A couple of weeks ago I wrote about how the payroll tax cut for 2011 was expiring at the end of the year, and unless Congress acted it would not be available for 2012. It would mean an increase in taxes this year for nearly 160 million workers.
Congress kept delaying and gong back and forth about possible bills to extend the payroll tax holiday, and it looked like something might not be done. Finally at the end of December they came to a temporary extension of the payroll tax cut that will be good through February 29th.
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2012 Payroll Tax Holiday
Congress extended the payroll tax holiday through February for employees meaning the 2 percentage point drop in Social Security taxes from 2011 will continue for at least 2 more months. From IRS:
Nearly 160 million workers will benefit from the extension of the reduced payroll tax rate that has been in effect for 2011. 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 percent to 4.2 percent of wages paid through Feb. 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.
The tax withholding rate for Social Security stays at the lowered 4.2 percent of wages paid through February. If nothing is done to extend it by that date it would expire, but most people expect it to be extended through 2012 before then.
How The Payroll Tax Cut Works
So how does the payroll tax holiday work?
Normally when an employee gets a paycheck from their employer the taxes are withheld, including the FICA portion of the paycheck. The FICA portion of your taxes go to fun Social Security and Medicare, and is usually set at 7.65% for employees. This payroll tax cut essentially cuts the amount of taxes you pay on the Social Security portion of those taxes from 6.2% to 4.2% until it expires on February 29th 2012. If they choose to extend it past that point it will probably mean you'll pay 4.2% through the end of the year.
NOTE: The reduction in taxes paid essentially means that all taxpayers are seeing more in their paychecks. If the tax cut were extended through the entire year, the average taxpayer will see a savings of around $1000 in taxes. The maximum savings seen by higher income individuals was around $2202 since the tax is capped at $110,100 in income.
New Provisions Of The 2012 Payroll Tax Holiday
One thing to note is that the current extension of the payroll tax cut includes a provision to impose an additional tax on those who earn more than $18,350 in wages during the first two months of the year. From the IRS:
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 percent 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.
So if someone were to earn more than 2/12 of the annual limit during those two months, they'll be subject to an additional 2% tax on the money over $18,350. Confusing, right?
So what do you need to get your additional 2% in your 2012 paycheck? Nothing, it should just be adjusted automatically by your employer to stay at 2011 levels through 2/29/2012.