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Payroll tax cut puts employers in quandary

Following the 2012 election, when Congress convenes to determine whether to extend the federal income tax cuts launched by President George W. Bush, it is unlikely that it will extend the 2010 payroll tax reduction.

Employers need to plan now to update payroll systems to address any changes, and to communicate to employees how their take-home pay might be affected.

The 2-percentage-point cut of the federal Social Security tax was part of an economic and jobs package enacted at the end of 2010. In February 2012, Congress approved an extension of the tax cut through the end of the year as a way to stimulate consumer spending. At the end of 2011 and beginning of 2012, President Barack Obama and Democratic leaders pushed to extend the payroll tax cut, but support for it has since dwindled.

“This has to be a temporary tax cut,” said Timothy F. Geithner, the U.S. Treasury secretary, when he testified recently before the Senate Budget Committee. “I don’t see any reason to consider supporting its extension.”

House Minority Leader Nancy Pelosi, D-Calif., told reporters in late September that it was time to let the payroll tax cut expire. According to sources familiar with the issue, both Democrats and Republicans would rather debate extending or amending the across-the-board federal income tax cuts enacted during the first term of President George W. Bush. Congress voted in December 2010 to extend all the Bush-era tax cuts through the end of 2012.

Congress failed to reach agreement on extending any tax reductions before adjourning the first week of October 2012. In addition, Congress did not make any changes to extensive reductions in federal spending that are set to take effect in January 2013. Many refer to the looming tax increases and deep federal spending cuts as “the fiscal cliff.”

The winner of the presidential election will have a tremendous impact on what the “lame duck” Congress ultimately decides. If President Obama is re-elected, then sources say GOP leaders will be much more willing to work with him and Democrats on extending the Bush-era tax cuts only to taxpayers whose annual household income is less than $250,000. If Romney is elected, then Republicans will try to delay or block any spending and tax policies supported by Obama and the Democrats, according to observers and sources familiar with the issue.

A slight chance still lingers that Congress could alter course and approve an extension of the Social Security payroll tax cut. Jan Hatzius, chief economist of the investment bank Goldman Sachs, has estimated that allowing the tax cut to expire would reduce U.S. economic growth in 2013 by 0.6 percent. He and other Wall Street economists have begun promoting an extension of the 2-percentage-point cut.

Impact on employee paychecks

Any changes to the Social Security payroll tax or federal income tax rate will affect everyone’s take-home pay, so employers should prepare their employees by explaining the implications. Expiration of the Social Security tax cut will mean that middle-income families will see their federal taxes increase between $700 and $1,000 in 2013, according to estimates from the Congressional Budget Office (CBO). If the Bush tax cuts are allowed to expire, then CBO projections reveal that middle-income workers could see their annual federal tax bill increase an average of $3,500.

Adjusting payroll systems

Employers faced the same uncertainty at the end of 2010 as Congress waited until mid-December to extend the Bush-era tax cuts and then again at the end of 2011, when, less than a week before Christmas, Congress passed a two-month extension of the Social Security payroll tax cut and then approved another 10-month extension in February 2012.

Employers are advised to be prepared and have the systems and software in place to make the proper withholding adjustments when Jan. 1, 2013, rolls around.

Bill Leonard is senior writer for SHRM.

©2012 SHRM. All rights reserved.

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