You might have heard that paychecks are getting a little fatter thanks to the federal government’s latest efforts at providing COVID-19 relief to the average worker: an executive order deferring payroll taxes.
We hate to be the bearers of bad news (even though we’re accountants) but we would caution you against expecting a meaningful increase in your take-home pay. Let’s take a look at what’s actually happening.
What’s a Payroll Tax?
When we say “payroll tax” we’re talking about the combined payments into Social Security and Medicare. Every paycheck, employees contribute 6.2% of their earnings into Social Security and 1.45% to Medicare, and their employers make a matching contribution (for a combined 12.4% payment into Social Security and 2.9% into Medicare). Or at least that’s how it worked before an unchecked pandemic sent the economy spiraling into crisis-control mode.
The original COVID relief act, passed in March, gave employers the ability to defer their share of the Social Security portion of these payroll taxes. Trump’s executive order, signed in Sharpie and held up proudly for all to see, defers the individual workers’ contributions to Social Security as well.
Theoretically that means paychecks should grow by 6.2%.
Deferment means that these payments are being postponed. By deferring these payments, the federal government is essentially handing out an interest-free loan. The original corporate deferment of payroll taxes is to be paid back in two installments: half in 2021, and half in 2022, then the economy has theoretically rebounded. For the individual payments deferred by the new executive order, repayment would be due in the first quarter of 2021.
Because this tax is taken out of your paycheck before it’s handed to you, your employers will ultimately be the ones responsible for paying it back when it comes due. Which means that they may be a little hesitant to pass along that additional income. If there’s no real indication that the economy is improving, and no clear plan for recouping the funds to repay Uncle Sam, paying employees an extra 7.65% right now could be a tough ask. Would you take that extra money right now if your employer had to lower your usual salary by an equal amount for the first quarter of 2021 to pay it back?
It’s possible, but not guaranteed, that these deferments will be forgiven, in which case the loans would not need to be repaid. And while that certainly sounds like an easy solution, it’s not clear if it can even happen. Because it’s not even clear if this executive order is constitutionally valid.
Doesn’t Congress control the purse?
If you paid attention in your middle school social studies class, you may have the phrase “Congress controls the purse” rattling around somewhere in your head. That’s because, according to the first clause of Article 1, Section 8 in the US Constitution, Congress controls the purse. Which means that a president can’t do things like issue executive orders deferring payroll taxes.
Except that this one did.
While lawyers and courts work this one out, it gives your employers even more reason to hesitate on passing that extra 6.2% of your earnings on to you. What happens if, a year from now, the courts decide that former steak-by-mail entrepreneur Donald Trump didn’t have the legal right to postpone the nation’s Social Security payments?
6.2% doesn’t sound like much.
It’s not! But it’s better than nothing, which is what the federal government has provided in relief to the average US citizen since that initial $1200 stimulus check. The average salaried worker is expected to take home around $1200 this time as well, although that is spread across their paychecks between now and the end of the year.
And remember, this time they’ll owe the government back—unless the deferment turns into a waiver.
Also remember that this deferment only affects the paychecks of salaried workers. If you’re a freelancer, a contract worker, a tip-based service industry professional, or in any of the other million and one possible scenarios where you don’t earn a regular salary, this rule change will have no effect on you. You can take that as a good thing if you’d like.
What about Social Security?
If employers haven’t been paying into Social Security since March, and employees won’t be paying into it for the last quarter of the year, what’s going to happen to Social Security funds? If you’re under 40, you’ve probably heard that “you’ll never collect on your Social Security payments anyway.” Whether or not that’s true, this funding freeze will have very little impact on the future solvency of Social Security. That’s part of the reason these payments have been deferred, not stopped completely. Of course, it’s entirely possible that these deferments will be expanded to a degree that actually threatens the sustainability of Social Security. That’s why it’s best to have a future financial plan that doesn’t rely on Social Security anyway—and we’d be happy to help create the right plan for you.