What happened to my paycheck?

After receiving the first paycheck this year many employees had a moment of shock and awe. The immediate response was likely a desire to run to whoever processes payroll and demand to know why they had received a pay reduction. However, the decrease in take-home pay was not a result of a bad work ethic or a failure to bring your boss coffee; it was a result of the expiration of the Payroll Tax Holiday (which began in January 2011).

Social security tax is made up or two parts. Traditionally, half would be paid by the employee and the other would be paid by their employer. Prior to the Payroll Tax Holiday both the employee and the employer were paying 6.2%, for a total of 12.4% being paid towards social security. As part of an economic stimulus package, in January 2011 Congress agreed to reduce the employee portion of the payroll tax from the 6.2% to 4.2%. The idea was that with the reduction of taxes paid into the social security program the employee takes more money home each pay. With rising gas prices and a slowing economy, employees taking home extra money in their paycheck had more to spend. Spending stimulates the economy.

Originally the Payroll Tax Holiday was set to expire in January 2012. However, as part of the Middle Class Tax Relief and Job Creation Act of 2012 it was extended through December 31, 2012. The new “Fiscal Cliff” Act that passed this January did not extend the Payroll Tax Holiday. Beginning January 1, 2013 the social security tax rates for employees reverted to the previous rate of 6.2%.

Unfortunately it does not appear at this time that the reduced employee social security rate will be returning. Below is an example of how the reinstatement of the 2010 social security rates affects the employee. It should be noted that the employer was obligated to pay 6.2% throughout the tax holiday, never paying a reduced rate.

John Doe works as a manager of a rental car company. He earns $39,000 a year or $1,500 dollars every two weeks.

In 2012 John paid $63, or 4.2% of $1,500, every two weeks. At the end of the year John will have paid $1,638 in social security tax.

In 2013, if John continues to make the same money, he will pay $93, or 6.2% of $1,500, every two weeks. At the end of the year John will have paid $2,418 in social security tax.

The increase in social security tax for John Doe is $780 a year, or $30 each pay. A good rule of thumb is that for every $100 dollars you make (before taxes) you will pay an additional $2.

Late on January 1, 2013 the fiscal cliff had been averted. The American Taxpayer Relief Act had passed both the Senate and the House of Representatives and now awaits President Barack Obama’s signature. While many details of the bill are still unavailable, the act starting in 2013, permanently extends some provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRAA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). We wanted to provide you with information that is currently at hand.

Individual Taxes

Marginal tax rates:

      • All individual marginal tax rates under EGTRAA and JGTRRA are retained. (10%, 15%, 25%, 28%, 33% and 35%)
      • A new top tax rate of 39.6% is added for taxable income over:
        • $400,000 for single filers
        • $425,000 for head-of-household filers
        • $450,000 for married taxpayers filing jointly
        • $225,000 for each married spouse filing separately

Phase-out of personal exemptions and itemized deductions reinstated to:

      • $250,000 adjusted gross income for single taxpayers
      • $275,000 adjusted gross income for heads-of-household
      • $300,000 adjusted gross income for married taxpayers filing joint

Capital gains and dividends:

      • Zero rate for taxpayers in the 10% and 15% tax bracket
      • 15% rate for taxpayers in the middle brackets (25%, 28%, and 33%)
      • 20% rate for taxpayers in the top bracket, 39.6%

Alternative minimum tax (AMT):

      • Permanently indexed for inflation.
      • Relief from AMT for nonrefundable credits is retained

Individual tax credits extended through 2018:

      • The American opportunity tax credit for qualified tuition and other expenses of higher education.
      • Child tax credit
      • Earned income tax credit

Energy tax credits extended through 2013:

      • The tax act also extends various deductions through 2013 and makes others permanent.

Estate and gift tax:

      • Estate and gift tax exclusion stays at $5 million indexed for inflation.
      • Top tax rate increases from 35% to 40% effective January 1, 2013.
      • The “portability” election was made permanent by the act.

Business Tax Credits and other provisions extended through 2013:

      • Research and development credit, modified to allow partial inclusion for acquired trade or business or major portion of one.
      • Increased expensing amount under Section 179
      • 50% first-year bonus depreciation under Section 168(k)
      • 15 year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
      • Reduction in S Corporation recognition period for built-in gains tax
      • Energy tax credits
      • Various other provisions

New taxes not in the act:

    • Additional hospital insurance tax on high-income taxpayers:
      • Normally 1.45% of covered wages, is increased by 0.9% on wages that exceed:
        • $250,000 combined wages of a joint return or surviving spouse
        • $125,000 for married individual filing a separate return
        • $200,000 for a single individual or head-of-household return
    • Additional Medicare tax of 3.8% of the lesser of the individuals’ net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds:
      • $250,000 for a joint return or surviving spouse
      • $125,000 for a married individual filing a separate return
      • $200,000 for a single individual or head-of-household return
    • Threshold increase for unreimbursed medical expenses from 7.5% of AGI to 10% of AGI.
      • For taxpayer or spouse age 65 before the end of 2013, the threshold remains at 7.5% for years 2013 – 2016.
    • Maximum flexible spending arrangement is $2,500 for plan years beginning after December 31, 2012.

Many of the details of the American Taxpayer Relief Act are not available; as they become available we will keep you informed.

For more information contact Emily Norman, CPA from PKS & Company P.A. at 410-546-5600 or [email protected]

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