Payroll taxes: Tax relief … for now

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in Small Business Tax,Small Business Tax Deduction Strategies

Just when it looked darkest, Congress revived a tax break for employees, at least for the short term.

Alert: New legislation enacted late in 2011 temporarily extends the “payroll tax holiday” for two more months. And Congress is already working on an extension for the remainder of 2012.

The president signed the “Temporary Payroll Tax Cut Continuation Act” into law on Dec. 23, 2011. Without the extension, employees would be paying an additional 2% payroll tax on wages received through Feb. 29, 2012.

Here’s the whole story: Both employees and employers must pay a 6.2% Social Security payroll tax on wages up to an annual wage ceiling. The wage ceiling for 2012 is $110,110 (up from $106,800 for 2011). The 1.45% Medicare tax payroll tax applies to all wages.

The 2010 Tax Relief Act provided a one-year reprieve for employees by reducing the  usual 6.2% Social Security tax withholding rate by 2% to only 4.2% for wages paid in 2011.  Self-employed individuals who pay Social Security tax as part of the self-employment tax were also entitled to a 2% Social Security tax rate reduction on net self-employment income earned in 2011.  

Now the new law extends the 2% Social Security tax rate reduction for two months to give Congress time to hammer out a new agreement. Employers should use the updated payroll tax rate immediately, but no later than Jan. 31, 2012. If an employer overwithholds on an employee’s payroll tax in January, it should make an offsetting adjustment as soon as possible, but no later than March 31, 2012. (IRS News Release 2011-124)  

Recapture rule for high-income folks

Special rule: The new law also includes a recapture provision for employees who receive more than $18,350 in wages in the first two months of 2012. This threshold is based on the annual wage base of $110,000 multiplied by 2/12. These high-income employees must pay an additional tax equal to 2% of the amount of wages above $18,350 received in January and February (not to exceed  $110,100)  The recapture tax is paid on the employee’s 2012 federal income return.

Example: You’re paid an annual salary of $150,000 on a monthly basis. So your wages for the first two months of 2012 are $25,000 ($150,000 ÷ 12 x 2). Because your wages exceed the limit, you must pay a recapture tax of $133 ($25,000 − $18,350 x 2%) when you file your 2012 return.

The new law also extends unemployment benefits for 2 million individuals and avoids a 27% cut in Medicare reimbursements to physicians.

Tip: The cost of the new law will be offset by increased fees for Fannie Mae and Freddie Mac loans.

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