President Donald Trump’s executive order to defer the collection of payroll taxes from employees through the end of 2020 has created more questions than answers for businesses and their employees.
Normally, payroll tax is a 6.2% tax on a employee’s salary (up to $137,700 annually for 2020) is withheld from their paycheck to fund Social Security, and the employer pays another 6.2%. The CARES Act gave businesses the option to defer their share of this year’s payroll taxes, and now, Trump’s recent executive order instructs the Treasury Department to defer collection of the employee-side payroll tax payment for those making up to about $104,000 during the period of Sept. 1 to Dec. 31.
But the order is vague and is a deferral (not tax forgiveness or a tax cut — only Congress can do that). So here’s what you need to know about the new deferral and will impact workers and employers.
The deferral is essentially a loan
According to Urban-Brookings Tax Policy Center senior fellow Janet Holtzblatt, the deferral could be viewed as a “payroll tax loan,” she tells CNBC Make It.
“It’s a loan, and if people understand it, they would know that they or their employer would have to repay it eventually.” (If re-elected, Trump has said he would push to make this deferral a permanent cut, but that would depend on congressional approval.)
That means if employers do not withhold the taxes for those months, employees could be hit with a sizable bill in the new year.
It’s unclear whether employees could opt out of the deferral, and the IRS could potentially set up a way for workers to pay the deferred taxes ahead of time, Garrett Watson, senior policy analyst at the Tax Foundation, says, but that would require firms to track each employee and how they handle the situation, which would be complicated.
“It’s also possible that workers may have to rectify [the deferral payment] on a [tax] Form 1040 in 2021,” Watson says, “but that’s unclear at the moment.”
Those are the kinds of details that IRS and the Treasury Department will need to give guidance on before the deferral start date, he says.
Employees might not even get the deferred money
There are so many issues for businesses that they may decide to withhold the tax money anyway.
“It’s actually not clear that firms would be required to necessarily pass along the deferred savings to employees,” Watson says. “It’s very possible that firms would be able to take the deferred savings and withhold from employees.”
One big issue is that firms must still pay the payroll tax at the end of the year.
Currently, the tax has to be repaid after Dec. 31, says Holtzblatt, so “employers may just sit on the money or they may go ahead and pay [the tax] anyway.”
For instance, it may be possible that employers can take the deferred savings and put it into an escrow account, Watson says. Companies will be “very cautious, especially in this economic environment,” he says, so it’s unlikely that they’d be willing to bet on the payroll tax potentially eventually being cut by Congress in 2021.
Additionally, the cost to businesses and the time it would take to make administrative changes to payroll to defer the taxes “may exceed any cash flow benefit seen in the short run,” Watson says.
For example, “changing the software for payroll taxes, particularly in this instance, where it’s not going to be straight across the board,” can cause problems, Holtzblatt says. “It’s only going to be a payroll tax supply to people who have less than $4,000 of wages over a two week period. That’s going to require reprogramming.”
The bottom line is, “there’s a strong incentive for [employers] to continue to withhold,” Center on Budget and Policy Priorities (CBPP) senior tax legal policy analyst Samantha Jacoby says, “and if that happens, employees will not see extra money in their paychecks.”
It may not be a boon for the economy
“The thought was by deferring this tax, that it would pass along some of the savings to those who are already employed [and] that may help stimulate economic activity, either through increased spending, through additional savings for those who are employed,” Watson says.
But the experts say there are a lot of holes in this theory.
First, there are so many “ifs,” says Holtzblatt: “If the employer does [pass the deferred savings to employees]; if it gets passed on to the wages; if workers understand that this is just a loan and not a payroll tax cut — would they actually increase their spending? Because otherwise, they’re going to possibility get hit with a big [tax] bill just as their Christmas bill is arriving.”
The plan also does not provide any assistance to people who are unemployed, Holtzblatt says. “It’s only going to affect people who are working.”
“The bottom line is, it’s probably not going to have the impact on the economy that maybe Trump and his advisers are envisioning,” says Holtzblatt.
So many logistics need to be worked out
Many details are still up in the air.
For instance, there may be legal challenges to this executive order, Holtzblatt predicts.
Already, some lawmakers have voiced concern that Trump’s order is unconstitutional. Andrew Rudalevige, chair of the Department of Government and Legal Studies at Bowdoin College, told NPR on Saturday that the order is particularly controversial because it is “really using appropriated funds by Congress in ways that Congress might not have intended.”
And there are many logistics to be addressed.
“There are lots of questions that still need to be answered before an employer could even begin to implement this,” Jacoby says, like what would happen if employees leave their jobs and switch companies, or whether employees would have to rectify the deferral on a Form 1040 in 2021.
“The memorandum directed the Treasury to issue guidance, so I think that will answer a lot of questions. But before that point, there’s not much anyone can say for sure about what the affects are and how this is going to be implemented.”
“There’s been a lot of speculation, but no one knows for sure.”