Payroll Tax Cut Extended into 2012…Temporarily

December 30, 2011 by Ed Becker

Feds Approve Payroll Tax Cut Extension

Nearly 160 million workers will benefit from the extension of the 2011’s reduced payroll tax rate into 2012. The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2% to 4.2% of wages paid through Feb. 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.  Consult your bookkeeper as to how best to implement this extension and make sure your payroll tax returns are completed properly.

What’s the Payroll Tax Cut?

Payroll taxes include federal income tax withholding and FICA taxes (Social Security/Medicare taxes) withheld from employee pay and matched by employers. The payroll tax cut is a 2% decrease in Social Security costs for employees; the purpose was to stimulate spending. Before the cut, employees had to pay 6.2% of their gross pay each payday, as their portion of the Social Security Tax, withheld from their pay.

Employers should consult with their CPA’s as to how to implement the new payroll tax rate as soon as possible in 2012 but not later than Jan. 31, 2012. For any Social Security tax over-withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2012.

Most bookkeeping services and/or payroll companies will handle the withholding changes, so workers should not need to take any additional action.

What were the terms negotiated?

Under the terms negotiated by Congress, the law also includes a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year  amount). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100).

This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions.  The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year. With the possibility of a full-year extension of the payroll tax cut being discussed for 2012, the IRS will closely monitor the situation in case future legislation changes the recapture provision.

The IRS will issue additional guidance as needed to implement the provisions of this new two-month extension, including revised employment tax forms and instructions and information for employees who may be subject to the new “recapture” provision.  For most employers, the quarterly employment tax return for the quarter ending March 31, 2012 is due April 30, 2012.

How Does This Payroll Tax Cut Extension Affect My Company?

Your bookkeeper should have been adjusting the amount you withhold from employee paychecks to account for this 2% Social Security tax cut. For the first two months of 2012, you should continue this adjustment. This payroll tax cut also affects how you complete Form 941 (quarterly wage and tax report) for 2011.

If you are self-employed, this payroll tax cut affects you too.  Self-employed individuals can cut their self employment tax by 2% in 2011 and in the first two months of 2012. There’s nothing you need to do to get this cut; it’s reflected in the calculation of your self-employment taxes on your personal income tax return, Schedule SE.