Payroll Tax Reduction Extended into 2012

No one likes to hear that they have to work through the holidays, but that’s exactly the news delivered to Congress by President Obama in early December. The President wanted to ensure that action would be taken on Capital Hill to extend the payroll tax cuts enacted in 2011. As predicted, Congress did act before the end of 2011, and in a compromise measure, the reduced payroll tax rate was extended for two months.

The tax cut extension was passed by Congress on Friday, December 23, and signed into law by President Obama later that day (with plans to return after the new year to find a way to agree on how to pay for extending the tax cut through the rest of the year).

By the estimation of the IRS, nearly 160 million Americans would benefit from the extension of the reduced payroll tax rate that has been in effect for 2011.

Technically, this Act of Congress (called 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. The tax cut extension is paid for with an increase on the guarantee fee paid by lenders on all new mortgage loans whose principal and interest are backed by Fannie Mae and Freddie Mac.

Employers and payroll companies will handle the changes to payroll withholding, so workers should not need to take any additional action.

Small businesses should recognize that there are steps to be taken to ensure that accounting for this last minute extension. Payroll providers are working fervently to program the rate changes into their systems as soon as possible. If a small business uses a third party payroll provider, they should ensure that the changes are properly accounted for by the first payroll run. The IRS advises that employers should implement the new payroll tax rate as soon as possible in 2012, but not later than Jan. 31, 2012.

In addition, employers should communicate the impact of the rate cut extension to employees so they are aware of the impact on their paycheck, both for January and February, as well as in March (if the measure is not extended through 2012).

The IRS has also provided guidance stating that 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.

On the face of it, the extension of the cuts is very simple. However, one issue that arose in the negotiations of the rate reduction relates to individuals that receive high wages.

The law adds a provision for a 2% tax on W-2 earnings in January and February of 2012 in excess of $18,350. This provision is in place to ensure that individuals earning more than the $110,100 maximum wage base do not receive a benefit on earnings in excess of two-twelfths (2/12) of the maximum wage base. This is yet another wrinkle that payroll providers will need to address to ensure accurate reporting to taxpayers.

While Congress was able to benefit from their holiday for the last week of 2011, and workers can enjoy a small bump in their paycheck for January and February, businesses should stay tuned to see if Congress will apply the rate cut for the entire year for 2012.

Written by:
Steve Arman
TGG Accounting

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