This article refers to provisions covered under the CARES Act of 2020. It was last edited on August 23, 2021.
Under the CARES Act, employers were allowed to defer the employer’s share of the Social Security tax for part of 2020. Similarly, self-employed individuals could defer up to half of the Social Security portion of the self-employment tax. (The Medicare portion of the self-employment tax could not be deferred). In this article, we’re answering tax professionals’ top questions on the self-employment tax deferral.
How does the self-employed tax deferral work?
Self-employed individuals are allowed to defer 50% of the Social Security portion of the self-employment tax for the period beginning March 27,2020 and ending December 31, 2020. For example, let’s say one of your self-employed clients earned $65,000 in 2020. Here’s how you would calculate how much self-employment tax they could defer:
How to calculate the maximum deferral of self-employment tax payments
1.Determine their income for the eligible period of March 27 – December 31, 2020. While the IRS will accept a variety of “reasonable accounting methods” in determining this figure, multiplying yearly income by 77.5% or .775 would be the most common. In this example:
$65,000 x .775 = $50, 375.
2. Multiply their income for the eligible period by .9235 to find their taxable income. The IRS regards 92.35% of a self-employed taxpayer’s net income as taxable. In this case:
$50,375 x .9235 = $46,521.
3. Multiple their taxable income for the eligible period by .062. The Social Security portion of self-employment tax is 12.4% of taxable income; self-employed taxpayers can defer half of this amount (i.e. 6.2%) of their taxable income for the eligible period.
$46,521 x .062 = $2,884.
So in this example, your client could defer a maximum of $2,884. In most cases, they can choose to defer all, none, or only part of this amount. If they have no outstanding tax liability when they file, they cannot choose to defer since they have already paid their self-employment taxes in full. Similarly, if they owe less than the maximum deferral amount, they can only defer their outstanding tax liability. Your TaxSlayer Pro software allows you to enter the amount they chose to defer.
Do you have to replay the self-employment tax deferral? How does the repayment process work?
Yes, it’s important to make sure your clients understand that they will still have to repay the full amount of any taxes they chose to defer. Payments can be spread out between 2021 and 2022. If they deferred the maximum amount, half of this amount would be due by December 31, 2021 and any remaining amount by December 31, 2022.
If they chose to defer only part of the maximum deferral amount, any excess of 50% of the maximum deferral amount will be due in 2021 and the remaining 50% will be due in 2022. For example, if they were eligible to defer $5,000 of self-employment taxes but chose to defer only $3,000 of this amount, they would need to pay $500 by the end of 2021 and the remaining $2,500 by the end of 2022.
The IRS’s preferred method of payment is the Electronic Federal Tax Payment System or EFTPS.
If my client has already paid all or some of their self-employment tax for 2020, can they receive a refund or credit for the amount that they could have deferred?
No. The self-employment tax deferral isn’t a credit and can’t be received as a refund. If your clients have already paid their full tax liability for 2020, they can’t take advantage of the tax deferral.
Will the self-employment tax deferral cause underpayment penalties?
No, taking advantage of the self-employment tax deferral won’t cause underpayment penalties as long as your clients paid appropriately on the rest of their tax liability each quarter. If they fail to repay their deferred taxes on time, however, they could face penalties later.
Can my clients defer their 2021 self-employment taxes too?
No, only self-employment taxes for the period between March 27, 2020 and December 31, 2020 can be deferred.
How can tax preparers help guide their clients through this process?
With the tax deadline behind us, most of your self-employed clients have already decided whether to take advantage of the tax deferral or not. If they did, you can guide them through the repayment process by calculating how much money they will owe at the end of 2021 and 2022 and showing them how to use the EFTPS if they are not already familiar with it.
Clients who chose not to defer tax payment, will simply pay any tax liability as they usually would.
If you have any late-filing clients who haven’t decided whether they would like to defer self-employment taxes, you can help them weigh the pros and cons of each option. Taking advantage of the tax deferral will reduce the amount of taxes they owe right now, but ultimately, they’ll still have to pay the full amount later. In general, if they can pay their full self-employment tax now, it’s a good idea to do so.