As you’re likely aware, Congress recently agreed to extend the Bush-era tax cuts, which means that tax rates in 2011 will look the same as they did in 2010.
If you were paying attention, you might have also heard the phrase “Payroll Tax Holiday.” Today I want to talk a bit about what that means.
What is the payroll tax?
The payroll tax refers to the Social Security portion of your FICA taxes. As I’ve noted in the past, this works out to 6.2% of your gross compensation. The balance of your FICA taxes (1.45%) goes to Medicare, for a grand total of 7.65% on the employee side.
As I’ve also noted in the past, there is a ceiling associated with your Social Security taxes. As things currently stand, only the first $106,800 of your earned income is subjected to this tax. After that, you continue to pay the Medicare tax, but the Social Security tax drops off.
The tax holiday
So what’s all this talk about a payroll tax holiday? Well, during 2011, your Social Security taxes will be reduced by 2%, from their current 6.2% level to 4.2%. Because of the tax ceiling, this works out to a maximum savings of $106,800 x 2% = $2136.
In case you’re wondering, employers will continue to pay their share of the payroll tax at the full 6.2% rate, so… If you’re self-employed, and thus responsible for both halves, you’re only getting half a break.
The payroll tax holiday timeline
Because this legislation got passed at the last minute, employers don’t have a lot of time to update their payroll systems. According to tax blogger Kay Bell, the IRS has asked all employers to have the changes in place no later than Jan. 31, and to rectify any over-withholding by the end of March.
So… The bottom line here is that most workers will see their paychecks grow by 2% as we head into 2011. If your employer is slow to implement the changes, just be patient. But if things develop too slowly, don’t be afraid to ask your HR department about what’s going on.