If your employer stops withholding Social Security taxes on your paycheck, expect to take home less money in early 2021.
According to the new guidance, employers that don't withhold payroll taxes between September and December 2020 will be responsible for withholding those taxes during the first four months of 2021.
Translation: If you get a bigger paycheck during the last four months of 2020 due to the temporary payroll tax break, don't be surprised when you have skimpy paychecks between January and April of next year, due to more withholding.
"Essentially, the Treasury Department seems to be encouraging employers to stop withholding now through the end of the year, and then double withhold for the first four months of 2021," wrote Joe Bishop-Henchman, vice president of tax policy and litigation for the National Taxpayers Union, in a blog post last week.
And if you're no longer working for your employer come January? The guidance says your company can "make arrangements to otherwise collect" the taxes you owe.
No word on how they'd do so if you're no longer earning a paycheck that they can withhold money from.
Why You'll Have to Pay Back Your Payroll Tax Cut
Trump issued four relief orders in August, one of which directs the Department of the Treasury to temporarily stop collecting Social Security taxes for people earning less than $104,000 a year. Social Security taxes amount to 6.2% of the first $137,700 of earnings for most employees.
But the payroll tax cut Trump ordered isn't really a tax cut. Cutting taxes requires changes to the tax law, which Congress must approve.
So without Congress, the only thing the president can do is push back the due date during a year when a disaster is declared. That means that unless lawmakers sign off on a tax cut, you'll owe the money sooner or later.
Of course, Congress could step in and agree on a compromise that forgives the taxes, possibly in the next stimulus bill. But thus far, both Republicans and Democrats have opposed a payroll tax cut, in part because it doesn't help the millions of people who are still unemployed.
Plus, it's likely that Congress would have to step in and provide funding for the tax cut to avoid a Social Security shortfall. Not surprisingly, lawmakers are less than enthused about that prospect.
4 Ways to Avoid a Big Payroll Tax Bill in 2021
There are plenty of payroll tax cut questions that businesses throughout the U.S. are still scrambling to answer. One pressing concern for employers is that they could be on the hook for the employee's share of payroll taxes if they leave the company for any reason. As a result, many companies aren't expected to implement withholding changes.
But based on what we know so far, here are some ways to reduce the pain of a smaller paycheck or big tax bill in 2021.
1. Ask your employer if you can opt out.
Since it appears that employers don't have to stop withholding Social Security, don't assume this is something you have to worry about.
But if your employer does plan to stop withholding payroll taxes, it's worth asking if you have the option to continue having the money withheld from your paycheck.
Still, you may not get to choose. Politico reports that the National Finance Center, one of the largest payroll processors for the federal government, has said it will defer the taxes for all eligible employees and doesn't mention the ability to opt out.
2. Automatically save the extra money.
If your employer does implement the changes, do not spend it. Set up automatic transfers to your bank account each payday for at least the 6.2% that's no longer being withheld. You can use that money to offset your lower paycheck come January if needed.
Consider setting up an account that's separate from your regular savings. This is not your emergency fund, so avoid commingling the two.
3. Adjust your withholdings
Another option is to ask your employer to withhold more money from your paycheck by submitting a new W-4. This won't stop your employer from withholding extra payroll taxes at the beginning of 2021, but it will increase your tax refund. If you file quickly, you can use that money to make up for your temporary pay cut.
4. Assume that you're paying this back.
Until Congress approves a payroll tax cut, assume you'll pay back any extra money you receive -- most likely in the form of less pay next year.
That means don't go spending this money. Don't invest it. Don't put it toward debt.
The only safe thing to do is to keep this money in a bank account and treat it like money that was never yours to spend.
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