Recent Legislation Cuts Payroll Taxes for Most Workers

January 27, 2011

Recent legislation cuts employment taxes for most workers by 2%. For employees, the payroll tax cut applies to wages received in 2011. For self-employed individuals, the self-employment tax cut applies to self-employment income earned in 2011 (for calendar year taxpayers). The legislation also extends an income tax credit for certain employers.

President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Tax Relief Act) into law on Dec. 17, 2010. The law provides many benefits to employers and employees, as well as other Americans. Among other things, the Tax Relief Act provides a payroll tax holiday for employees, and extends an income tax credit for certain employers.

The payroll tax holiday reduces the employee portion of Old Age, Survivors and Disability Insurance (OASDI) Federal Insurance Contributions Act (FICA) taxes from 6.2% of employee taxable income by two percentage points to 4.2% for 2011. For self-employed individuals, the OASDI portion of their Self Employment Contributions Act (SECA) taxes has also been reduced by 2%, from 12.4% to 10.4%. FICA and SECA taxes apply to the first $106,800 an individual earns in a given year.

Thus, for example, employees earning $70,000 per year will save $1,400 per year in taxes, while employees earning $106,800 or more per year in wages will save $2,136. For families where both spouses work, the maximum tax savings is $4,272. Although the employee portion of OASDI contributions is used to help fund Social Security benefits, the payroll tax holiday will have no effect on an individual’s future Social Security benefits.

The Tax Relief Act’s payroll tax holiday for employees follows a similar payroll tax holiday implemented in 2010 for employers under the Hiring Incentives to Restore Employment Act (HIRE Act), which, among other things, provided a temporary 6.2% payroll tax holiday for employers that hired certain unemployed workers. That law, unlike the Tax Relief Act, only reduced payroll taxes for employers, and was intended to reduce unemployment by reducing the cost of hiring new workers.

In addition to providing a payroll tax holiday for employees, the Tax Relief Act also extends the Work Opportunity Tax Credit (WOTC) through the end of 2011. The WOTC provides employers with an incentive to hire additional workers from various disadvantaged or lower income groups by providing employers with a credit against their federal taxable income tax liabilities.

To implement the provisions of the Tax Relief Act, the Internal Revenue Service (IRS) issued Notice 1036 – Early Release Copies of the 2011 Percentage Method Tables for Income Tax Withholding – in December 2010. Notice 1036 provides guidance to employers regarding payroll tax withholding in 2011. Employers are required to implement the 2011 withholding tables no later than Jan. 31, 2011.

In light of the Tax Relief Act, employers should ensure that they are properly withholding from their employees’ paychecks, and should also ensure that they are maximizing their opportunities to take advantage of benefits such as the WOTC.