It's Official: Payroll Tax Holiday Extends through 2012

By Ken Berry

Update: President Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012 on Wednesday, February 22.
 
Ending several weeks of uncertainty, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012 shortly before adjourning for a long President's Day weekend. President Obama is expected to sign the bill as soon as it reaches the White House.
 
The centerpiece of the new measure is an extension of the "payroll tax holiday" through the remainder of 2012. (It also extends unemployment benefits and adjusts physician payments under Medicare.) Absent this legislation, the holiday would have ended March 1, 2012, after a previous two-month extension. 
 
Normally, both employees and employers must pay the OASDI (Old Age, Survivors, and Disability Income) portion of federal payroll tax at a 6.2 percent rate on wages up to the annual "wage base." For 2012, the wage base is $110,100, up from $106,800 in 2011. Self-employed individuals must pay the OASDI tax at a 12.4 percent rate on the same wage base, but they may deduct half of their payments "above the line" on Form 1040.
 
First, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 reduced the usual 6.2 percent OASDI rate for employees (but not for employers) by 2 percent to an effective rate of 4.2 percent. But this tax break was created to last just one year - 2011. Self-employed individuals also benefitted from a 2 percent reduction in OASDI tax on amounts up to the 2011 wage base. The full 1.45 percent Medical Hospital Insurance (HI) portion of the federal payroll tax continued to apply to all wages for both employees and employers.
 
Subsequently, legislation enacted late last year - the Temporary Payroll Tax Cut Continuation Act of 2011 - extended the payroll tax holiday for two additional months through February 29, 2012. This extension included a recapture provision for employees receiving more than $18,350 in wages during the first two months of 2012 (the two-month equivalent of the $110,100 wage base). These employees were required to pay any additional amount owed on their 2012 tax returns.
 
Now, the new law wipes the slate clean. Under the Middle Class Tax Relief and Job Creation Act of 2012, the payroll tax holiday will continue unabated through December 31, 2012. In addition, the new legislation repeals the recapture provision included in the 2011 law. As was the case last year, high-income employees will benefit from the 2 percent reduction on wages up to the annual wage base. 
 
Although the latest extension was hardly unexpected, the outcome remained in doubt during contentious debates within the halls of Congress. Surprisingly, gridlock over the required revenue offset was eased when both parties agreed to use transfers from the general funds of the Treasury to the Social Security fund. The new law also removed an estimated tax provision for certain large corporations that had accompanied the previous extension. 
 
The IRS has gone on record as saying that implementing the payroll tax holiday for the entire year should not cause any major problems in its systems.
 
Make sure your business clients are on board. 
 
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