New 2011 Tax Plan Highlights: 2% Payroll Tax Reduction, Extension of Current Tax Rates

Our tax rates for the next two years have been decided, a two whole weeks before January 1st! Just in time for their winter break, what a coincidence. ;) The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010″ was signed into law last Friday. There’s a lot of stuff in it, as with any tax-related it seems, but here are the two big highlights for individuals:

Payroll Tax Cut

The employee portion of the Social Security tax is reduced to 4.2% in 2011, down from 6.2%. This lasts only for one year. The employer portion remains unchanged at 6.2%. The limits on wages subject to Social Security tax remains at at $106,800 for 2011. Medicare taxes remain unchanged at 1.45% each for employers and employees.

For example, someone earning $50,000 will pay 2% less towards Social Security, for a tax savings of $1,000 spread out over a year of paychecks. The maximum savings per person is then $2,136. Your future Social Security benefit is not directly affected by this change.

However, what has been expired is the “Making Work Pay Tax Credit” of 2009 and 2010, which was a refundable tax credit 6.2 percent of earned income, up to $400 (single) or $800 (married filing jointly). This meant that if you were single with earned income of at least $6,452 in 2010, you got a $400 tax credit. Married couples filing joint returns earning over $12,903 got $800. Note that this tax credit was phased out for taxpayers with modified adjusted gross income in excess of $75,000 (single) or $150,000 (married couples filing jointly).

Net Benefit
Here’s a chart from the Tax Policy Center showing the net difference in tax savings from two as a function of earnings.

As you can see, our example of a single person earning $50,000 would be paying approximately $600 less in taxes in 2011. (Gain of $1,000 payroll tax cut, loss of $400 MWP tax credit.)

Current Individual Income Tax Rates Extended

The current income tax rates, sometimes referred to as the “Bush Tax Cuts”, are extended for everyone for two years. Although the exact income ranges are not set, here are projections from the tax software provider CCH Group. They are slightly higher than the 2010 Federal tax brackets, due to inflation.

For the curious, it is estimated that an individual earning $50,000 in 2011 will paying $890 less in federal income taxes as compared to what would happen if no action was taken (even though that was highly unlikely).

Also…

  • The top rate of 15% for qualified capital gains and dividends is extended for another two years, along with the 0% rate for taxpayers in the 10 and 15 percent income tax brackets.
  • Another last-minute patch was made for those subject to the Alternative Minimum Tax because the brackets were not mandated to be adjusted with inflation. The 2010 exemption amount will be $47,450 (single) and $72,450 (married filing jointly).
  • Extended unemployment benefits are to be continued at their current level for 13 months.

Since we know that the income and capital gains tax rates will stay the same for the next two years, the standard end-of-year tax actions should apply. The general idea being to take any deductions you can right now, and defer as much income as possible until next year.

Comments

  1. It’s actually 54 weeks before the January 1st that matters. Congress can and does make changes up to the end of the year and applies them retroactively. This is why you can’t download the final versions of Turbo Tax, TaxAct, or TaxCut until after Jan 1st. Congress has all of 2011 to make whatever changes they want to taxes due for 2011 and payable 15 April 2012. All they’ve done is kept from having to make retroactive laws and enabled more proper withholding over the course of the entire year.

  2. unless i am reading the graph wrong, it appears that married couples have more to gain from the changes. so any thoughts from the proponents of the marriage tax penalty?

  3. Go national deficit go!!

  4. @Sunil – I think the graph is labeled wrong; instead of saying “married couples”, it should say something like “two income families with essentially identical earnings between the two incomes”. Guess it didn’t fit on the chart.

    Simply put, the “married couple” saves more from this because they have two seperate incomes that are both subject to the payroll tax, so they can end up saving more on the upper income ends. Also note that because the income is split between two workers, they are also subject to more payroll taxes on that income, so it all works out.

  5. Dominicanoendeuda says:

    I wonder how these credits will really impact the economy in general. They are aimed to stimulate the economy but due to the current environment I dont think the majority of the people will in fact spend it.

    Savings rates are low but people are more incline to save than just spend the money away.

  6. according to the tax table for singles, I should be charged 10%-15% in taxes, yet I’ve NEVER actually been charged income tax in my life (either thru refunds of all withholdings or my return showed I didn’t owe any tax). Why do they even bother saying those brackets exist? From the standard deduction and EITC it comes to $0.

    (Of course I’ve been charged SS & medicare tax btw)

  7. Does any of you get hit with the AMT? That $47.5K looks awfully low.

  8. @pogo – You bring up a good point, that these charts always say “taxable income”. Things like the standard deduction and personal exemptions reduce the amount of your income that is taxable. It’s impossible to include every possible combination of deductions/exemptions that people/couples/familes are eligible for.

  9. I’m afraid I’m going to get hit with AMT! Yikes.

  10. @Sunil – The marriage penalty was dead with the Bush Tax cuts. There is no longer a marriage penalty. (Most marriage penalties were removed).

    This FICA tax reduction is another perk for the married, since both people can get the tax reduction.

  11. I understood the “marriage penalty” as the lower bracket limits for a married couple are double the single taxpayer bracket, whereas the higher bracket limits are less than double. If that’s the case, then the penalty is still in effect.

    For example the high end of the single taxpayer’s 25% bracket is $83,600. Twice that amount is $167,200, which is greater than the top of the married 25% bracket at $139,350.

    So a couple of college-educated DINK’s working professional jobs in a coastal area end up in the 28% bracket as a married couple, when they’d each have topped out at 25% then if they’d stayed single.

  12. @ Randy

    Exactly! My wife and I fit into your exact scenario. We withold at the higher single rate AND have additional witholding on top of that whereas our single friends at the same job and pay rate don’t have to have additional witholding.

    A tax motivated divorce my save us a bundle!

  13. “Does any of you get hit with the AMT? That $47.5K looks awfully low.”

    AMT is a little complex.

    That $47.5 amount is the amount of income that is entirely exempt from AMT. If you make under that then AMT will never apply. If you make over $47.5k then you figure AMT based on a 26% tax of the taxable amount over $47.5k. You still get to subtract many of your normal deductions.

    AMT is never higher than the amount you would pay for normal taxes if you had the standard deduction.

    Lets say you make $100k. You exempt the first $47.5k so that leaves $52.5k. AMT tax rate on that is .26 so we’re looking at an AMT tax of $13.65k.

    If you make $100k and take the standard deduction then your tax is $19k.

    You pay the higher amount so in this case you pay $19k.

    Now lets say you make $100k and have a bunch of weird deductions for $30k so you itemize and your taxable deductions get your taxable income down to just $66k, then your normal tax is only $12k. THe AMT of $13k is higher so you’ll pay the AMT rate instead. Your tax bill is $13k total. Keep in mind when I say “weird deductions” it does not disqualify stuff like your home mortgage interest, but it does disqualify state/local taxes. So its a mix of somethings being deductible off AMT and some not.

    AMT does not “add” extra super bonus tax or anything. Its a MINIMUM tax rate.

    Unless you have a high income and high deductions then AMT will never impaxct you. AMT only sets a minimum level of tax that is far lower than the tax based on a standard deduction.

  14. I should point out that my discussion of AMT is simplified a bit. Thers more details than that like the AMT rate is 29% over a certain level. What you can/can’t deduct from AMT is also a bit complex. I made an example just to illustrate the basic point and I’m leaving out details.

    People are more afraid of AMT then they should be.

  15. TAX = THEFT

    The idea that tax cuts for the “wealthy” is a give away is fundamentally flawed – it’s our money in the first place.

    Our government does not have a revenue problem – it has a spending problem.

    Stop stealing and spending my money.

  16. Jim,

    Thanks for that explanation..it was really helpful!

  17. How can they cut the S/S payroll tax and say it will not affect future Social Security benefits? Does not make sense given the poor state that S/S is in now. After this recession, it will be in worst shape than ever with payroll tax cuts, unemployment etc. Somebody’s getting duped!

  18. I agree with Johnny. And on another note, how in the world does cutting ss tax create jobs? It is just reducing revenue from the lucky people (I’m one) who are gainfully employed.
    Doesn’t make sense to me…of course, a lot of what Obama does doesn’t make sense to me anyway.

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