The Payroll Tax Holiday Will Last (at Least) Another Two Months

January 2012

The “payroll tax holiday,” which was scheduled to end on December 31, 2011, was extended by Congress through the end of February. But with partisan politics playing a major role as national elections loom in 2012, the long-term outcome is far from certain.

 New “Recapture” Provision

    Under the terms negotiated by Congress, the new law also includes a new “recapture” provision, which applies only to employees who receive more than $18,350 in wages during the two-month period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year amount). This provision imposes an additional tax on these higher-income employees in an amount equal to 2 percent of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100).
    This additional tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions. The recapture tax will be payable in 2013 when the employee files his or her 2012 tax return. With the possibility of a full-year extension of the payroll tax cut being discussed for 2012, the IRS stated it will monitor the situation in case a new law changes the recapture provision.
According to the IRS, it will issue additional guidance as needed to implement the two-month extension. For most employers, the quarterly employment tax return for the quarter ending March 31, 2012, is due April 30, 2012.

Two More Provisions in the New Law

1. Emergency federal benefits for the unemployed, which were scheduled to expire on December 31, were extended for two months.

2. Medicare payments to physicians, which were scheduled to be reduced 27 percent after December 31, will not be cut.

For the time being, let’s look at the way things used to be and the way things are now.

The way things used to be: There are two separate components of the federal payroll tax known as FICA (Federal Insurance Contributions Act) tax. The first portion, the 6.2 percent OASDI (Old Age, Survivors and Disability Income) portion, applies to amounts up to the annual “wage base” which is adjusted for inflation. The adjusted wage base for 2011 is $106,800 (increasing to $110,100 for 2012). In addition, the 1.45 percent HI (Hospital Insurance) portion of the tax applies to all wages. Thus, the FICA tax on amounts up to the wage base are taxed at a 7.65 percent rate.

Both the employee and the employer must pay FICA tax. Self-employed individuals effectively pay both shares of the tax, but they may deduct half of the tax payments on the income tax return for the year.

The way things are now: Under a tax law passed last year, the usual 6.2 percent OASDI rate for employees is reduced by 2 percent. A comparable tax break is available to self-employed individuals. However, employers aren’t eligible for any reduction. For employers, the 6.2 percent OASDI tax rate continues to apply to amounts up to the wage base.

The amount an employee saved in 2011 depended on the amount of his or her wages. For example, a worker earning $50,000 saved $1,000 (2 percent of $50,000) for the year. Someone earning $100,000 saved $2,000 (2 percent of $100,000). The maximum savings was $2,136 (2 percent of $106,800).

The payroll tax cut reduction was supposed to be in effect for 2011 only. But toward the end of the year, lawmakers began arguing about extending it for another full year. Political bickering ensued about how to finance the tax cut — through a new tax on wealthy Americans or through spending cuts.

On December 23, finally Congress passed a law extending the payroll tax cut through the end of February. The law is aptly named the Temporary Payroll Tax Cut Continuation Act of 2011.

Congress Will Revisit the Issue Soon

Therefore, if the tax holiday is going to last throughout 2012, Congress will have to take up the issue again when they get back to Washington after the holidays. Absent any new legislation, the OASDI tax rate for employees will revert to the 6.2 percent level on March 1, 2012 on wages up to $110,100.

So be aware that payroll tax withholding could still change in March. Consult with your tax adviser if you have questions about your situation or the impact on your business or organization.