TL;DR: If reducing the payroll and self-employment tax, also update the safe harbor provision for estimated taxes, or the tax reduction won't have the expected impact until 2021!

There is speculation about the administration eliminating payroll and self-employment taxes due to the Coronavirus. For those involved in designing new rules, this describes a small additional change (to the estimated tax safe harbor provision) that really would need to be included in order for the rule change to actually have the effect for self employed taxpayers that everyone probably assumes would be automatic from such a rule change.

For self-employed people who cannot predict their income, the only way to prevent penalties for underpayment of estimated tax is to use the "safe harbor" provision when paying estimated taxes quarterly during the tax year. This safe harbor requires paying (in quarterly installments) 110% of the amount of the total tax bill for the prior year (including payroll and self-employment tax paid during the previous year.) For example, 110% of 2019's tax must be paid in quarterly installments during April 2020, June 2020, September 2020, and January 2021. This is true regardless of any changes in either income or tax rates during 2020 – the actual tax paid during 2020 must be 110% of the 2019 tax bill, whatever it was, with the difference (extra payment or a refund) only happening with the 1040 filed in April 2021.

Rationale: Taxpayers are encouraged to "estimate" their annual income and pay quarterly "estimated taxes" accordingly – use of the safe harbor is not formally required. But it's always possible that there could be a large contract late in the calendar year. Taxpayers not using the safe harbor provision would need to anticipate this future contract (that they don't yet have, and might not even be on their horizon), and pay taxes quarterly (starting on April 15, 2020) against that future income that might (possibly) arrive late in 2020. That's impossible without a crystal ball. Therefore in practice, use of the safe harbor provision is effectively mandatory for self-employed people who aren't the proud owners of crystal balls, even if the IRS instructions do not describe use of the safe harbor as mandatory.

Therefore, immediate elimination of the payroll and self employment tax would not actually reduce how much tax must be actually paid by self-employed taxpayers until April 15, 2021. Self employed taxpayers would need to pay 110% of the 2019 self- employment tax during 2020, even if the 2020 self-employment tax is reduced to $0. These taxpayers would probably see a big refund in 2021, but this change would not reduce the tax that in practice must be paid by even $1 during this calendar year.

The fix is simple. If eliminating the self-employment tax during 2020, ALSO update the safe harbor for estimated tax payments. The safe harbor is currently 110% of the "Total Tax" (2019 1040 Line 16 possibly minus some credits) and that is what must be paid during 2020, regardless of any changes in either

income or tax rates. This safe harbor amount should be reduced by the amount shown on 2019 1040 Schedule 2 Line 4 (Self-Employment Tax). If THAT is also done, then self-employed people would actually realize a reduction in the taxes they must pay during calendar year 2020.

I'm not saying what tax policy should be. But if the administration wants to reduce the payroll and self-employment tax burden during the pandemic, I felt it might be important to convey this practical information, or a rule change that appears to have this effect could easily miss the target.