Implementing the Payroll Tax Extension

As most Americans know, Congress recently passed and the President signed the "Payroll Tax Cut Continuation Act of 2011," which will extend the payroll tax holiday, unemployment compensation and Medicare physician payment, and provide for the consideration of the Keystone XL pipeline, among other purposes, reports govtrack.us.

With the passage of the bill, employees' Social Security tax withholding will remain at 4.2% through February 2012, after which it will revert to 6.2%.

Whatever one's thoughts on the extension, employers now must implement its provisions. According to the IRS, they should do this as quickly as possible in 2012, and no later than January 31. An employer that inadvertently over-withholds in January should correct for this, again as quickly as possible, but not later than the end of March.

One provision that has received less fanfare is a "recapture" provision, which applies to employees who earn more than $18,350 during the two-month period of January and February 2012. The provision imposes an additional income tax on these employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of $18,350, and not greater than $110,100. The IRS notes that the Social Security wage base for 2012 is $110,100; $18,350 represents two months of this amount.

This recapture is an additional income tax liability for these employees for 2012, and can't be reduced by credits or deductions, the IRS says. It will be payable in 2013, when the employees file their 2012 tax returns.

A letter from the non-partisan National Payroll Reporting Consortium to Congress, sent before the final bill was signed, provides some insight into the reason for the recapture provision. An earlier bill, H.R. 3630, would have established a new Social Security Taxable Wage limit of $18,350, to which the reduced 4.2% rate would have applied through February 29, 2012; wages over $18,350 paid during the first two months of 2012 would still be subject to the 6.2% Social Security tax rate. Without such a provision, highly compensated employees could meet more or all of their 2012 Social Security obligation at the reduced 4.2% tax rate, while lower-paid workers would get the 4.2% rate only for the first two months.

However, in its letter, the NPRC said, "we believe there is insufficient lead time to accommodate the proposal embodied in H.R. 3630. In our opinion enactment of HR 3630 as written could create substantial problems, confusion and costs affecting a significant percentage of U.S. employers and employees."

The recapture appears to be a way to address concerns about effectively administering the tax cut extension, while also ensuring that highly compensated employees didn't benefit from a two-month extension more than lower-paid employees.

Of course, all the concern could be moot, if the extension is again extended. Stay tuned.