As you’ve probably heard, there is a really unusual change happening with our payroll tax withholding for the next few months, and it has created a TON of questions. And when you have questions, I have answers! So, first I’m going to explain what’s happening, and then I’ll answer the questions I’ve received. And you can add your questions in the comments, and I’ll answer them, too.
What Is Happening?
President Trump has issued a memorandum instructing employers to stop withholding Social Security taxes from the paychecks of most workers. While many civilian employers are choosing not to follow this instruction, the federal government will be following this instruction. This means that military service members will not have Social Security taxes withheld from their paycheck from September through December of 2020.
BUT, the President’s memorandum doesn’t state that the taxes are being eliminated because that’s not within his powers.
So, unless there is Congressional action or someone finds some other loophole, these taxes will need to be paid at some point in the future.
The IRS guidance states that the delayed taxes will be withheld from January 1, 2021 to April 30, 2021, on top of the regular payroll taxes due for earnings during that period. Unless Congress passes something to waive these taxes, this isn’t a pass on these taxes – you will probably need to pay them eventually.
Update: The repayment will occur over the full 2021 calendar year, January through December.
When Does This Happen?
The memorandum specifies September 2020 through 31 December 2020. Most military members receive a mid-month deposit of a portion of their monthly pay, and the mid-month payday for September is Tuesday, 15 September 2020. So for most military members, Tuesday’s payday will be the first paycheck that doesn’t have payroll taxes withheld. Without those taxes withheld, your paycheck will be larger. (A huge number of military members receive their military pay prior to the actual payday, and therefore their pay will be in their account between Friday, 11 September and Monday, 14 September.)
What Are Payroll Taxes?
Payroll taxes are the taxes that fund Social Security and Medicare. They have absolutely nothing to do with your regular income taxes. If you look on your LES, you’ll see them here:
But this change only applies to the Social Security portion of payroll taxes. The employee’s portion of regular Social Security taxes is 6.2% of taxable income. When the memorandum was first announced, many people, including me, thought that it applies to both Medicare and Social Security taxes, but after further investigation, it is just Social Security.
Side note for those who like to understand things a little bit more: The total amount of payroll taxes that are usually withheld is 15.3% of taxable income, up to an income limit. If you work for an employer (versus being self-employed), your employer pays half and you pay half. So for a regular, W-2 employee, 7.65% of your wages are withheld each check (6.2% for Social Security and 1.45% for Medicare.)
Who Does This Affect?
This applies if you make less than $104,000 a year in taxable income, or $8,666 per month. That’s generally anyone with a pay grade below W-5 or O-5.
What Pays and Allowances Are Covered?
Trick question. Just basic pay.
Why is that, you ask? Because many special pays are taxable, so should they be subject to this?
Great question, and surprising answer! There are over 30 special pays that are taxable, but they are not subject to Social Security tax withholding. (And I just learned that TODAY!) Hat tip to Jerry Zeigler of Better Financial Counseling Network for finding the actual source on this.
Side note: In general, anything called a Pay is taxable and anything called an Allowance is non-taxable, except CONUS COLA. Despite being an allowance, it is taxable.
Do I Need To Do Anything?
On one hand, you don’t need to do anything. The responsibility for this lies on the employers or their payroll organization. For military members, that’s the Defense Finance and Accounting Service (DFAS) or the Coast Guard Pay & Personnel Center.
On the other hand, you should probably put those taxes aside because, as it stands now they need to be repaid in 2021. Because, as I said, there is not yet any provision to make those taxes go away, simply to defer collection.
Check your August Leave and Earnings Statement and see how much of that paycheck was withheld was for Social Security. Find a way to put that money aside, either by using a savings account that isn’t being used, or opening a new account, or whatever you need to do. If that means taking that cash out of the bank and putting it in an envelope under your mattress, do it. If the taxes eventually are eliminated/forgiven/washed away, then you’ll have a nice little chunk of change to beef up your emergency fund, pay off debt, or enjoy a treat. If the taxes do come out in the future, you’ll have money to make up the difference in your paycheck.
What If I’m Deployed?
Even though income earned in Combat Zone Tax Exempt areas is exempt from federal taxes, it isn’t exempt from payroll taxes. So deployed folks will also see a change to their pay, and will still (presumably) need to repay these taxes next year.
Does This Affect Retirees?
Military retirement pay is not considered earned income, and does not have Social Security and Medicare taxes withheld. So your military retirement income should not be impacted. However, if you have another job, this may impact that income depending on how your company/organization is handling it.
What Happens If I Leave The Military Between Now and April?
Good question. The IRS has stated that employers “may make arrangements to otherwise collect the total Applicable Taxes from the employee.” But they don’t say HOW. My guess is that it will come out of the final paycheck, but that’s simply a guess.
What If The Military Isn’t Your Only Income?
First, let’s be clear about individual income vs. family income. The $104,000 limit applies to individual income, not family income. But if your combined personal income exceeds the $104,000 annual limit, you should definitely keep this money aside. You may need to make a repayment even other workers have those taxes wiped out.
The limit is per person, so you don’t have to worry about spouses who make more than $104,000 per year together.
Can I Opt-Out Of The Deferral?
Many civilian employers are continuing to withhold payroll taxes, or giving their employees the option to opt-out of the change. Unfortunately, that’s not an option for military service members. DFAS will make this change,and your paycheck will be bigger.
How Will This Impact My Tax Return Next Year?
Because this is about a payroll tax, and not an income tax, there should be no impact on your income tax returns next year.
Note that I said “should.” As we know, strange things can happen. But it seems very unlikely that this will end up being part of the federal income tax returns.
Should I Change My Withholding To Balance This Out?
Probably not. Income taxes and payroll taxes live in different buckets, so changing your federal income tax withholding will not have any impact on this payroll tax change. The withholding that you direct through your W-4 Employee’s Withholding Certificate is for your federal income taxes.
For most people (employees who are paid by an employer and reported on a W-2), payroll taxes are paid via the employer. (Self-employed people are different, but not what we’re talking about in this article.) You don’t get to give instructions for your payroll taxes.
You can read the DFAS announcement here, but it doesn’t really say much.
Please let me know what other questions you have, and I’ll try to find answers!
Do you want to know more about your military pay and benefits?
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