Worried About The Payroll Tax Deferral? Here’s A Solution To Consider.

Does President Trump’s Social Security payroll tax deferral make sense from an economic point of view? Is it going to give people who are employed but struggling, that small bit of a boost in finances to keep them away from the payday lender? Is it going to cause people to spend just that small bit more that, cumulatively, it helps boost the economy? No one seems to have particularly much confidence in this.

But there are workers who are worried (or experts, worried on their behalf) that this will do them more harm than good because of the way the deferral program works: from now through the remainder of the year, for workers whose employers choose to participate, the employee portion of the Social Security (FICA) payroll tax, 6.2% of pay, will not be subtracted out. Then, beginning in January, the amount will be “paid back” by having double the amount (more or less) taken out of workers’ paychecks instead, up through April. (See more info here.) It’s possible that before then, Congress acts to make this into a cut rather than deferral, but — let’s face it — unlikely.

The number of employers who will participate is unknown, but one group will definitively be in the program: the federal government will defer payroll taxes of the members of the military as well as civilian federal employees. Critics of the plan said it makes these workers into “pawns” and sets them up for financial struggles.

There is a a way out, however, and, as a bonus, a way to take control over tax withholding: the W-4 IRS form.

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In 2019, according to the IRS Data Book, 154 million taxpayers filed individual income tax returns, and the IRS issued 120 million refunds. In other words, over 3/4ths of taxpayers had too much tax withheld during the year. The average refund per taxpayer was about $3,300. And while many people look forward to the tax refund and some even consider it a beneficial form of “forced savings,” a third of adults surveyed by the National Retail Foundation (before the pandemic was an issue) reported they would use the money to “pay down debt” — debt which they might not have accumulated in the first place if their withholding rates had been lower!

So let’s take a look at the W-4 IRS form. Some sections are straightforward enough: all you are required to do is provide your personal information, your filing status, and a signature. If you have multiple jobs, there are extra steps to prevent too little from being withheld (because the withholding tables would otherwise be based on the assumption the taxpayer is poorer and taxed at a lower rate than is actually the case). If you have dependents, you can report that so the the withholding takes into account their eventual child tax credits or other exemptions. And then there are three additional optional steps:

You can choose to report additional income that otherwise wouldn’t have withholding (like interest income). This will be added into the calculations your employer does.

You can choose to report additional deductions that you expect. This mattered a lot more for more people before the 2017 tax changes, but even still you can reduce your tax withholding by estimating your expected deductions.

And finally, you can add an extra amount to be withheld. This doesn’t have to be the result of any specified calculation; it’s just an amount of your choice.

What’s more, you can file a W-4 at any time to make changes; it doesn’t have to stay the same ever since the first day you reported for work, and probably shouldn’t stay the same. (How many people got married and had children without updating their W-4, the IRS doesn’t say.)

Which means that anyone concerned that they’ll overspend the extra 6.2% of their paycheck, can file a new W-4 with their employer requesting that the extra 6.2% be taken out of their paycheck after all, by using that “extra withholding” box, and adding in 6.2% of your current pay, then filing another new W-4 in the new year, filing taxes, and using the refund to cover any gaps in family finances due to the extra payroll tax in 2021 — an imperfect solution (yes, a tax refund comes all-at-once rather than split out into 4 months of paychecks) but probably easier to manage for most people who struggle financially than trying to simply save the extra money for the future.

But there’s a wrinkle — the form was redesigned in 2020 to try to be more accurate, although the IRS still gives tables for employers to use with old W-4s, so that no employee was required to file a new form. This means that, solely by completing a new form, employees might have less taken out of their paycheck than in the past. The IRS does provide a handy Tax Withholding Estimator that individual taxpayers can use to check what their withholding would look like if they filed a new form. Alternatively, you may decide, after using the estimator and thinking about your usual tax refund, to use your refund to help you afford the future double-FICA payments, and then file a new W-4 and move away from having the government take away more money than necessary in your paychecks in the future.

And if your reaction is that this is absurd, that the sort of workers who can’t handle 6.2% extra income now and 6.2% less in the new year without getting into financial trouble, certainly couldn’t manage the task of managing a W-4 — well, then this becomes a message for those who advise others, doesn’t it?

As always, you’re invited to comment at JaneTheActuary.com!

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