Every worker, from the wage-earner to the self-employed, will see their take home pay rise for the 2011 tax year. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, signed by President Obama in late December, provides a two percent payroll tax cut on the employee portion of the old-age, survivors, and disability insurance (OASDI) tax, commonly referred to as Social Security tax or FICA. The rate of Social Security tax computed on an individual’s 2011 wages will be lowered from 6.2% to 4.2%. To translate this savings to dollars, a person earning $100,000 per year will find $2,000 more in their take home pay by the end of the year. Self-employed workers will see a total payroll tax cut from 15.3% (employer plus employee portions of Social Security tax and Medicare of 6.2% and 1.45%, respectively) to 13.3%. This being said, only the employee’s portion of the Social Security tax has been reduced by two points. The employer’s share of Social Security tax remains unaffected.
The payroll tax reduction was intended to take the place of the 2009 Stimulus bill’s Making Work Pay credit, which sunset at the end of 2010. That break represented a credit for Social Security tax on the first $6,450 of wages, but was phased out for taxpayers earning more than $75,000 ($150,000 for couples). The credit, which was originally proposed to stimulate the economy, wasn’t the fix-all that the government was hoping for. It only put a maximum of $400 ($800 for couples) back in people’s pockets.
The new rate reduction provision will reach across a broader spectrum and will include every person earning income. There is NO phase out for high-income taxpayers. The reduction will provide a greater tax benefit than the Making Work Pay credit, maxing out at $2,136 ($4,272 for couples). Although the reduction will cost the government an estimated $120 billion, it has been designed to boost consumer spending across the board by essentially giving workers a pay increase and that this increase will lead to new hiring by businesses.
The payroll tax holiday will not affect the worker’s future Social Security benefit, as benefits are based on lifetime earnings, not the amount of tax paid by the worker into the Social Security system. The gap in Social Security funds will be closed using transfers from the U.S. Treasury’s general fund. The transfers will be made using the same discretion as the transfers that would have occurred without the rate reduction.
Employees generally do not need to take any action in order to receive the benefit of the new payroll tax reduction. The withholding changes will be handled by employers and payroll companies. Employers should start using the new tables as soon as possible in 2011, but no later than January 31, 2011. If any OASDI tax is overwithheld, employers should make an offsetting adjustment in the employee’s pay as soon as possible, but no later than March 31, 2011. Although a self-employed individual will generally not receive the benefits of the payroll tax reduction until their 2011 tax return is filed, they may adjust the amount of their quarterly estimated tax payments by an equivalent amount to account for the 2% reduction in the Social Security taxes.
Should you have any questions about the 2011 payroll tax reduction, please contact your Marcum Tax Professional.