As Americans continue to navigate the COVID-19 pandemic, the government put forth one more attempt at relief when President Trump signed an executive order waiving the collection of Social Security payroll taxes for the rest of the year.
The payroll tax cut is meant to put more money back in the hands of working Americans and stimulate the economy. However, the same working Americans could be on the hook to repay the tax later. In addition, this relief effort won’t assist the unemployed. Here’s a breakdown of what a payroll tax could really mean for you and your finances right now.
What the payroll tax cut means
The payroll tax cut is a reduction in Social Security tax implemented by an executive order from the president. As the name implies, the Social Security tax funds Social Security, and is 12.4% tax taken from your paycheck that employers and employees split evenly. Your half is 6.2%, which means that from September 1 thru the rest of 2020, if you qualify for the tax cut, you may get to keep that 6.2%.
Employers already received payroll tax relief through the CARES Act, which allows most business to put off paying their 6.2% of the Social Security tax until 2021. The executive order focuses on the employee’s share of tax.
Who gets the payroll tax cut?
Anyone who makes less than $104,000 per year or $4,000 for any bi-weekly pay period is eligible for the payroll tax cut.
Since the payroll tax cut only effects a portion of working Americans, employers will need to work with the IRS to determine who in on their payroll is eligible. Not all payment systems are equipped to adjust quickly to this type of change, so you may not see the extra money right away.
Is the payroll tax a cut or a deferral?
Despite being called a tax cut, your Social Security tax payments are merely suspended, and may need to be repaid in 2021 if a permanent cut is not implemented. A cut could happen, since President Trump announced that if he were reelected, he would eliminate payroll taxes completely.
This cut/deferment status can be confusing for both employees and employers, who might still withhold Social Security tax from employees in order to avoid a large tax bill in 2021. In addition, when the taxes need to be repaid, it’s not clear if employers could take more from your paycheck than the 6.2%, which would be a shock to your budget if you are not prepared.
3 things to do if you get the payroll tax cut
If you qualify for the payroll tax cut, there are ways you can make that extra money in your paycheck go further and protect yourself from any payback requirements.
- Build up an emergency fund. The U.S. personal savings rate has increased month over month since March. But, if you are one of those who haven’t been saving, you could use the tax cut to build up an emergency fund. Aim for at least two to three months of expenses first. A fully fund emergency fund is usually defined as three to six months of expenses or more saved.
- Pay down existing debt. If you have high-interest debt, use extra money you get in your paycheck to pay it off. Even if you need to repay these taxes later, at least you reduced your debt and paid less in interest.
- Invest the additional earnings. Many Americans struggle to save for retirement, especially during the pandemic. Now might be the time to invest the extra cashflow to stay ahead in your retirement planning.
2 steps to take if you have to make payments on the payroll tax cut later
If you know you’ll have to make up the payments later or just want to be prepared, there are two things you can do.
Step 1. Separate your savings: Put the money into a separate savings account so that you don’t have to worry about finding the funds later on. This won’t put more money into your pocket, but if you have a high-interest savings account, that money can at least earn some interest while you’re stuck in a holding pattern.
Step 2. Set new payment priorities: You may want to re-prioritize your current bills and payments. If you are behind on bills, you could use the payroll tax cut money to get current on your bills. This could reduce the amount you owe and interest accrued. You could also pay off a debt and free up a payment that could then be used towards making up your payroll taxes.
2 steps to take if you’re excluded from the payroll tax cut
While the executive order is meant to stimulate the economy, it leaves out workers who are unemployed, some veterans, and higher income earners who may be struggling with high debt. If you fall within any of these categories, there are things you could do.
Step 1. Find some help: You may want to continue to look for assistance in unemployment and forbearance options. Some states have stronger unemployment assistance and some creditors are offering financial assistance during the pandemic; you can use a step-by-step forbearance guide to help.
Step 2. Use your savings: It might be time to spend from your emergency fund. Since many of us have been quarantining at home and reducing spending, now could be the right time to use your savings if you lost your job or an unexpected expense pops up. While this should probably be a last resort, this is exactly what an emergency fund is there for.
Make money management a priority
A payroll tax cut could be a welcome break for your budget, but managing your money and especially your debt should still be a priority. If you are unsure of what your next financial step should be, the Freedom Debt Relief debt management guide can walk you through your options. Get started by downloading the How to Manage Debt guide now.
Update, Aug 31, 2020: IRS guidance to employers dated August 28th instructs employers that they would be liable for tax amounts deferred from paychecks under the executive order signed by President Trump. This could mean double the tax would be taken from employee’s checks in the first four months of 2021, if they choose to defer the tax. Employers have the option to opt out all together.
- Financial Advice to Ignore During a Recession (Freedom Debt Relief)
- How to Protect Your Credit Score During the COVID-19 Recession (Freedom Debt Relief)
- Trump’s Payroll Tax Cut? It’s Actually a Deferral (Bankrate)
- What is the Employer Payroll Tax Cut Deferral? (Investopedia)