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Is a Tax Time Bomb Lurking in Your Paycheck?

Blog & Social Media   |   Financial Planning   |   Is a Tax Time Bomb Lurking in Your Paycheck?

Is a Tax Time Bomb Lurking in Your Paycheck?

Does your paycheck look a little higher than normal? If so, it could be a tax time bomb.

The Potential Problem

A payroll tax deferral beginning September 1 was signed via a presidential executive order. The potential deferral of your portion of Social Security as an employee could raise your take home pay temporarily until January 2021. Beginning in 2021, the deferred Social Security taxes will then need to be paid. This year’s tax deferral is NOT currently a tax holiday. If your employer removes your Social Security tax from your paycheck, there is a real possibility you will need to pay it back between January 2021 and April 2021. That could mean an unexpected tax increase for you in early 2021.

What are Payroll Taxes?

American workers pay for the entitlement programs Social Security and Medicare through taxes on their earnings. As W-2 employees, 7.65% of your earnings are withheld from your paycheck to fund these programs. It breaks down to 6.2% for Social Security and 1.45% for Medicare. The withholding for the portion representing Social Security stops at what is called the taxable wage base, which is $137,700 of earnings in 2020. The withholding for Medicare does not have a cap, and an additional 0.9% Medicare tax is collected on earnings over $200,000 for the year. You can learn more about payroll taxes here.

What You Need to Know

  • The payroll tax deferral applies to the portion that goes to support Social Security (6.2%). It does not apply to the withholding for Medicare.
  • The payroll tax deferral doesn’t apply to every dollar earned. It only applies to the amount of your pre-tax bi-weekly salary that is $4,000 or less.
  • The payroll tax deferral is optional for most employers. Your employer is not required to defer your Social Security payments. However, federal employees will be seeing this tax reduction from September through December of this year. If your employer chooses to defer your Social Security taxes, in all likelihood, they will let you know.
  • Compare paychecks. If you are unsure whether your employer is participating in the tax deferral, get your last paycheck from August and compare it with your most recent paycheck. If the amounts are the same, then your Social Security and other taxes are still being withheld. If you notice that the amounts are different, or that no Social Security taxes are withheld from your current paycheck, then that’s a signal you may have a tax repayment bill in early 2021.
  • Remember to keep checking each paycheck. Companies are struggling to figure out if they are required to comply with the presidential executive order and payroll providers are trying to figure out how to comply. Everyone is wondering whether the tax obligation will be permanently forgiven. We recommend keeping an eye on your paycheck throughout the balance of 2020.
  • Be prepared to pay it back. If taxes have been deferred from your paycheck through the end of 2020, be prepared to have your paycheck withholdings increase beginning in 2021. If possible, set aside the taxes that were not withheld from your paychecks. When it comes time to pay your taxes, you will have funds to weather the repayment storm.
  • Check for updates. There is a chance Congress passes a law that forgives the deferred taxes and the extra money in your paycheck will be yours to keep.

If you have any questions about how this payroll executive order affects you, please be in touch.

 

wisdom wealth strategies

 

Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.

Filed Under: Financial Planning, Tax

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Wisdom Wealth Strategies, LLC is an SEC-registered investment adviser. Our firm is notice filed in Colorado and Texas, and may be exempt from notice-filing in other jurisdictions where we serve our clients.


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