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Payroll tax cut losers

By Kay Bell · Bankrate.com
Tuesday, January 11, 2011
Posted: 11 am ET

The first paychecks of 2011 are being prepared. Or maybe you've already gotten one.

You might be in for a surprise.

Despite all the talk about the 2 percent payroll tax cut that's in effect this year, including by me here on Bankrate's Taxes Blog, some folks won't get any benefit from the new law. In fact, they could pay a bit more in withholding in 2011.

The problem is that old law of unintended consequences. In this case, we have the Making Work Pay tax credit, which expired in 2010, and the new payroll tax cut from 6.2 percent to 4.2 percent colliding.

The bottom line is that people who don't earn much will end up getting nothing from the payroll tax reduction.

Here's the deal.

If you worked last year, the Making Work Pay credit afforded you up to $400 in extra income last year. A married couple filing jointly got a possible $800 bonus. Although the credit was accounted for in your 2010 paychecks via reduced withholding then, you'll actually claim it when you file your tax return this year.

Once a worker starts making more than $20,000 or $40,000 if married, then the bonus of the payroll tax cut will be felt.

So single workers making less than $20,000 and couples earning less than $40,000 actually will receive less from the payroll-tax cut than they did from the Making Work Pay credit.

And remember all that talk about tax breaks for the rich that preceded the law change creating the payroll tax cut? Those wealthy workers are the ones who are going to really benefit from this new law.

An extra 2 percent in pay for a worker making $50,000 comes to $1,000, much more than the $400 available via the Making Work Pay credit.

The news is even better for those making more. The payroll tax cut applies on earnings up to $106,800. That's the Social Security wage base limit, the top amount at which payroll taxes to pay for that government benefit are withheld. If you make more than that, you don't pay any taxes into Social Security out of your income above that threshold.

Someone making $106,800 this year will get $2,136 more in pay. If a husband and wife each makes that much, they get double the tax break with the payroll tax cut. It makes the Making Work Pay amounts look paltry, doesn't it?

Even better: High earners don't have to worry now about the income limits that applied to the Making Work Pay credit. Last year's tax break was reduced for single taxpayers with modified adjusted gross income between $75,000 and $95,000 and for joint filers with earnings between $150,000 and $190,000.

And around 6 million workers employed by Uncle Sam and state and local governments won't get any payroll tax relief because they don't contribute to the Social Security system.

So for some, the payroll tax cut isn't a tax break at all. For others, it's a much more generous tax benefit. As the old saying goes, life (and taxes) just ain't fair.

Make sure you get all the latest tax news and tips this filing season by subscribing to Bankrate's free Daily Tax Tip newsletter.

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10 Comments
Reality Check
February 10, 2011 at 11:17 pm

We got quite a jolt when filling out our tax form this year. Turns out we earned a little more money last year, putting us just $3000 over what qualifies for getting the EITC. So instead of getting a refund, we owe the IRS over $900. Now we're changing our W2s to get extra money taken out each paycheck. Don't know how we are going to come up with the $900 by April 18...

janet
January 17, 2011 at 12:28 am

1. I wish I had been able to figure out how to pay a tax preparer when I was making under 20K a coupld of decades ago.
2. Actually, I don't wish that at all. There was no good reason for me to have my taxes done by a pro.
Since this is about INCOME Tax, I really have to put it out there that the low income folks probably are hard working just like the "successful" ones.
4. This article seems to be implying that the FICA deduction cap is something new for 2011. Hasn't there been a cap in place for decades or since the very beginning with a few tweaks for increased salary levels?

Mallik
January 14, 2011 at 5:16 pm

I never knew someone could get a tax return more than they paid in taxes.. Mike how would that work? 1400+550 = 1950, how one got a return of 9K?

Mike
January 13, 2011 at 10:44 am

Kay,

Thank you for your reply. I have had the pleasure of helping individuals prepare their tax returns, some you would consider wealthy, others in the poverty range. I can certainly understand where you are coming from in regards to MWP, but a large majority of my clients because of various deductions, filing status (single / head of household etc) often times do not end up paying federal or state taxes. Additionally, most in the $20k or less category actually got considerably more back in tax returns than most of my wealthy clients that have substantial deductions. How is it fair that one individual pays zero in the way of taxes, and additionally gets federal and state money returned to them while others are working hard, paying taxes, and are attacked for being 'successful'? From my perspective, it would appear that the taxes the wealthy / successful are paying simply get redistributed to those less fortunate. I would argue that those individuals making less than $20k should be thankful for the preferential tax treatment that they currently are receiving as it far outweighs the $400 MWP in of itself. Here is my example: A single parent, filing as head of household, with $18k of earned income, paid $1400 in federal, and $550 in state taxes, yet is receiving a tax return of over $9k. I realize everyone's situation is different, and I have no problem helping those less fortunate that truly need help, but fundamentally, the current tax system is flawed.

Kay Bell
January 13, 2011 at 10:04 am

Mike, everything in life, and especially taxes, is relative. As I said, those who are closer to wealthy will get more from this payroll cut, especially when compared to the Making Work Pay credit. Under the credit, folks making less than $20K got $400. Here they get less than $400. But those who, under the MWP couldn't get the maximum because they made more than $75,000 will now get the benefit of the payroll tax cut up to earnings of $106,800. Is $75K wealthy? I'd take it in a heartbeat and not count myself at rich. But it and the new cutoff of $106,8000 is much closer to wealthy than incomes of $20,000. Of course, I lived many years in Washington, D.C., and have friends in big cities like NY and LA and I know that the cost of living in those regions are markedly higher. Again, that relativity factor. But the bottom line is that this payroll tax cut for 2011 is going to cut out a large chunk of earners (the comments Bankrate has received so far have been from folks getting less, not more) at the lower income ranges.

Mike
January 13, 2011 at 9:05 am

Kay,

Could you be more specific as to how this tax break benefits the wealthy, in your opinion? And relatively speaking, what exactly would you consider to be wealthy?

Donald
January 12, 2011 at 6:05 pm

My wife's weekly pay is $410 before taxes. That
adds up to just over $21000 a year. Shouldn't her
paycheck be slightly more this year with the payroll
tax holiday than it was last year with the Making
Work Pay credit? So far it is not working out that
way. Her paycheck last week was about $2 less than
last year's weekly check. Can anyone explain why?

Kay Bell
January 12, 2011 at 12:06 pm

totally agree Elizabeth. But those who truly are closer to wealthy will benefit more from this tax break.

elizabeth
January 12, 2011 at 11:55 am

News flash - couples making over $40,000 are not rich!