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?
Updated January 2, 2013 and originally published December 31, 2012.