5 things to know about your payroll tax cut
It's automatic, but it will expire Feb. 29 unless Congress extends the tax break. Employers and payroll services that didn't make adjustments in time will refund overpayments.
This post is by Barbrara Weltman for U.S. News & World Report.
When Congress agreed to extend the payroll tax cut Dec. 23, it created an important holiday gift for 160 million workers. Here are five things to help you understand how this tax break applies to you.
The extension is temporary. For 2011, workers enjoyed a 2-percentage-point reduction in their Social Security taxes. Instead of paying 6.2% on earnings up to the annual wage base ($106,800 in 2011), they paid only 4.2%. This rate had been set to run only through the end of 2011, but Congress extended it for two more months.
Thus, the rate applies through Feb. 29, 2012, on earnings up to the annual wage base of $110,100.
Congress likely will extend the rate reduction for the balance of the year. However, nothing is certain from Washington until a bill is signed into law by the president.
The extension also applies to the self-employed. The rate cut is not limited to employees. It also applies to the employee portion of the Social Security tax that is part of self-employment tax. The tax rate for the employer portion of the self-employment tax remains unchanged. (Post continues below video.)
Self-employed individuals are allowed to deduct the employer portion of the tax as an adjustment to their gross income. Before 2011, they deducted 50% of their self-employment tax, which was the employer portion. However, because of the rate reduction that began in 2011, the deduction is more complicated; it reflects the employer portion of the tax, which works out to more than 50% of the self-employment tax.
The rate reduction is automatic. To enjoy the rate reduction, employees don’t have to do a thing. The employer takes it into account when figuring the withholding for Social Security tax.
Because Congress acted so late in the year, many employers and payroll services may not have had time to implement the change at the start of the year. The IRS says that employers should put into effect the new payroll tax rate as soon as possible in 2012, but not later than Jan. 31. If an employer did not implement the change immediately, any Social Security tax overwithheld from a paycheck in January will be refunded to the employee. Employers are instructed to make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31.
The reduction has no impact on your Social Security benefits. Even though workers are paying less tax into the Social Security system, they do not suffer any reduction in the benefits that will ultimately be collected. The federal government promises to pay the benefit that would otherwise have been received. The benefits are figured on the basis of earnings (up to the wage base limit for the year) and not on taxes paid.
Higher-income earners are subject to a new recapture tax. Those who earn more than 1/6th of the wage base limit in the first two months of 2012, or $18,350 ($110,100 divided by 6) face a new recapture rule when they file their 2012 income tax return in 2013. The 2-percentage-point reduction applies to their actual earnings during the extension period, but any tax on earnings in excess of this amount will be included as an additional income tax on the 2012 return.
For example, say someone earns $12,000 per month ($144,000 for the year). This means that earnings in the two-month period will exceed the $18,350 cap by $5,650 ($24,000 minus $18,350). This person must include $113 (2% of $5,650) as an additional income tax on the 2012 return.
In conclusion, enjoy your tax savings while you can. If the economy continues to improve, it is unlikely that the payroll cut will be extended beyond 2012. Also remember that there is no reduction in the Medicare tax, which remains at 1.45% for employees and 2% for self-employed individuals. If you have any questions about how the tax change affects you, consult a tax adviser.
More from U.S. News & World Report and MSN Money:
Republicans have been complaining that SS benefits are crippling the nation's deficit. Now they join the Democrats in another cut which will simply add to the problem if their really was one.
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