In times of economic crisis, Congress has a tool they turn to from time to time: a payroll tax holiday.
While payroll tax holidays can come in different forms, they typically suspend or defer certain payroll taxes, such as Social Security and Medicare, for a limited time. This can help employers facing cash flow problems avoid layoffs and allow workers to keep more of their paychecks.
But what does a payroll tax holiday really mean for small businesses? Here’s everything you need to know.
Payroll Tax Holiday Explained
In response to the coronavirus pandemic, lawmakers instituted two payroll tax holidays—one for employees and one for employers and self-employed workers.
The Payroll Tax Holiday for Employees
President Donald Trump enacted a payroll tax holiday for workers via executive order. This payroll tax cut required the Treasury to allow employers to suspend collecting the Social Security portion from employee paychecks from September 1, 2020 through December 31, 2020.
However, the tax holiday wasn’t a freebie. In fact, it was more like an interest-free loan from the federal government to American workers that would have to be repaid.
Originally, the federal government required participating employers to increase withholdings from their employees’ wages to repay the deferred payroll taxes between January 1, 2021 and April 31, 2021. However, the Consolidated Appropriations Act of 2020 extended the repayment period through December 31, 2021. If employers do not repay the deferred taxes by then, the IRS will start accruing interest and penalties on the balance due on January 1, 2022.
There are a couple of other important things to note about the 2020 payroll tax holiday. First, it applied only to employees whose wages were less than $4,000 for a biweekly pay period. That covered salaried employers earning less than $104,000 per year.
Second, the payroll tax holiday was optional for all employers except the federal government, and many chose not to participate. In fact, many large companies and state governments issued statements announcing they would not participate in the payroll tax holiday due to the burden it would place on employees to pay back the deferred amount in 2021 and the challenges it would pose for payroll systems and departments.
The Payroll Tax Holiday for Employers
The Coronavirus Aid, Relief, and Economic Security (CARES) Act allowed companies to defer paying the employer’s share of the Social Security tax on employee wages for up to two years.
Amounts normally due between March 27, 2020 and December 31, 2020 could be deferred. Employers must repay 50 percent of the deferred amount by December 31, 2021, and the remaining amount by December 31, 2022.
Self-employed people could also defer 50 percent of the Social Security portion of their self-employment taxes for the same period.
Did You Take Part in the 2020 Payroll Tax Holiday?
Not sure whether you took part in the payroll tax holiday? Here are tips for employees and employers.
If you’re an employee and not sure whether your employer deferred your Social Security payroll taxes, the easiest way to find out is to ask your employer’s human resources or payroll department.
You can also check your 2020 pay stubs. Normally, the employee portion of FICA is 7.65 percent of your gross earnings, with 6.2 percent going toward Social Security and 1.45 percent toward Medicare tax.
If your employer took part in the payroll tax holiday, your employee’s share of FICA for September through December 2020 would be only 1.45 percent.
You may also have noticed a drop in your take-home pay in 2021 when the program ended.
For example, if you earned $4,000 bi-weekly during 2020 and your employer decided not to withhold 6.2 percent in payroll taxes, you could have received $248 more per paycheck. However, once the payroll tax holiday ended, your employer would have to withhold and pay all deferred taxes PLUS your regular payroll and income taxes due for 2021.
While there was some discussion of forgiving the repayment of the deferred taxes, Congress did not make that part of their year-end tax bill, instead choosing to stretch the repayment period out over 12 months instead of four. The Biden administration also did not attempt to forgive the deferred amounts, which would have given federal employees (and workers of the few companies that participated in the payroll tax holiday) a tax cut that most American workers did not receive.
If your company decided to participate in either of the 2020 payroll tax holidays, you must have decided back in 2020 when they were announced.
Repayment of the employee’s portion of the deferral started on January 1, 2021 and continues through the end of the year. Keep in mind that repaying the deferred amounts is the employer’s responsibility. So while you could increase withholdings in 2021 to pay the deferral back, if the employee has since left the company, you’re responsible for repaying the employee’s payroll taxes.
According to the IRS, the employer can try to “collect the employee’s portion using their own recovery methods.” That could involve taking the funds from the employee’s last paycheck or sending former employees a bill.
To repay both the employee payroll tax holiday and the employer payroll tax deferral, you can make payments via EFTPS, credit or debit card, money order, or check. The IRS requires you to make those payments separately from other federal tax payments to ensure they’re applied to the deferred payroll tax balance.
If you don’t repay the deferred taxes by the due date (December 31, 2021 for the employee portion and December 31, 2021 and 2022 for each half of the employer payroll tax deferral), the IRS will start charging penalties and interest.
Can Employers Defer Payroll Taxes in 2021?
No. Both the employee payroll tax holiday and the employer payroll tax deferral ended as of December 31, 2020. In 2021, employees and employers have to start repaying the taxes deferred in 2020.
The History of Payroll Tax Holidays
President Trump’s payroll tax holidays weren’t the first of their kind. In fact, there have been a handful of payroll tax deferrals in the last several decades.
The Great Recession
In 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act temporarily reduced the Social Security contribution rate for employees and self-employed workers by two percentage points. This brought the Social Security rate for employees from 6.2 to 4.2 percent, and the self-employment tax rate from 12.4 to 10.4 percent. That payroll tax cut remained in effect during 2011 and 2012.
It replaced the Making Work Pay tax credit, which gave employees a 6.2 percent refundable tax credit on their earnings, up to $400 for single filers or $800 for married couples filing jointly.
The Great Inflation
In the 1970s, rising inflation and repeated energy crises increased the cost of oil and stalled U.S. growth. In response, the Carter white house enacted the New Jobs Tax Credit to encourage job growth. This short-term payroll tax holiday gave employers a tax credit worth 4 percent of their portion of Social Security taxes. That payroll tax credit eventually phased out in 1978.
Stay on Top of Repaying Temporary Payroll Tax Cuts
A payroll tax holiday might sound nice, but it’s important to remember that it simply postpones your tax obligations—it doesn’t eliminate them. It may benefit workers and companies in the short term but can add financial stress when the tax bill comes due.
The payroll tax holiday may have been created with good intentions but can create more problems than expected when put into practice.