Temporary Payroll Tax Cut

On December 23, 2011, Congress passed, and the President signed, legislation that extends the 2011 temporary payroll tax cut by two months, to the end of February 2012.  The Federal Insurance Contributions Act (FICA) consist of two separate taxes:  6.20% on the first $106,800 (for 2011) of compensation for Old Age, Survivors and Disability Insurance (OASDI); and 1.45% on all compensation without limit for Medicare Hospital Insurance.  These taxes are imposed on both the employee and the employer.  For 2011, the 6.20% rate was reduced to 4.20% for the employee's share only.  The rate reduction expired December 31, 2011, and Congress squabbled over how to extend the tax cut into 2012.  Congress only managed a two-month extension and so will need to address this issue again shortly.  A similar extension was made for the self-employment tax rate.

In 2012, the OASDI tax applies to the first $110,100 of compensation.  However, the new law only permits the 2% rate cut to apply to the first $18,350 of 2012 compensation (two-twelves of $110,100) during January and February by means of a 2% recapture tax.  This provision prevents those who can control the timing of their compensation from front-loading their compensation to gain the full benefit and also relieves a burden on employers to monitor the tax withholding rate based upon the amount of compensation paid during this two month period.  The recapture tax would be paid on the employee's 2012 income tax return.  However, the recapture provision only applies if the rate cut actually ends on February 29, 2012.  Congress is expected to extend the tax cut to all of 2012.