can change in the next few months. As of now, we don’t know if events like a job loss or reduced income will have any impact on repayment.

If you’re forced into deferral, the best course of action would be to examine your budget. Plan ahead by saving the extra bit of cash you get this fall so that you can prepare for a drop off in cash flow early next year. You can establish one-time or recurring transfers into a Club Savings account set up exclusively for you to have the funds to pay when the double tax is due.

Resources: The Washington Post. Marketplace, org, HRB Digital LLC