Payroll Tax Takes Another Holiday

By Ken Berry 

After a bitter political dispute gridlocked Congress for several weeks, our nation's lawmakers finally agreed to a compromise extension of the so-called "payroll tax holiday." The new law signed by the president on December 23 – the Temporary Payroll Tax Cut Continuation Act of 2011 – keeps the payroll tax break alive for another two months. Without this legislation, the payroll tax holiday would have expired midnight December 31.
The new law also extends unemployment benefits, and Medicare will continue paying doctors at current rates for two months, averting a 27 percent cut that would otherwise occur on January 1. The overall cost of the package is offset by increased fees for Fannie Mae and Freddie Mac housing loans.
Normally, both employees and employers must pay the Old Age, Survivors, and Disability Insurance (OASDI) portion of federal payroll tax at a 6.2 percent rate on wages up to the annual "wage base." For 2011, the wage base is $106,800; it is increasing to $110,100 for 2012. But the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 created a unique tax break. It reduced the usual 6.2 percent OASDI rate by 2 percent, to an effective rate of 4.2 percent. The catch: This payroll tax holiday only applied to employees and only lasted for one year – 2011. 
Self-employed individuals, who paid at a 12.4 percent tax rate prior to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, will maintain their 2 percent reduction (10.4 percent) on amounts up to the wage base for 2011. Of course, those who are self-employed may deduct half of their payments on their tax returns.
Finally, the full 1.45 percent Hospital Insurance (HI) portion of payroll tax remains in effect. It continues to apply to all wages for both employees and employers.
The new eleventh-hour legislation extends the 2 percent reduction for employees through February 29, 2012. Employers should implement the new payroll tax rate right away, but no later than January 31, 2012. For any tax that is overwithheld in January, employers should make an offsetting adjustment as soon as possible, but no later than March 31, 2012.
The new law also includes a "recapture" provision that applies to employees who receive more than $18,350 in wages during the first two months of 2012 (the two-month equivalent of the $110,100 wage base). This new rule imposes extra income tax on these high-income employees in an amount equal to 2 percent of the amount of wages above $18,350 (and not greater than $110,100) received in the two-month period. The recapture tax is paid on an employee's 2012 return.
Proponents of the payroll tax holiday had argued for a minimum of a one-year extension through 2012. The agreement calls for Congress to revisit the issue when it returns from adjournment in the New Year. At this point, the likelihood for a longer payroll tax holiday seems promising.  
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