President Trump signed an executive order that will allow businesses the option to defer tax withholdings of their employees for the rest of the year. For federal employees, this is not an opt-in option. All federal employees who make less than $4000 on a bi-weekly pay period will begin to have their taxes deferred for September through December of 2020. The term “Tax Holiday” is being thrown around as if this is some kind of favor to everyone. Let’s break down exactly what is happening here. You can read the memorandum here.
This is not free money
You will begin to notice on your next paycheck that it is significantly higher. That is because your normal taxes will not be deducted from your pay for the next few months. Those who are not aware will think they just got more money and will spend that money quickly. All this means is that the tax owed will not be deducted from your pay and come January 2020, you will have to make up those payments on top of your 2021 tax withholdings.
Don’t expect a big return
Your annual tax returns are actually the government returning cash to you because they withheld more than what you owe in taxes each month and at the end of the year they return the difference. If they stop withholding taxes altogether, not only will you not get a refund, but you will have to actually pay come tax time.
The purpose of tax withholding
The main idea of the IRS withholding taxes every month is because people are generally not great at setting aside money to pay their taxes due at the end of the year. So every paycheck has a portion automatically withheld prior to you ever seeing it. Then at the end of the year, we do not owe anything if the amount withheld was sufficient enough to cover the taxes owed based on gross taxable income. In fact, many of us overpay and therefore receive a refund. You can adjust the tax withholdings by changing the number of dependents you claim. Generally, the more dependents you claim, the less they withhold and vice versa.
What you need to do now!
Since this is not optional and most all service members will automatically opt-in, you need to take action now to avoid having a hefty tax bill in 2021 that you cannot pay. Go back over your last few LES’s and add up how much tax withholdings you had under deductions. Then on your next paycheck review your LES to see how much extra you are receiving. That extra amount in your paycheck needs to be placed in a safe location and not spent. Trump suggests that he will explore avenues to exempt the deferment later on if he is re-elected which would mean you get to keep that extra money. However, it is uncertain if he will even have the authority to do so. I would not rely on the exemption ever happening. Those who do not properly set aside the extra money will find themselves in quite a bind come April 2021 when that money is due.
Where you should store that money
You need to place the extra money aside somewhere safe. Separate the funds from your normal everyday account to avoid accidentally spending it. Do not invest in stocks as stocks are not always the safest place to store your money for such a short period. Instead, find simple online savings account to park the money until January. You can find many free online savings accounts at BankRate.com. When January comes, you may notice taxes will begin to be withheld at a higher rate than they were and you will have smaller paychecks. You can then supplement the difference using your savings account. If the deferred taxes are not automatically withheld on top of your normal tax withholdings come 2021, then you will need to pay the IRS directly. This tax deferment is essential just an unsolicited loan from the government that you cannot deny.