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Reduced Social Security Withholding for 2011 and 2012

Payroll tax holiday provides tax savings for workers


Updated January 03, 2013
Workers will see less taxes deducted from their paychecks for Social Security. For the years 2011 and 2012, Congress has legislated a temporary payroll tax holiday designed to put more money into the hands of American workers.

Temporary Reduction in the Social Security Tax Rate

For 2011 and 2012, employees will pay 4.2% of their wage earnings for the Social Security tax, instead of the normal 6.2% rate. Employers still pay the full 6.2% rate.

Self-employed persons, who pay both halves of the Social Security tax through the self-employment tax, will pay a combined rate of 10.4% (the employer's 6.2% plus the employee's 4.2% rates).

Implementing the Payroll Tax Holiday

The Internal Revenue Service has directed employers to implement the lower 4.2% Social Security tax rate paid by employees no later than January 31, 2011. Additionally, employers are supposed to refund to their employees any excess tax withholding if they were using the old 6.2% rate during January; the IRS has instructed employers to refund the difference no later than March 31, 2011.

Self-employed persons pay their Social Security tax through estimated tax payments. Self-employed workers may utilize the lower Social Security tax rates when calculating their tax payments.

How Much Will You Save from the Reduction in Social Security Tax?

The difference between the normal 6.2% rate and the 4.2% rate in effect for 2011 results in a 2% savings on labor income. How much tax savings you will enjoy depends on your labor income for the year. Labor income is composed of wages, salaries, and net self-employment income. The Social Security tax is also capped at a maximum wage base of $106,800 for the year 2011. Thus the maximum savings any particular worker will enjoy from the rate reduction is $2,136 in 2011 (which is two percent of the $106,800 wage base for 2011). For 2012, the Social Security wage base is $110,100, and so a 2% reduction in the Social Security tax translates into a maximum savings of $2,202.

If your labor income is less than the maximum wage base, your tax savings will be 2% of your wages, salary or net self-employment income. If your salary for the year is $50,000 (for example), then your tax savings amounts to $1,000.

What Happens to the "Missing" Social Security Funds?

To prevent Social Security from losing tax revenue, Congress mandated that revenues be transferred from the general fund to the Social Security trust funds to make up for the tax reduction. This is provided for in section 601 of the Tax Relief Act, which reads in part, "There are hereby appropriated to the Federal Old-Age and Survivors Trust Fund and the Federal Disability Insurance Trust Fund established under section 201 of the Social Security Act (42 U.S.C. 401) amounts equal to the reduction in revenues to the Treasury by reason of the application of subsection (a). Amounts appropriated by the preceding sentence shall be transferred from the general fund at such times and in such manner as to replicate to the extent possible the transfers which would have occurred to such Trust Fund had such amendments not been enacted."

What to Do With Your Savings from the Payroll Tax Holiday?

When Congress implemented the payroll tax holiday, they were hoping to help stimulate consumer spending by putting some extra money into people's paychecks. It certainly is tempting to spend that money, but I have a different opinion on the subject. Social security taxes goes to pay for a permanent, lifelong benefit. As long as I pay in now, I'll get guaranteed benefits later when I retire or become disabled. So it stands to reason that I would want to utilize the Social Security tax savings to create some sort of lifelong benefit. I asked my colleagues at About.com for some suggestions for utilizing your tax savings, and here's what they advised:

Invest in education. Wendy Connick, About.com's Guide to Sales, recommends "putting it in a college fund for the kids, or taking that class or training program you've been eying." There can even be a tax-angle to this strategy. College tuition expenses can generate tax credits or a deduction, thus you'd be using tax savings from Social Security to generate additional income tax savings. Alternatively, putting your payroll tax savings into a Section 529 college savings plan can help shelter your college savings from taxes on the earnings and growth.

Buy insurance. Mike Meulemans, About.com's Guide to Insurance, recommends buying long-term care insurance coverage. "One great way to reinforce our retirement assets is to purchase long-term care insurance." There's potential tax savings with this strategy too, as long-term care premiums can potentially payroll tax savings if purchased through your employer or can be included in the health insurance deduction for self-employed persons, or could be deducted as part of your itemized medical deductions.

Boost your retirement savings. Both Erin Huffstetler (About Frugal Living) and Jean Murray (About Business Law/Taxes) recommend saving your Social Security tax windfall. Murray feels this is particularly important, "If you believe, as I do, that Social Security will not be adequate to fund your retirement years, put that extra money into an IRA or 401(k)." Retirement plans have significant tax advantages too, as you may be able to get a deduction now for savings you contribute, and any earnings is tax-deferred until withdrawn later.

Payroll Tax Holiday Ended in 2012

The temporary reduction in the Social Security tax rate expired at the end of 2012. This tax incentive was not renewed as part of the American Taxpayer Relief Act. For 2013, the Social Security tax reverts to its normal rate of 6.2% of wages (employee-paid), 6.2% (employer-paid), and 12.4% for self-employed persons.
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