Wipfli Alerts & Updates: The Payroll Tax Holiday

January 7, 2011
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As you’ve probably heard by now, Congress recently passed sweeping new tax legislation affecting personal, business and estate taxes. Most of the changes are effective through the end of 2012, but there is an additional bonus in 2011 for those who have earned income.

In 2011, there is a tax cut on the amount of Social Security tax (FICA) that is assessed. This has commonly been referred to as the “payroll tax holiday.” Normally, there is a 6.2% tax for Social Security, but in 2011 that tax is reduced to 4.2%. The tax is only assessed on the first $106,800 of earned income, resulting in up to a $2,136 savings per individual. It is important to note that the 2% reduction applies to the employee but not the employer portion of FICA. For a married couple who each work, the savings could be more than $4,000. This reduction applies whether you receive wages or are self-employed.

You can put this tax savings to work for you in a number of ways.
If you are eligible to participate in an employer sponsored plan, such as a 401(k), 403(b), 457 or SIMPLE plan, and are not already contributing the maximum amount allowed, a portion or all of the reduced FICA tax could be funneled into it. If already doing the maximum allowed or you do not have access to an employer sponsored plan, a contribution could be made into a traditional or Roth IRA. Other ways to shelter it include funding into a Health Savings Account if you are eligible to maintain one or using it to pay the tax on a Roth conversion if you choose to do one.

An added benefit to the 2% FICA reduction is potential income tax savings. Since non-Roth contributions to employer sponsored plans, certain traditional IRA’s and HSA’s are deductible, you also recoup the marginal federal and state tax rate. For example, assuming wages of $50,000 and a combined federal and state rate of 30%, tax savings on the additional 2% contribution of $1,000 is $300. Finally, the increased contribution may result in an additional matching contribution from the employer. In any case, whether deductible or not, the tax sheltered earnings can provide enhanced retirement benefits in the future.

Keep in mind that the tax savings will be realized during the year through less withholding in paychecks if you are an employee and through lower estimated tax payments and/or lower 2011 tax liability if you are self-employed. So, if you actually want to see that savings at the end of the year, you should plan to put aside the projected 2% amount from each paycheck or net income as you receive it.

If you wish to discuss financial implications or related aspects of this legislation, please contact Pam Branshaw, Tom Krieg, Bob Buss, or your Wipfli relationship executive.

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