Benefits & Comp 5 min

What’s a Payroll Tax Holiday & What Do You Need to Know About It?

November 6, 2020

In August, President Donald Trump issued an Executive Memorandum, which, in addition to other coronavirus relief efforts, directed Secretary of the Treasury Steven Mnuchin to allow a “payroll tax holiday” for employees making less than 4,000 dollars biweekly or 104,000 dollars in yearly salary. But what does that mean, and what do you need to do about it? Here’s the simple version.

What Are Payroll Taxes?

Payroll taxes are all of the taxes paid by employers and employees to local and federal government agencies. They include all taxes withheld from employees’ paychecks and the taxes paid by employers based on the employee’s earnings, including:

  • Federal and state income taxes
  • Federal and state unemployment taxes
  • Social Security tax
  • Medicare tax

State payroll tax rates vary by state, whereas Federal payroll tax rates are determined yearly and applied throughout the nation. Federal income tax rates are progressive, meaning they increase in stages (known as tax brackets) as earnings increase. Meanwhile, Social Security tax is paid as a percentage of earnings up to a limit, making it regressive. Medicare tax is simply a flat percentage applied to all earnings.

In the case of the payroll tax holiday, the affected tax is only the Social Security tax, which in 2020 stands at 12.4 percent of earnings up to a maximum salary of 137,000 dollars. Since Social Security tax is split evenly between the employer and the employee, that means the most any employee would owe is 6.2 percent of their salary or a maximum of 8,220 dollars.

The Payroll Tax Holiday Is a Payroll Tax Deferral

The payroll tax “holiday” is actually a deferral, or suspension, of payroll tax collection until 2021, at which point those taxes would become due. The final due date for deferred taxes is April 1, 2021, meaning payments can be spread over the initial four-month period from January 1 to April 1, 2021. After the due date, any remaining unpaid payroll taxes from 2020 would incur a penalty.

Who Is It For and What Is It Supposed to Do?

The payroll tax deferral is intended to provide some temporary financial relief to middle-class workers who remain employed (and thus ineligible for unemployment benefits) during the coronavirus pandemic. Suspending the collection of Social Security taxes would boost take-home pay by 6.2 percent for the remaining months of the year. That payroll tax obligation would carry over to the next year and be due on or before the first of April.

If the President Is Reelected, Will the Deferred Taxes be Wiped Clean?

It’s true that President Trump has promised that if he is reelected, he will forgive the payroll tax holiday debt incurred in 2020. However, experts have noted that forgiving the debt would require approval from Congress and that concerns about Social Security funding (independent of any additional burden like forgiving millions in deferred tax payments) make such approval unlikely.

Is the Payroll Tax Holiday Required by Law?

In short, no, unless you are a federal government employer. For the private sector, the payroll tax holiday is an optional program that employers can participate in if they feel it is worthwhile, but they are not required to do so. Chances are, if your organization is participating in the program, it is already in effect for all employees or for employees who opted in on an individual basis.

It’s important to note that the payroll tax holiday is not a “right.” If your organization is not participating, chances are good you heard about the program from a coworker, and it’s possible you heard about it in the form of a demand from an employee wishing to participate. However, despite what anyone may say to the contrary, participation is determined by the employer, and it is not required by law. Therefore, it’s not illegal for an employer to continue to withhold Social Security payroll taxes as normal during the payroll tax holiday.

Should My Organization Participate in the Payroll Tax Holiday?

Again, if your organization was going to participate in the payroll tax holiday program, it’s likely that you made the decision earlier this year when the memorandum was announced. However, if you are just hearing about this now and wondering if it’s a good idea, the answer is: it’s really up to you and your employees; however, most employers are choosing not to participate.

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There are two main reasons employers are not participating in the payroll tax holiday. First, since the “holiday” is only a payroll tax deferral, employees who remain with your organization will owe those taxes in 2021. That means that unless the debt is forgiven (and that’s highly unlikely regardless of who is in office), their paychecks in the first four months of 2021 would be smaller than usual until their payroll tax obligation is brought up to date. Assuming the pandemic is still a thing in the new year, adding an additional financial burden to employees at that point could be worse than any benefit gained by temporarily reducing it today.

Second, even if employees leave your organization, those taxes are still owed to the U.S. Treasury—not the I.R.S.—which leaves employers on the hook to repay them. Again, with the uncertainty of the economy during a pandemic, most employers are not willing to take the risk that they will owe back taxes due to a downsizing event or employee departure.

The Payroll Tax Holiday Probably Isn’t Worth It

Finally, if you’re thinking, “What if we just withhold the taxes now and wait to see if the debt is forgiven?” you’re not alone. On the surface, that idea of watching and waiting makes sense. But if you know payroll, you understand what is involved with an undertaking like this: there is a ton of administrative overhead, from notifications to setting up accounts to doing individual pre- and post-tax calculations for each employee who decides to participate (remember, it is optional).

That burden of extra work is likely the reason some third-party payroll providers are actually refusing to provide the service for their clients; in fact, if your organization uses a third-party payroll provider, their refusal to participate may mean this is a foregone conclusion for you, and you’ve wasted five minutes of your life reading this article. But at the very least, now you know more about the payroll tax holiday and what it means for you and your employees.

Rob de Luca
Copy Director | BambooHR

Rob de Luca is the copy director for BambooHR. Since 2016, he has written extensively on culture and best practices in the HR industry. He believes culture is the key to organizational success and that every HR professional has the potential to become a culture champion and strategic business partner.