The Payroll Tax Cut: Here’s What It Means for You

After weeks of stalled negotiations in Congress, President Donald Trump took it upon himself to issue a series of presidential executive orders, or memorandums, designed to reinvigorate the U.S. economy.

One of those executive measures, called the “Memorandum on Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster,” includes a directive to suspend certain payroll taxes for American workers earning less than $4,000 on a pretax biweekly basis, or about $104,000 annually.

“I am directing the Secretary of the Treasury to use his authority to defer certain payroll tax obligations with respect to the American workers most in need,” the memorandum says.

If you’re caught off guard by this new development, you’re not alone. Vocal support for payroll tax cuts has been limited, even among Republicans, and there are questions about whether Trump has the authority to make this directive a reality.

Additionally, many Americans may be unfamiliar with what a payroll tax cut — technically, a deferral in this case — means for their personal financial situations.

If you’re still trying to parse out what a payroll tax cut means for your wallet, here’s what to know.

[Read: Why Haven’t I Received a Stimulus Check?]

What Is a Payroll Tax Cut?

A payroll tax cut halts the collection of certain wage-based taxes, typically those collected for Social Security and Medicare. Workers who benefit will receive a fatter check on payday.

Here’s how those taxes break down: The federal government levies a 12.4% Social Security tax on workers’ paychecks. The cost is split between employers and employees, with each taking on 6.2% of the tax bill. Wages above $137,700 in 2020 aren’t subject to Social Security tax.

Medicare withholds an additional 2.9%, or 1.45% each, split between employees and employers. An extra 0.9% is levied on salaries above $200,000.

Money received through a payroll tax cut doesn’t hit your bank account in a big windfall like a stimulus check does. Instead, it’s more of a slow trickle, with paychecks boosted by a few hundred dollars per month, depending on the worker’s salary.

[See: 9 Red Flags That Could Trigger a Tax Audit.]

What Is the Trump Payroll Tax Cut?

Trump’s executive order defers Social Security taxes on wages or compensation of less than $4,000 on a pretax biweekly basis. That means that this will apply to workers earning less than approximately $104,000 in 2020.

Medicare taxes are not deferred in Trump’s memorandum.

It’s important to note that, as it stands, payroll taxes accumulated between Sept. 1 through Dec. 31 will be deferred, not forgiven. In theory, they may need to be repaid come January 2021 if no permanent cut is enacted.

Treasury Secretary Steven Mnuchin addressed this possibility in an interview with Chris Wallace, saying, “(Trump’s) going to go to the American people and tell them that when he’s reelected, he will push through legislation to forgive that so, in essence, it will turn into a payroll tax cut.”

Until further guidance is released, experts are waiting to see how this will play out. “There’s a lot of head-scratching going on right now,” says Lawrence Pon, a tax specialist who owns an accounting firm in San Francisco.

Some questions that remain unanswered include:

— How are wages and compensation counted? Do tips count? Annual bonuses?

— What year are these wages based on?

— Is this elective for employers?

— Will the deferred payroll taxes need to be repaid? And if so, how?

In the meantime, tax and employment professionals are awaiting additional details and guidance to determine the best path forward. “I’m going to take a wait-and-see attitude on it,” Pon says.

Who Benefits From Trump’s Payroll Tax Cut?

If you earn a paycheck of less than $4,000 every other week, your take-home pay is increased by a payroll tax cut. In short, Trump’s payroll tax cut gives you a four-month 6.2% raise.

Since the cut is based on wages, a worker earning a relatively high salary (up to $104,000 in the case of this executive order) takes home a bigger benefit than a worker earning $25,000. For example, an employee earning $104,000 would take home an additional $2,149 over the four-month deferral period while the worker earning $25,000 would pocket an additional $517 over four months.

On a larger scale, proponents of a payroll tax cut argue that it helps the economy, subsequently benefiting a broad swath of Americans, even those who aren’t in the workforce. Employers already have the ability to defer their portion of Social Security taxes under the CARES Act for the remainder of the year.

Who Doesn’t Benefit From the Payroll Tax Cut?

Those who don’t earn a paycheck, including unemployed folks, full-time parents, retirees and Americans whose income derives from government benefits, won’t benefit from a payroll tax cut. “Anybody who doesn’t have wages or compensation wouldn’t be able to take advantage,” says Edward Karl, vice president of taxation for the American Institute of CPAs.

Critics of the payroll tax cut point out that it leaves out those most financially impacted by the COVID-19 health crisis, including millions of out-of-work Americans. “Anybody who doesn’t have an earned income, who is living off of Social Security, whatever savings they may have, anybody who is already out a job is not benefiting from this,” says Derek Klock, a certified financial planner and professor in the department of finance at Virginia Tech.

Some experts note that eligible higher-income workers will benefit more, and some voice skepticism that it will drive Americans back to work while unemployment remains high.

[SEE: Ways to Prepare for Deflation.]

Is There An Impact on Social Security?

Some Americans worry that the suspension of payroll taxes will deal a crippling blow to the Social Security program, which many Americans and retirees rely on to pay their bills.

“It does put one of our, right now, vulnerable institutions in a vulnerable situation for a short-term spike,” Klock says.

To counter that criticism, Mnuchin has said that there would be an automatic contribution from the general fund to provide for Social Security funding.

How Should I Prepare for the Payroll Tax Deferral?

Because it’s unclear whether the payroll tax cut will result in forgiveness or merely a postponement of Social Security taxes, experts recommend acting cautiously. “If I were the general public here, I wouldn’t make any decisions or act on what you see in the news,” Pon says.

Some experts theorize that, if employers aren’t required to withhold Social Security taxes from paychecks, they won’t since they’ll anticipate having to repay those deferred taxes in 2021.

Until there’s more information about whether this money will need to be repaid, it’s wise to be cautious about making a spending plan for it and anticipate the possibility it’ll need to be repaid next year. Says Klock: “The overriding message is don’t count your chickens before they hatch.”

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The Payroll Tax Cut: Here’s What It Means for You originally appeared on usnews.com

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