I am very confused. Your blog says that we will be getting back more money this year because of the payroll tax holiday. My withholding must be screwy because I am making less money. What is going on?
Okay, this is where tax laws can get really confusing.
Yes, there is a payroll tax holiday this year. This means that instead of paying in to Social Security at 6.2%, you’ll pay in at 4.2%. In theory, this means you’d see 2% more in your check.
However, if you were previously affected by the Making Work Pay Credit (most folks were, unless you were phased out or made a change to your withholding), it’s not going to be a net extra 2% in your check from last year. This is because your withholding was likely adjusted by the tables in 2010 to reflect the Making Work Pay Credit. Since that credit wasn’t extended, the extra that you saw in your paycheck last year disappears and in its place, you’ll see the 2%.
Here’s a quick example:
Let’s say your income is $50,000. And let’s assume that you’re married and received the entire Making Work Pay Credit in 2010. Let’s also assume that your withholding was adjusted to reflect the credit during the year. That means that your employer withheld about $15.38 less each week. At the end of the year, you were $800 better off.
This year, you won’t get that $800. Your withholding will be adjusted so that the extra $15.38 is not reflected in your check. What happens instead is that you will get the 2% break. Assuming a weekly paycheck, that means that you would see an extra $19.23 (2% of your weekly salary of just under $1,000). At the end of the year, you will have “saved” $1,000 with the break (2% of $50,000).
Where it gets tricky is that in terms of sheer dollars, you’re not $1000 ahead of last year, you’re $1,000 ahead of where you would have been without either credit. You’re actually only $200 ahead of last year ($1,000 for 2011 versus $800 for 2010).
For most taxpayers, that should mean that you will see more money in your paycheck. But as I explained in this prior post, the break isn’t equal – in terms of dollars – for all taxpayers because the payroll tax holiday is calculated based on a percentage of your income. The Making Work Pay Credit was a flat amount. The math works out so that some taxpayers will be better off, some will break even and some will be less well off.
If you’re concerned about whether you need to adjust your own withholding, check with your tax professional. You can also use the withholding calculator on the IRS web site. Be aware, though, that the calculator has not yet been updated to reflect the new law – the IRS hopes to have it running properly some time this month.