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What a COVID-related payroll tax cut could mean to you now and your retirement later

UPDATE, July 23, 2020: The White House has dropped its push for a payroll tax cut as part of the next round of COVID-19 relief. Although Donald Trump cited Democrats' objections to the payroll tax cut, top Senate Republicans also disliked the idea, seeing it as too expensive as they struggle to craft a relief version to counter the already-passed House bill.

Payroll taxes and social security

Federal lawmakers are working on the next COVID-19 relief package. Specifically, Republican Senators are working on a stimulus deal since House Democrats, who control that Congressional chamber, approved their proposal back in May.

But in addition to dealing with Democrats, Republicans on Capitol Hill also will have to find a way to convince the GOP president to agree to their plan.

It won't be easy. Donald J. Trump and his surrogates are insistent that a payroll tax cut be part of the next coronavirus stimulus bill.

Here's a look at what such a cut, if it passes, could mean to you.

Payroll taxes primer: When you get a paycheck, payroll taxes are withheld from your wages each pay period. These taxes go toward Social Security and Medicare.

Payroll taxes total 15.3 percent of your wages. Of that total 12.4 percent goes to Social Security and 2.9 percent to Medicare. But that's not what comes out of your paychecks.

The Social Security and Medicare payroll tax amounts, usually referred to as FICA taxes for the Federal Insurance Contributions Act (FICA) that created them, are split and paid equally by workers and employers.

So you see 6.2 percent of your earnings go toward Social Security each payday and 1.45 percent to Medicare. Behind the scenes, your boss pays those same percentages on your behalf to the two major government retirement and medical benefits programs.

Wealthy workers existing payroll tax break: That's how it works for most of us. Higher-income workers already get a payroll tax break, at least as far as the Social Security FICA portion.

The 6.2 percent tax from workers and bosses is collected on tax year 2020 earnings of up to $137,700. The tax year is important because every fall the Social Security Administration adjusts this so-called earnings cap for inflation.

For now, that means the most a wealthier work would pay this year in Social Security payroll taxes is $8,537.40. For those of you who, like me, are challenged by doing math in your head, that tax figure comes from 6.2 percent X $137,700. Once earnings are more than the cap, there's no more payroll tax withholding for Social Security from workers or payment of the matching percentage by their employers.

The Medicare portion, however, is not limited by earnings. All income, even that in excess of the annual cap, is subject to the 1.45 percent federal retiree healthcare payroll tax.

Self-employed pay payroll taxes, too: If you're self-employed, whether are your full-time job or due to a side hustle or two to supplement your wages, you also are responsible for payroll taxes via a Schedule SE filing.

In this case, you cover both the employee and employer portions. Don't freak out. You get to subtract your employer amount as an adjustment to income, aka those above-the-line deductions.

If you're doing really well at your own business or gig work, then the income cap for Social Security payroll taxes applies to these earnings, too.

Payroll tax cut winners and losers: Obviously, if the combined 7.65 percent in payroll taxes was stopped, you'd get that much more as regular pay.

Simultaneously, if the cut extended to employers, which some has suggested since companies also have cash-flow needs, then your boss wouldn't have to worry about collecting that portion of payroll taxes. (Quick note: The first COVID-19 relief package already allows many firms to defer paying their payroll taxes until next year and some into 2022.)

Suddenly getting more money into peoples' hands and then presumably having it flow back into the economy sounds good.

It's worked before. Congress and then President Barrack Obama signed off on a 2 percent cut (from 6.2 percent to 4.2 percent) of the Social Security portion for tax years 2011 and 2012 to help boost an economy that was still sluggish due to the Great Recession. That appeared to work.

That payroll tax history, plus the relative ease of implementing the cut is why, presumably, the White House is so insistent on trying it again. A flip of a tax collection software switch and workplaces and their staff across the company see the benefits of a payroll tax holiday.

So a win-win, right? For some, yes. For others, no.

If you still have a job, either as an employee or as your own boss, you'd be a winner.

But if you're among the millions who lost their jobs when COVID-19 closures started in the spring and didn't see it return even when some places started reopening this summer, a payroll tax does you no good. No paycheck means no added pay from a payroll tax break.

CARES Stimulus vs Payroll Tax Cut_CBPP
The Trump Administration tried to get a payroll tax cut into the Coronavirus Aid, Relief and Economic Security (CARES) Act, which created the first pandemic payments. The Center on Budget and Policy Priorities (CBPP), which created the graphic comparison above, says stimulus payments can deliver more relief far more quickly than a payroll tax cut.


That's why on the other side of the tax and economic coin so many are opposed to a temporary halt or cut in payroll tax collection.

Any COVID-19 stimulus package should help those hurt the most by the pandemic. A payroll tax wouldn't do that. Instead, the folks who've been out of work for months need money now and directly as another relief payment.

Social Security losses, too: A payroll tax holiday also alarms many economists and those of us who plan to collect federal retirement benefits one day.

Social Security benefits rely almost exclusively dependent on payroll taxes for funding. But the program has been facing recent cash shortages, with current payroll taxes failing to keep up with the expanding retirement sector (thanks, Boomers!) and the increasing demands on the benefits.

To cover the deficit, the SSA has been tapping its two trust funds. The SSA Board of Trustees' latest estimates say those funds should last until 2034. But once that money is gone, payroll taxes alone will cover only around 76 percent of projected benefits.

Cutting payroll taxes, even fractionally and temporarily, could speed up the expected Social Security benefits shortfall date.

If that happens, lawmakers would have to come up with additional funds or let Social Security benefits be reduced. What do you think Representatives and Senators dependent upon senior citizens, the more reliable voter base, will do?

That's rhetorical. We know they'll find a way to fund the program so they can stay in Washington, D.C.

With the 2 percent tax reduction in 2011 and 2012, Congress replaced the lost Social Security funds with general revenue. That's the money Uncle Sam collects from other taxes.

But since so many people have been out of work, fewer are paying taxes. That means less income tax revenue for the U.S. Treasury. So any added support of Social Security to replace lost payroll tax funds likely would mean more deficits, which is another of revenue policy problems.

Devil in the tax details: While all these policy (and electoral) considerations are being bounced around Capitol Hill, there also are the more practical issues of how a payroll tax holiday would work.

Would payroll taxes be eliminated fully? Or only a percentage of them as was done earlier? Businesses, too, or no?

How long would the payroll tax holiday last? A few months? Until the end of the year? Into 2021 if COVID-19 cases continue to affect the economy?

Those issues presumably are up for negotiation over the next three weeks as lawmakers aim for the early August deadline set by Senate Majority Leader Mitch McConnell (R-Kentucky).

The key date to mark on your calendar is Aug. 7. The Senate plans to start its summer recess the next day, so if there's no COVID-19 relief by 8/7, there likely won't be a second round of relief from either a payroll tax holiday or more direct economic relief payments.

You also might find these items of interest:

 

Coronavirus Caveat & More Information
In 2020, we're all dealing with extraordinary circumstances,
both in our daily lives and when it comes to our taxes.
The COVID-19 pandemic and efforts to reduce its transmission
and protect ourselves and our families means that,
for the most part, we're focusing on just getting through these trying days.

But life as we knew it before the coronavirus will return,
along with our mundane tax matters.
Here's hoping that happens soon!
In the meantime, you can find more on the virus and its effects on our taxes
by clicking Coronavirus (COVID-19) and Taxes.

 

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