Thanks to Trump, millions of Americans might unwittingly take a loan they didn’t ask for in the first place. Tuesday marked the first official day of the “payroll tax deferral,” the White House’s new policy purportedly aimed at providing relief to American employees during the Covid pandemic via a temporary suspension of the 6.2% share of their Social Security tax.
It’s a wonky law, and perhaps because of that has gone unnoticed by much of the general public. But beware: In the history of tax policies, the payroll tax deferral may just be the mother of bad tax policy.
In effect, it could force millions of Americans to take a tax loan in 2020 that they will have to pay back in 2021. You heard that right. People are unwittingly taking a loan they didn’t ask for in the first place.
Let me explain a bit further.
Currently all workers who earn income pay what are called “payroll taxes” on their first $137,700 in earnings. This is not “income tax”; it is a separate 6.2% taken out of every paycheck that goes to fund Social Security. It is how the checks to Grandma and Grandpa get funded.
On your pay stub it is part of FICA, which stands for Federal Insurance Contributions Act. Here, 6.2% of your check goes to Social Security and 1.45% goes to Medicare. Your employer also pays an additional tax on your behalf, at the same rates, that goes toward funding the same programs.
This is somewhat true. Under the 2020 CARES Act passed by Congress, employers who want to participate could defer their portion of payroll tax payments into 2021. This means that the employer wouldn’t pay these taxes up front for the rest of 2020. Their bill would come due in 2021. If employers opted in, workers wouldn’t see any difference. Your 6.2% would still be withheld.
The White House recently released an executive order that allows employers to defer their workers’ portion of payroll taxes. This is where the forced loan kicks in. If your employer elects to participate, you do not get to opt out. Read that again and let that sink in.
If your employer participates (currently the White House has directed that all federal employees have to take this forced loan), and you make less than $104,000 a year, you would see that your paycheck magically will be a little bigger until December 31, 2020. This means suddenly you have 6.2% more in income every pay period. Yay!
But curb your enthusiasm. This is not a tax break; it is a deferral. You should hold on to that money because come 2021, those taxes are legally due. Starting in January 2021, your employer will double your 6.2% of tax withholdings to pay back the deferred taxes.
If you do not pay the taxes back on your own — say you change jobs or lose your job — you will owe interest and penalties, and your April 2021 tax refund is likely to be intercepted in part (or in whole).
Well, it appears to be a political ploy. In the short run, many Americans will think they have more money in their pocket. Of course, the gambit might be to help the Trump campaign by pleasing voters’ short-term pocketbooks while kicking the can down to after the next presidential inauguration.
It appears from the executive order that the White House believes that a solution would be to forgive the debt, and that perhaps there will be pressure in 2021 to write off billions in taxes owed. To do so would require an act of the next Congress in 2021, and while technically it can happen, there are many reasons it would not.
Remember, I said that these payroll taxes are what funds Social Security. If the taxes are not collected then this causes a shortfall in the Social Security trust fund. By law, this shortfall in revenue would trigger cuts to Social Security down the line when the money runs out. It would almost certainly lead to future cuts to benefits or increases in the retirement age to compensate.
The other alternative would be for the federal government to go into debt to pay back the Social Security trust fund for the lost revenue, so at best they’d be set up to rob Peter to pay Paul.
In a weird way, yes, maybe. One of two things can happen. In one scenario, millions of Americans are bamboozled and never realized they had been forced to take a tax loan. They will suddenly see big chunks of their paycheck taken out in 2021, have to cut a check to the IRS, see their April 2021 tax refunds intercepted, or some combination.
In the second scenario, somehow the next Congress in 2021 passes a law to officially forgive these billions in tax debt. This creates another problem. If the federal government does not collect the taxes that fund Social Security, it means the trust fund could run out sooner rather than later. This could, and likely would, mean cuts to Social Security would follow due to the shortfall in revenue. This is what happens if you don’t collect the taxes that fund Social Security.
Yes, it is a dumb policy. Yell at your employer if they’re forcing you to take the loan. Watch the FICA part of your pay stubs to make sure the regular amounts are being withheld. If you’re forced to take the loan, don’t spend the money, and save it to pay back to the IRS in January.