Payroll Tax Holiday: Why Most People Will Get A Raise In 2011

Many people will receive (or have already received) their first paycheck of 2011, and notice something different. Thanks to the Payroll Tax Holiday, there will be a reduction in the amount of payroll taxes taken out of our paychecks in 2011!

What Is The Payroll Tax Holiday?

As part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 that was signed into law on December 17, 2010, there will be a temporary reduction in the employee’s share of the Social Security portion of payroll taxes from 6.2% down to 4.2% in 2011.

The payroll tax holiday (also known as the FICA cap for 2011) essentially means that workers who currently pay into the Social Security system will receive a 2% pay increase in 2011. For 2011, Social Security OASDI (Old-Age, Survivors, and Disability Insurance) payroll tax is only applied to the first $106,800 that a taxpayer earns, and so the benefit will only be fully realized by workers who make that or less in 2011.

Just keep in mind that since the Making Work Pay Tax Credit ended at the close of 2010, the decrease in Social Security payroll taxes will be slightly offset by the increase in your Federal Tax Rate (check the Income Tax Rates for 2011 to see where you stand).

How Are Employers Affected By The Payroll Tax Holiday?

Employers are responsible for withholding Social Security taxes from your paycheck. Therefore nothing is required on the part of the employee to facilitate this change. However, employers have until January 31, 2011 to make the change in their payroll systems, due to the late passing of the Tax Relief Act (which also lead to the tax deadline being extended).

The payroll tax holiday only pertains to Social Security taxes, and not to Medicare:

The Hospital Insurance (HI) or Medicare tax remains at 1.45% of wages, for both employee and employer. Employers should not make any adjustment to the withholding and payment of Medicare tax for any employees, including government employees who are covered by Medicare tax only (not social security).

To Whom Does The Payroll Tax Holiday Not Apply?

There are some workers who will not see a benefit from the payroll tax holiday. We already mentioned that those making over $106,800 in 2011 will only see a partial benefit. However, the IRS points out another group who will not benefit:

The reduction only applies to wages paid that are subject to the social security tax. Thus, if a state or local government entity has established a retirement plan that is a replacement or substitute for social security and the entity does not also have a section 218 agreement providing for social security coverage, the reduction does not apply. Further, the reduction also does not apply for Federal employees who are covered by the Civil Service Retirement System.

What To Do With The Extra Money?

I was really hoping that you’d ask that question! You can use the extra money to increase your retirement account by taking advantage of the 401k contribution limit or at least enough to get the full 401k employer match!

You can even open up an IRA for 2010 in order to increase your 2010 tax return, or build up one for this year – here are the IRA contribution limits.

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