There’s been lots of news recently regarding the tax compromise that President Obama struck with congressional Republicans. With the extension of the Bush tax cuts, people at all income levels will see their income tax brackets remain the same through 2012, and the AMT exemptions expanded.

The tax compromise also calls for a reduction of an employee’s portion of payroll taxes for 2011, called the “payroll tax holiday”. At the same time, the Making Work Pay tax credit, which was enacted as part of the stimulus package, is expiring. That credit allowed employees to earn a credit of 6.2% of wages, up to $400 total, with a phaseout for those earning over $75,000. The Making Work Pay credit expiration will mean an increase in taxes and thus a decrease in take-home pay – but for most people that decrease will be more than counteracted through the effects of the new payroll tax cut.

Update: Congress voted to extend the payroll tax cut for 2012. The 2 month extension of the payroll tax cut will be followed by more negotiations to extend the payroll tax cut for the entire 2012 calendar year.

2012 Update: Congress extended the payroll tax cut for the rest of the year; the payroll tax cut now applies to all of 2012. See the 2012 payroll tax cut extension for more updates.

2013 Update. The payroll tax cut expired and was not included in the Fiscal Cliff Deal. The 2013 rates will return to normal.

Finer Details of the Payroll Tax Cut

Currently, each employee pays 6.2% of their first $106,800 in salary into Social Security. Employers match that amount, and each party also pays 1.45% into Medicare. The one-year tax reduction from the payroll tax credit will reduce the employee’s contribution by two percentage points, meaning employees will pay only 4.2% of their first $106,800.

Like the Making Work Pay credit, this tax cut will be figured into each paycheck you receive throughout the year, giving you a small boost in take-home pay that legislators hope you will spend to help stimulate the economy. Since you receive the tax reduction as a percentage of your total employment income, there should be fewer of the types of issues that caused some people to have to repay the Making Work Pay credit.

Your Bottom Line for 2011

So what everybody really wants to know is…if the payroll tax reduction passes, what will paychecks look like come 2011?  The graph below illustrates the annual effect of this federal payroll tax cut as opposed to the Making Work Pay credit.

As you can see, those making over $8,000 receive the maximum amount ($400) for the Making Work Pay Credit. The credit stays equal to $400 until one’s annual income reaches $75,000, at which point it steadily decreases until hitting zero for those making $95,000 or more. By contrast, the 2011 payroll tax cut rises steadily until one begins making over $106,800.

With the expiration of Making Work Pay and the start of the payroll tax credit of 2011, most people will see an increase in their paychecks. The graph below shows the difference in weekly income that most workers will see in 2011. Those making over $20,000 will enjoy an increase in their paychecks when compared to 2010 while those making less than that (which includes minimum wage workers) will be looking at slightly less money in 2011.

Of course the comparison above is not true for everyone – if you’re part of a system that does not pay into Social Security (such as many state and local government employees, including teachers) you will see a decrease in your paycheck due to the expiration of Making Work Pay and the fact that you have no payroll taxes to have reduced. Retirees are in the same boat as there is not currently an equivalent tax cut for retirement income.

If you’re going to benefit from this tax cut, take this opportunity to bump up savings and/or retirement contributions to help you meet your goals for 2011 and beyond.

If your paycheck will decrease, check out some of these ways to manage your budget, save money on food and come up with extra cash.



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Comments to Payroll Tax Cut: What Your Paycheck Will Look Like

  1. Thanks Jill for that explanation. It looks like the new tax cut is going to be a lot better than the horrendous one that they gave us last year.

    Chris @ SmartPF.com

  2. Good analysis, but …

    Soc’Security taxes are taken out of our checks BEFORE other taxes. What we will get from this tax break will ultimately be Fed & State taxed with the rest of our pay. Therefore, you’re green line showing what will be added to our paychecks is technically correct for GROSS, but will be something lower in our actual NET take-home.

    Haven’t seen anyone mention this yet.

    Also, this ‘tax break’ is designed to generate more taxable income for the Fed & States, at the expense of Soc’Security. This ultimately means there will come a time in our futures when Soc’Security will be required to tax us more heavily or else payout less benefits. Either way, we’ll definitely pay for this later. Be sure to save your money!

    M Sparks

    • Wrong both times.
      You pay income taxes on your social security taxes. You also might pay taxes on your social security benefits. So there will be no increase in income taxes because of the social security tax cut.

      On to your next point: that ss will have less money to pay benefits because of the tax cut.
      There is no law that says benefits can only be paid out of the trust fund. There is not really any trust fund anyway. When the trust fund runs out, benefits will be paid from the general treasury, which is supported by all taxes (income, corporate, duties, fica)the ability of the govt to borrow, and its ultimate trump card, the ability to create money out of nothing.

      Bruce

      • Bruce, Do you pay taxes on your taxes? Really that’s a new tax I’ve not heard of. There is no Social Security Trust Fund? Really? Have you read the information available on the Social Security website? If you are knowledgeable and still disbelieve, does anything our govenment promises to you mean anything? What about the millionaires who loan millions to the good old USA in the form of Treasury Securities? Are they idiots for trusting the promise to repay with interest? I’m no millionaire but buy treasuries in my IRA, maybe thats foolish. Who should I trust Bruce? Maybe Uncle Sam will pay the millionares but not the marginally surviving elderly, the ones who paid in monthly for their retirement. Will the USA renege on it’s promise to repay debt? Maybe you should buy foreign bonds as you can’t trust your own country. Yes, we need to slightly revise Social Security taxes to keep it viable and especially Medicare but lets be constructive not destructive.
        The difference between the the “Making Work Pay credit” and the 2011 Tax Cut is that it benefits high earners more. For me I got a $800 tax credit in 2010 but will get a $400 tax cut with the 2011 cut, while a $100,000 earner gets a $2,000 cut, hey he needs it more, right? Did the Republicans gain control of the House or what?

        Andrew


  3. Instead of decreasing the payroll SS tax, why not help the people who depend on SS as their income and give them an increase?

    Also, this doesn’t help the working class people who are on the Federal CSRS who don’t pay SS does it? Will the pension money being taken out of our check decrease by 2%?

    dee kelly

    • To you first question, I understand that there ARE people that depend on SS, but that’s really not anyone’s fault than their own. SS has always been billed as a SUPPLEMENTAL system and benefits have never been guaranteed.

      PK

  4. The social security max amount remains the same, so for those making over $106,800 there will ultimately be no difference. Your weekly check may show an increase, but it will just delay the amount of time until you hit the max for the year.

    Overall social security doesn’t seem to be the best choice from which to sacrifice funds, whether it be on the tax side (lower FICA) or the benefit side (increased benefits).

    Cecil_T

    • Cecil, the FICA maximum is not a set dollar amount withheld each year, but it is really the maximum amount of wages that are taxable. On $106,800, the 2010 maximum FICA withheld from an employee would have been $6,621.60. In 2011, without any other changes, the maxumum withheld from an employee will be $4,485.60. You are absolutely correct, however, in saying that FICA may not be the best place to sacrifice funds.

      Jim

  5. I just crunched the numbers using new 2011 IRS tax withholding publication (Notice 1036).

    Based on my situation, a gross earning of $1000 per payperiod results in a $20 decrease for SS but a $16 increase in Federal Withholding.

    Yippee! Now to figure out what to do with that extra $8 per month.

    ronna m

    • Ronna, FICA reduction is in place of the MWP credit, so it’s INTENDED to be nearly the same. But your paycheck is $20 less than what it would have been without the credit. I think you’re of the mindset that the credits were additive; that is, you were probably expecting your paycheck to increase by both credits and that’s just not the case.

      Jim

  6. M Sparks,

    Both federal withholding and Social Security taxes are based on your gross wages. Social security taxes are not taken out before other taxes; otherwise everyone would need to deduct their social security taxes before calculating their AGI. (Self employed people can deduct the employer portion because they are self employed and that part of the tax is considered an expense). This change does not generate more federal income taxes. Federal withholding is always taxed on 100% of your gross wages (less any special deductions that are exempt, e.g. 401(k)/IRA)

    Cecil_T,

    There’s no delay until you hit the max for the year. 106,800 is the wage limit. If you make the same amount of money in 2011 as you did in 2010 you will hit the wage limit at the exact same time. The difference is the rate that is applied to those wages. 4.2% of that is taxed instead of 6.2%. That makes the maximum social security deduction for 2011 4,485.60 instead of 6,621.60.

    ronna m,

    The Making Work Pay tax credit (the tax cut nobody knows Obama passed) has been in effect for 2009 and 2010. It is going away in 2011. For the last two years, the federal withholding tables have been modified to take the MWP into consideration and so federal withholding has been lower than normal. For 2011 the tax tables go back to normal. That is why the federal withholding is increasing.

    The rate cut for the social security tax is a much simpler tax cut and in part it is meant to replace the Making Work Pay tax credit. MWP required some funky adjustments to the tax tables, you could run into problems with spouses that both work and have their taxes underwithheld because MWP was household based, and you to file an additional piece of paper with your tax return at the end of the year to get the credit.

    MWP was a strange animal. When running for president, Obama’s stated goal was to give 95% of people a tax cut. Close to half of tax filers pay no federal income tax. So the only way to do that was to cut social security taxes (sometimes called “payroll” taxes by people who want to obscure the connection of these taxes to social security) which nearly everyone pays.

    But to actually cut the social security tax is politically tricky; there’s always been a supposed link between the taxes you pay and the benefits you receive, and if I’m not mistaken the rates we pay today go all the way back to the commission in the 1980′s that was supposed to “save” Social Security for the baby boomers.

    So MWP was invented as a refundable tax credit against your federal income taxes to avoid tinkering with the social security taxes. The refundable part is the key for low income earners that don’t pay income tax. If you don’t pay any income taxes, you still get 400 or 800 (depending on marital status) back from the federal government for MWP.

    For better or worse, we have a “tax holiday” on social security. Some people will come out better (single workers earning over 20,000 and married workers earning over 40,000 will get a bigger tax cut, dual income families benefit because each spouse gets the cut, etc.) and some people won’t (see dee kelly’s comment, workers who make less than the limits I just cited get a smaller tax cut).

    matthewd

  7. Thanks matthewd, I misunderstood how that works. Glad to hear.

    cecil_t

  8. Thanks for posting this conversation. I’ve been working overseas and keeping up with all of the changes from afar is very difficult.

    For a wage earner near the SS max or even above, this seems like a good deal. Many of the latest tax rebates etc. have not benefited people above the 106k mark.

    Thanks again,

    John

    John

  9. Iam a retired teacher receiving a teachers pension. I have not received a Cola increase in 2 years, now am I to expect to receive less money in my retirement check with the 2011 tax law? Zettie Matthews

    Zettie Matthews

    • Zettie-
      It appears that is going to be the case. As a small local government employee, this hurts all of us to the tune of about $60 a month alone not counting the extra 11% increase of health care costs (following previous 25%, 18%, etc yearly increases).

      I feel your pain Zettie.

      William Crabtree

      • Blame the man that was put into office up in Washington for all of this.

        Zeta


      • Yes, I “blame” the man for giving the vast majority of Americans a tax break. You people just don’t give up, do you?

        AC Walker


    • I am a retired firefighter that worked for city that did not take out ss and now I’m out over $40 dollars a month. I understand not paying in means I will not be entitled to ss benefits so why must I pay now. On top of that if a second job does earn me some ss benefit, because of my retirement I’ll only be allowed to draw half of what I normally would from ss. I guess if I live long enough I’ll owe the government and health care provider at the end on the month cause at this rate my reitirement check want keep up for very long. I regret getting up every day for 24 years going to work when it looks like I should have stayed at home and waited for something I didn,t earn or deserve.

      James

  10. Does anyone follow this?
    These laws, rules, and tax regulations are utter insanity.
    How is the average Joe supposed to follow this?
    This is a great selling point for a STATIC tax..funny seams to work GREAT for every city in the country. There are no dedutions, are no credits, there are no add this, take away that. Just .. you earn X.XX dollars, you pay Y % in tax on those earned dollars.
    The End, Your Done.
    It would ELIMINATE the IRS Entirely…what would you need them for? The tax would be paid instantly by your employer.
    A HUGE tax savings for the country..anyone have any idea how many MILLIONS in wages we are paying for the (approx) 115,000 IRS employees.
    If you believe the many recent news articles about all the over paid Federal Employees, all these federal employees are making $100,000 year … we would instantly cut $11,500,000,000.00 out of the federal budget (yes, that says 11 BILLION).
    ..any idiot can multiply $00,000.00 by .02 (2%) or .03 (3%) or whatever the percentage was..no complicated tax forms..no figuring out this that or the other…just DONE. PAID. OVER.

    Chris

    • Chris, there is not nearly enough time to explain why a static (ie, flat) tax would be a HORRIBLE idea, but let me pass along this one nugget. The Realtor association estimated that, should the deduction for mortgage interest be repealed, the value of American houses would decrease by 25%. Without challenging their estimate, I think over the past four years, we have seen what happens when home values decrease. And that is just ONE LINE of the tax code. Tax incentives, which is the President’s ONLY tool to influence the economy, is much too imbedded in the American economy to simply change it all at once. And, by the way, IRS employees do NOT average $100K per year. And do you think no one would be needed to monitor compliance by employers regarding the computation and timely payment of those taxes to the Treasury?

      Jim

  11. Actually you should blame the two men who where in office before our current president…every action has a reaction…and all they did led us to this current state we are in…now the Man in office is trying to fix the mess He was handed…

    Kaye

    • Kaye you are soooooooo sooooooo right on your comment lol. All in black and white.

      rene

  12. you failed to explain how the tax tables were adjusted down resulting in many of us paying more tax for making the same amount of money. funny how they still get more money from us while trying to convince us the gave a tax break. politicians always talking out of both sides of their mouth.

    jack

    • Jack, I will explain it to you. The MWP credit was to decrease your federal income tax withholding by about $10 per week starting in April 2009. Given that there were about forty weeks left in 2009 when this idea was introduced, that meant that your withholding was intended to be $400 less in 2009. You then filed your return and claimed the $400 tax credit, but your federal withholding was $00 less, so it was intended to be a wash at that point. In effect, you were paid $400 of your income tax refund in your paychecks.

      Now, in 2011, you do NOT get that federal income tax withholding reduction, but instead get a reduction in FICA tax withheld. As explained to Ronna above, the decrease in FICA withholding is intended to MATCH the increase in federal income tax withholding, at least approximately. If you make significantly more than $20,000, you would see a tax break, yes.

      Jim

      • Oops, that should read “federal withholding was $400 less…” in the first paragraph. Who would thought that typing would have been one of the more important classes we all should have taken in high school.

        Jim


  13. 2nd quarter 2011.
    I do not pay SS taxes on my pension and my Federal withholding increased but State withholding did not change.

    Mark

  14. i am retired and my federal taxes went up 40.00 in Jan. of 2011 even though nothing else change.My gross pay is the same and all deductions the same as they were in 2010 state taxes did not change.Any idea why my taxes increase?

    devaughn harness

  15. Question: Will you have to pay the payroll tax cut back when you file your tax returns even if it is just the SS tax? If not, what happens if we don’t pay enough into our SS when we are eligible to draw from it if we haven’t been paying enough into it because of the tax cut?

    Teresa

  16. to PK.
    Not it isn’t all on the SS receiving people. I had a retirement account that went ‘gone’ with 9/11. I think a lot of people lost some money then. Then those really wealthy? Bernie Madox sp? . Things happen; it isn’t just people not preparing, cancer, car accident, can wipe one out. I see no one answered you; I guess they are smarter than I. As mature people on here, understand all this. You must be young.

    Q

  17. If we are talking about withholding going up for some, that could just be ‘numbers’ for you, as all of this gets reconciled when you file your 1040 tax return. These amounts are just estimated. The IRS does not know, if you got married, how many children you have, how many DEDUCTIONS you have on your Schedule A, or if you take standard deductions. So, even if you have 40 taken out MORE right now, once you do your taxes, you will see it may not make any difference to you depending on how many exemptions you have and deductions. Now that Fica tax reduction? I don’t get how that is supposed to help anyone? Less tax paid by everyone; at the expense of the elderly, again. Those that worked their whole lives and PAID INTO Social Security. Government spent that money, now, we are at the mercy of government.

    Q

  18. If the payroll tax cut is not extended, I suggest you make the tax cut for yourself by cutting your needless and wasteful spending by the amount of the tax cut. The cut is 3.1% of your wages, up to $110,100. The tax cut could be $1,000, $1,500 all the way to $3,300. Here’s how to do it:

    1. Cut your cable subscription to “basic”. We did that a few years ago and have saved $900 per year.
    2. Cut your dining out and bar room tabs by going out less often and eating [and drinking, if needs be] at home. You will be shocked…shocked by how much you save. You could save the entire tax cut on this item alone.
    3. Stop buying all the junk you buy at malls. Consumer goods sold in this country have fallen terribly in quality and are for the most part cheap plastic junk made by child slave labor in third world countries.

    Who do you think owns the businesses that sell this junk to you? It is the 1% we keep hearing about. RICH PEOPLE DON’T BUY THINGS…THEY SELL THINGS…TO PEOPLE SUCH AS YOU. Your continuing to buy this junk is what keeps you in the 99%. You keep yourself poor.

    Put your savings into an IRA and resolve to keep doing this, year in, year out. How do you like being broke all the time? Being broke is not only embarrassing and inconvenient; it can be fatal.

    I’ve been an attorney dealing with trust and estate clients for over 30 years. I’ve seen the habits of wealthy people. I’ve seen how they’ve got and remain wealthy and I share some observations with you.

    Remember: A. Rich people don’t buy things, they sell things.
    B. There is no future whatever in spending money but there is a splendid one in saving and investing it.

    Good Luck.

    Ptolemy

  19. I’m a retiree. Last January 2011, they started taking $50 extra every month out of my checks because of withholding tables. If the tax cuts are not extended, how much more will they be taking this time?

    jeanne

  20. i’ve read that the payroll tax credit is costing our country about $150 billion a year. plus all the extra money congress is wasting, by voting on it’s extention every other month. this adds up to one pretty penney, and only saves me about $8 to $10 dollars per week. me personly, i would rather not get the tax break, have the government put the money back into social security, where it belongs. start spending the money we already give them wisly, and get our country out of debet. we have to live within our means, and live up to the the obligations we have already made. which probably means our country can not afford a tax break right now. as for me, i’ll happily give up my $10 per week, for the safty and security of my country.

    aaron


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