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Plan for the Payroll Tax Cut Expiring in 2013

This article was written by in Featured, Taxes. 20 comments.


Missing from discussions about the so-called fiscal cliff is the option to continue the payroll tax cut. To boost the economy, President Obama and Congress introduced a stimulus bill in 2010 that reduced the payroll tax, money collected at the time of each paycheck from employers and employees (workers with W2 forms).

The employee’s share of the tax has normally been 6.2 percent with a built-in ceiling. The ceiling ensures that those earning $110,100 or less pay the full amount of the tax, but those earning more pay no more tax than those earning the maximum, lowering their effective payroll tax rate. Earn $1 million as a W2 employee, and you pay only 0.07% towards the payroll tax.

The payroll tax funds Social Security. Watching the government can be interesting. As we observed while the country was beginning to dip into the recession, political rhetoric moves quickly from finding ways of boosting Social Security to adopting a tax cut which could accelerate the supposed demise of this government program. Once the idea of a stimulus today became more important than preparing for tomorrow’s realities, the conversation focused on reducing the payroll tax.

The stimulus bill reduced the employee’s portion of the payroll tax two percentage points, from 6.2 percent to 4.2 percent, and that change has been extended several times. The payroll tax cut is set to expire tomorrow, January 1, 2013, and neither the President nor the Congress has discussed extended this particular tax cut. Your first paycheck in 2013 will reflect the higher payroll tax rate, reducing your net take-home pay.

Regardless of whether income tax rates remain low or are returned to their levels before President Bush oversaw his round of income tax cuts, net pay will be lower in 2013 than it was in 2012. In general, with all other things being equal (which they never are), someone earning $50,000 will see $83 less each month.

There’s still time. Congress could decide at a later date to reinstate the payroll tax cut. It could take effect retroactively, which mean the government will take less from each paycheck going forward to reach the desired rate by the end of the year. Or the government could reduce the rate in the middle of 2013 without any concern for what has already been paid by employees. Either way, an extension of the payroll tax cut seems unlikely to me because it hasn’t been discussed in fiscal cliff negotiations thus far.

Employees should start planning today for the reduction in take-home pay. In this article, I’ll assume that net income will be reduced by $100 per month. That’s going to be a high estimate for most people affected by the return to the higher payroll tax rate, but it is a nice round number. If you plan for the worst, you’ll be pleasantly surprised when you end up with a more favorable cash flow.

Reduce your spending by $100 per month

If you already have a well-defined monthly spending budget, find an area where you can shave $100. Resist the urge to save less. Don’t sacrifice your savings and don’t reduce your contributions to retirement due to the payroll tax cut. Find the difference in spending rather than saving.

  • It may be time to drop Showtime or HBO, particularly if you signed up during a promotional period and are now paying full price to your cable company. Dropping some services might trigger a new deal that could save you money.
  • Re-evaluate your mobile phone plan, particularly if you’ve expanded your service to include data for tablets over the past few years.
  • How much money are you spending on clothing, particularly if you have children? If you’ve felt the economy improve over the last few years — and not everyone has — you may be spending more than you did in 2008 for expenses like these.
  • Note that gas prices have been declining. If you drive often, such as having a daily commute to work, you’ve probably seen your expenses drop already.

If you don’t have a budget and you don’t track your spending, you might not be aware of your opportunities for spending more efficiently. Start tracking where your money goes so you can better identify the possibilities for reducing your spending by $100.

Increase your non-payroll income by $250 per month

It sounds like employees are burdened by payroll tax, but self-employed individuals deal with it more. When you’re self-employed, you need to pay the employee’s share of the tax as well as the employer’s share. Self-employment income can come in different forms. You may be working for yourself in your own business, or you may be working as a consultant. If you’re issued a 1099-MISC tax form, you’re considered self-employed. If you own your own business, regardless of whether you issue yourself a W2, 1099 or no tax form, the full amount of the payroll tax ultimately comes out of your pocket.

Because of the additional tax burden on the self-employed, aim to increase your income by $250.

  • How would you feel about earning money from one of your hobbies? If you enjoy photography and have proven yourself to be more skilled than the thousands of kids who use their mobile phones as cameras, use automated effects filters, and share their “art” on Facebook, consider doing a family portrait session each month.
  • In the frenetic race to create ever-increasing content online, writers are in demand. Consider offering your skills as a freelance writer for one of a vast number of websites willing to hire good copywriters.
  • If you are not legally restricted, take what you do for a living and offer it to others for a fee. If you’re an in-house accountant, offer to handle your friends’ tax returns. That’s seasonal work, but it could provide enough self-employment income to cover the payroll tax increase for the entire year. If you do office work, find an opportunity to freelance data entry.

I’ve seen that those who begin to focus more on earning income by taking the initiative to make themselves available for freelance or consultant work based on their skills and passions start to see more opportunities. This is more than just earning an additional $250 each month. This could open doors to shaping an entirely new life in terms of income opportunities.

The elimination of the payroll tax cut is just one of those realities, a large-scale economic shift that everyone needs to deal with on an individual basis. We’d like to think we can keep all taxes low forever, but the society in which we would like to live requires funding. Low tax rates won’t remain, and in this case, the payroll tax cut was implemented as temporary from the start, like the Bush-era income tax cuts.

It’s up to the individual to prepare for the changes. When that means less coming home in the form of pay, the changes have to come from spending or income in order to leave saving unaffected. How will you prepare for the elimination of the payroll tax cut?

Photo: Flickr

Updated January 2, 2013 and originally published December 31, 2012. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 20 comments… read them below or add one }

avatar qixx ♦1,825 (Half-Dollar)

From my understanding the change will likely not happen for a few weeks. The IRS holding out for a last minute extension has not made the change. If no extension is given the IRS will likely make the change this week but it could take 2 weeks before it hits your paycheck. This could mean the first paycheck with the change will be higher than expected to makeup the difference dating back to the start of the year.

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avatar krantcents

The good and bad news was only my wife had the benefit of the lowered payroll tax. As a teacher, I am not in the Social Security system. Any increase in Social Security tax is offset by my savings in gas. I bought a hybrid car to replace my 17 year old Honda. I also have a shorter commute with my new teaching assignment.

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avatar Lance

I always thought it was funny they cut the social security employee rate when they said SS was not doing well financially… made no sense to me.

I’ll survive just fine without it. I got a small raise which will be negated by the fiscal cliff so I should be fine.

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avatar Christian L.

Lance,
I’m in the same boat. My raise will also be negated.

Such is life.

-Christian L. @ Smart Military Money

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avatar m

It must be nice to not have it effect you!! This could possibly break me!!

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avatar Tom Hannu

If $50-100/mo breaks you then you’ve been living outside your means for a while.

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avatar gette

There are many people who do not live beyond their means who will be greatly effected by losing this money every month.

avatar Don B

After I pay everything I have $82.00 and some change every two weeks, all of my bills are automated and go out on time. I know the exact amount I have to spen in gas for work and the $82 is what is left if I decide to or need to drive somewhere unexpected or treat myself to something once in awhile. And it’s not because I need to get a second job I’ve done this for a while I am 27 and my house will be paid off in September so yes 1600-2400 extra a month after but currently those payments are written into my mortgage. Some of us out there who do what I do may not be so lucky to say that. We purposely struggle to reap the rewards later but we get punished for that factor. Others of us it’s the difference if our child gets to go on a field trip with school or settles for 3 hand me downs. Everyone is different you don’t have to be outside your means for this to effect you.

avatar Rhonda Weiss

Exactly Tom. You just got to the bottom of most people’s financial issues.

avatar SteveDH

Just for the record Social Security did NOT take the hit for this tax reduction:
“The Social Security program, which is financed primarily by the earmarked payroll tax, has not lost any money over the past two years. While payroll tax revenues were down about $110 billion per year, the trust funds have been reimbursed from the general fund of the Treasury.”
Market Watch article 24 October 2012, Alicia Munnel.

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avatar Vickey Utting

Will this effect the portion matched by the employer?

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avatar LR

I have never understood why there is a cap on the taxable amount of one’s wages for SS and Medicare purposes. If these programs are in such dire fiscal shape as we are always being told, why don’t they just eliminate the cap on taxable wages? If everyone paid SS & MC taxes on all of their income (rather than to some arbitrary cap), I would guess that would solve the short-funding problem in a few short years. You never here this idea mentioned by news media or congress. Am I missing something?

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avatar SteveDH

The reason for the cap on earnings is the cap on benefits. As the law stands today there is a maximum amount you can receive in your monthly SocSec check. To do away with the earnings cap would do away with the cap on payments unless the law and formulas used to assign benefits is changed drastically.

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avatar LR

Thanks, Steve. I thought that might be the case. Still, it seems like a way to bolster the ss/mc programs with less pain than other proposed measures.

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avatar K Gollnick

Yes, my family knows we will NEVER see the level of $$$ we’ve paid into SocSec over our working lives. My husband calculated it once that if he had been allowed to bank his contributions to SS, with modest interest compounding, would have earned $1 million. However, we will NEVER EVER see that money back. That doesn’t take into account the SS contributions I’ve made during my work life.

As for ways to shore up SocSec., did you know that city, state, and federal employees do NOT pay into SocSec? It’s incomprehensible how much $$$ this equates to when extrapolating the amount of money not included by the numbers of people, city by city, state by state, and in WA DC who do NOT pay any social security tax. Instead, they have their OWN government-funded (read that “taxpayer funded” — you and me) pension fund.

I wish that we could come up with a transitional system of SocSec, maybe a half/half plan, so that those who paid into it could get retirement benefits, eliminate paying those who receive payments when they did NOT pay into it (except minors whose working and paying parent paid into it but died before the child came of age), eliminate disability so it’s reserved for retirement (what it was intended for), which may then allow younger workers to keep half or more of their FICA taxes (SocSec) for saving/investing for their own retirement.

Smart people should be able to fix this. The problem is, too many in Congress just want theirs. And harken to too many lobbyists and deep pockets.

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avatar JCinVA

K,

Not sure where you got your information from, but I am a federal employee and we do pay into social security! The old CSRS system did not, but FERS employees do, which was since 1986/7 timeframe. Unfortunately I got in the government in 1988 when I was 18. I would rather not because the government doesn’t know how to balance a budget. I could invest that money better and pay for myself.

avatar JCinVA

My husband is a Fairfax County employee and he pays into SS as well so you’re wrong there too.

avatar Lori

I am a Federal Govt employee, and I definitely pay into social security. I have worked
for the FAA since jan 1990 & for at least the last 8-10 years, have paid the maximum, or reached the cap. You may be thinking of a time long ago, when some people were hired in under the CSRS , civil service retirement, that no OASDI was collected, but everyone hired after the FERS system went into effect, is paying into social security.

avatar K Gollnick

Thanks for the additional info. This is curious, because I applied for a city job in human resources, and that’s when I learned that city, county, state and fed employees did not pay into the SS system like the private sector. Now I wonder if this is regional, or perhaps state by state? I don’t know why. The state where I lived at that time was Washington State in the Pacific Northwest.

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avatar K Gollnick

Just did a quick search online – this article sheds some light into the question of government employees and Social Security:

“Originally, the Social Security program excluded government workers. Changes in the law have now allowed states to add optional Social Security coverage to their public pension plans. However, many employees opted out of coverage. Laws have excluded some public employees from coverage and mandated coverage for others.”

And this: “Congress added Section 218 to the Social Security Act effective 1951, authorizing states to provide optional Social Security and Medicare coverage for employees. Approximately 25 percent of government employees still do not pay into Social Security. Beginning April 1986, all new employees and most current government employees pay into the Medicare program, even if they do not participate in Social Security.”

Here’s a link to the full article: http://tinyurl.com/afqrglx

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