The Payroll Tax Debate – Simplified

What is the present payroll tax cut debate all about and how does it affect workers and businesses?

If you look at your paycheck, you will usually see four taxes withheld from your gross pay.

  • The first one is Federal Tax, which is your payment toward the amount owed for your Income Taxes.  The more money that you make, the more you owe in Income Tax, as this tax is a function of earnings.
  • The next one is State Income Tax, if you live in a state that has an Income Tax.  Same concept as the Federal Income Tax, but this goes to fund your state.
  • The next one is Medicare Tax.  This tax funds the Medicare system, which is the retiree health insurance plan.  It is a flat 1.45% of total earnings.   Your employer matches this amount and remits to the government 2.9% (1.45% that you have paid and 1.45% the employer paid).
  • The final tax is the Social Security Tax and this is the subject of the debate in Congress.   For a very long time, the employee paid 6.2% of their earnings and your employer paid the same amount, therefore, remitting 12.4% (6.2% that you have paid and 6.2% the employer paid).  The employee and employer only pay this tax on about the first $110K in earnings, which is indexed annually.

In 2011, the employee only rate was cut from 6.2% to 4.2%.  The employer rate remained at 6.2%.  Therefore, if you are making $1,500 per week, you received an additional $30 in net pay (2% * $1,500) or about $1,500 more per year.  The thought is that this amount would be spent by the employee and it would stimulate the economy.

Initially, the main issue was how to pay for this tax cut.  The Democrats wanted to pay for this with their millionaire tax and the Republicans wanted to pay for this by continuing the pay freeze on government workers and by reducing the government workforce through attrition.

The issue now is gamesmanship between the Senate and the House.  The Senate voted a temporary 2 month extension and the House wants a full-year extension.  The House is trying to force the Senate to return to Washington this week to vote on a new bill.

Note that there is no impact to employers, as their taxes neither increase nor decrease.


IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.