Payroll Tax Holiday Continues

March 2012

Overcoming some bipartisan bickering, Congress finally agreed to extend the federal “payroll tax holiday” through the remainder of 2012. The Middle Class Tax Relief and Jobs Creation Act of 2012 was signed into law by President Obama on February 22, 2012.

Thanks to the new law, employees can continue to bask in the glow of a 2 percent reduction in FICA (Federal Insurance Contributions Act) tax for the next ten months. Plus, employers are relieved of

The Payroll Tax Cut Legislation Also:

  • Extends expanded unemployment benefits through the end of the year bthmb USA capitol dome evening America government Payroll Tax Holiday Continuesut reduced the maximum number of checks jobless people can receive.
  • Delays a scheduled 27 percent cut in Medicare payments to physicians.

accounting hassles for high-wage earners and changes to their payroll tax systems. Absent the legislation, this tax break would have expired on March 1, 2012.

Let’s quickly recap the sequence of events. Normally, you have to pay the OASDI (Old Age, Survivors and Disability Income) portion of FICA tax at a rate of 6.2 percent on amounts up to the annual “wage base,” which is adjusted for inflation. In addition, you must pay the 1.45 percent HI (Hospital Insurance) portion of FICA tax on all of your wages. Therefore, the combined FICA tax rate is 7.65 percent on amounts up to the annual wage base.

Both employees and employers must pay the FICA tax. A self-employed individual effectively pays both the “employee” and the “employer” shares of the tax for a combined tax rate of 15.3 percent. Saving grace: If you’re self-employed, you can deduct half of your self-employment tax payments “above the line” on your return.

Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the usual 6.2 percent OASDI rate for employees was reduced by 2 percent, but only for the 2011 tax year. A comparable tax break was granted to self-employed individuals for 2011, although employers did not benefit from any reduction. For employers, the regular 6.2 percent OASDI tax rate continued to apply to amounts up to the wage base of $106,800 in 2011.

Initially, the payroll tax cut reduction was envisioned as a one-shot deal. But late last year, lawmakers began arguing about extending it for another year, or even longer. Political bickering ensued about how to finance this tax cut as well as extending unemployment benefits. On December 23, 2011, a last-ditch measure was passed, the aptly-named Temporary Payroll Tax Cut Continuation Act of 2011, extending the payroll tax holiday for two more months through February 29, 2012. And the tax-law writing members of Congress promised to revisit the issue when they returned from their holiday adjournment.

Now, after a second round of contentious debates, another “compromise law” has been approved. The latest legislation, which includes a further extension of unemployment benefits, continues the payroll tax holiday through December 31, 2012. In other words, the regular 6.2 percent rate for employees is reduced by 2 percent to an effective 4.2 percent rate on wages for all twelve months of  2012 on amounts up to the inflation-adjusted wage base of $110,100.

How much will you save under the extended payroll tax holiday? It depends on the amount of your wages. For example, a worker earning $50,000 saves approximately $1,000 this year. The maximum savings for a high wage-earner in 2012 is $2,202 (2 percent of $110,100).

Without the new law extension, your company would have been required to adjust its payroll tax systems after February 29. The legislation also avoids problems relating to employees who earned more than the equivalent of the wage base amount over the first two months of the year. Those employees would have been required to recapture the excess tax savings on their 2012 returns.

Consult with your tax adviser if you have questions about your personal situation or the impact on your business or organization.