It could be tempting to put off paying your self-employment tax for a year, but it can come with some risks. It would help to consider the advantages of paying a deferred tax instead.
The Coronavirus, Aid, Relief and Economic Security Act (CARES Act) allows employers and self-employed individuals to defer payment of the employer’s share of Social Security taxes for two years.
Benefits of Deferring Taxes
Whether you are saving for retirement or putting money aside to help with future costs, deferring taxes can be a great way to save money. It can also help you get ahead of the curve when calculating your tax liability.
The CARES Act allowed some self-employed individuals to defer half of their Social Security portion of self-employment tax. This reduced the amount of Social Security tax that self-employed individuals would have to pay on their net earnings from self-employment during that period, reducing the total amount of Social Security and Medicare taxes they needed to pay on their income.
Although the deferral period was temporary, it came with a price. In 2021, employers and self-employed individuals who took advantage of the deferral must repay half their deferred tax amount. The IRS will likely apply penalties and interest if they cannot make this payment.
Tax Deductions
So how to pay deferred self employment tax? Generally, it’s best to pay the tax you owe in full by the due date. This is particularly true for self-employment taxes.
However, deferring taxes is a useful strategy for lowering your tax bill. For example, if you expect your net income to be lower this year but higher next year, deferring deductions can help keep the taxes you owe down for the current year.
For instance, if you expect your net income to increase significantly next year, you should spend money now on equipment and supplies that will generate a tax deduction in the current year.
The IRS allows self-employed individuals to defer payment of the Social Security portion of their self-employment tax for up to two years. This means they can deduct 50% of the Social Security taxes owed on net earnings from self-employment income during this time.
Repayment Due Dates
The IRS is reminding employers and self-employed individuals who used the deferral option that the due repayment dates are coming up.
It is important to pay the full amount you deferred back by each installment due date to avoid costly penalties. The penalty for failure to pay the entire deferred tax balance is 10% of the total deferred amount or $7,500, whichever is greater.
Fortunately, there is some flexibility in the repayment due dates that can allow an employer to choose when they want to pay their deferred payroll taxes. However, if an employer does not make the payments by the deadlines, it is subject to penalties under Code sections 6651 (failure to pay) and 6656 (underpayment of deposits).
To repay deferred Social Security tax amounts, use EFTPS or Direct Pay and select “Deferred Social Security tax” as the reason for payment. Be sure to apply the payment to the 2020 tax year, where the deferred amount was deposited.
