How the payroll tax cut works

An executive order that Trump signed last month allows employers to hold off on collecting some federal payroll taxes through the end of the year, to give plumper paychecks to Americans who earn $4,000 or less every two weeks.

Specifically, the president's memorandum lets bosses temporarily stop dinging their employees for a 6.2% tax that funds Social Security. A worker making the $4,000 threshold amount at a participating business would get an extra $248 in each biweekly paycheck, through Dec. 31.

But the order doesn't cancel the taxes — it just delays them. The IRS says payroll taxes deferred between September and December of this year under Trump's order will have to be paid between January and April of next year, "or interest, penalties, and additions to tax will begin to accrue on May 1, 2021."

The official White House memo says Treasury Secretary Steve Mnuchin will "explore avenues, including legislation" to permanently wipe out the tax debt, but there's no guarantee Congress will agree.

Major business groups, including the U.S. Chamber of Commerce, have balked at the payroll tax holiday. Workers won't have anything to worry about if their employers don't participate.

But Trump's order will apply to an estimated 1.3 million federal employees and more than 1 million U.S. service members, starting with the pay period ending Sept. 12, according to The Washington Post and other media outlets.

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What to do if your payroll taxes are deferred

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The payroll tax deferral has been described as a "payroll tax loan" by Janet Holtzblatt, a senior fellow at the Urban-Brookings Tax Policy Center, in multiple interviews. Holtzblatt says affected workers who treat it that way should be fine.

This kind of no-interest loan may be welcome relief for people who have been racking up debt during periods of unemployment. But if they don't plan ahead, wintertime will be a shock as their paychecks suddenly come up short. Here are a few coping strategies.

Put the excess pay into savings.

If the money is a loan, "pay it back" as you go. During the months payroll taxes are deferred, examine each pay stub and find the "gross pay" amount, before taxes. Multiple that by 0.062 (6.2%) to determine how much you didn't pay into Social Security, as you normally would. Then, deposit that amount into a high-yield savings account.

You'll need that stash to get through the winter and early spring, when your paychecks shrink to make up the unpaid payroll taxes from the fall. And, you might as well earn some interest on the money while you sit on it.

Use the extra cash to pay down debt.

If you've got a lot of debt from credit cards, follow the advice above to see how much additional pay you're receiving while your payroll taxes are cut temporarily. Apply the amounts to your debt, to help reduce your balances and your minimum payments. You will experience a pay cut early in 2021 as the deferred payroll taxes are paid back, but you should find yourself paying smaller bills.

Make a New Year's resolution to be more responsible with debt, and consider taking out a debt consolidation loan to help shrink your credit card balances to zero.

Devote some of your padded pay to new financial habits.

Calculate how much extra pay you're getting and squirrel away most of it into savings for the first part of next year. But spend a small amount on a financial goal you haven't been able to get around to, like buying life insurance to protect your loved ones if something happens to you, or getting into investing if you've wanted to put money into stocks.

Life insurance policies can be surprisingly inexpensive; the industry nonprofit Life Happens says you can pay as little as $13 a month, depending on your age and desired coverage level.

And, today's investing apps allow you to start with as little as $1, and you can find yourself paying no fees or commissions.

The fate of the payroll tax deferral

Though White House economic adviser Larry Kudlow told reporters last week that the payroll tax break will be "extremely helpful" for workers, members of Congress are unconvinced.

More than 20 mostly Republican members of the U.S. Senate have signed a letter urging the administration to let federal government employees and members of the military say no thanks, and opt out.

"Federal workers and service members should not be used as pawns for a payroll tax scheme that many private-sector employers are unlikely to join and where key questions remain unanswered," the letter says.

Republicans say they plan to introduce legislation to forgive the deferred taxes, as the White House wants. But since that proposal is likely to face resistance in the House, which is controlled by Democrats, the safe move for affected workers is to put at least a little extra aside.

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About the Author

Doug Whiteman

Doug Whiteman

Former Editor-in-Chief

Doug Whiteman was formerly the editor-in-chief of MoneyWise. He has been quoted by The Wall Street Journal, USA Today and CNBC.com and has been interviewed on Fox Business, CBS Radio and the syndicated TV show "First Business."

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