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Archives for February 2012

Payroll Tax Cut Extended

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Quick Background on Payroll Taxes

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed people.  One tax is the Old Age, Survivors and Disability Insurance (OASDI, commonly known as the Social Security tax).  The other tax is for Hospital Insurance (more commonly known as Medicare A).  The Social Security tax has been 6.2% and the Medicare tax has been 1.45%.  An employee pays the 6.2% Social Security Tax on her first $110,100 of wages (this wage base changes periodically), and pays the 1.45% Medicare Tax on all wages without limit.  The employer must match employees’ Social Security and Medicare Tax contributions.  Therefore, the employee pays a combined Social Security and Medicare tax rate of 7.65% of wages and the employer matches this 7.65% contribution for a combined FICA rate of 15.3%.

Self employed people pay both employer and employee portions of the tax on their self employment income.  The self-employment rate has been 15.3%.  There are two adjustments that self employed people make that are related to self employment tax:

  • The first adjustment is to multiply self-employment income by 0.9235. This adjustment basically allows the employer portion of FICA taxes to be deducted from self employment income.  Notice that the 0.9235 number is equal to 1 – 7.65%.  7.65% representing the employer portion of FICA

Example:  Joan has $100,000 of self employment income from her proprietorship.  She multiplies this income by 0.9235 and the product is $92,350, which is equal to her $100,000 self employment income less the employer portion of 7.65%.  The self employment tax rate of 15.3% is then multiplied by $92,350 to arrive at self employment tax of $14,129.

  • The second adjustment is a deduction equal to one-half of the self employment tax on the self employed person’s tax return.

On Joan’s personal tax return, she would be allowed an above the line deduction of $7,064.50 (one half of the $14,129 self employment tax).

What’s New

During 2011, the employee portion of Social Security was reduced to 4.2% from 6.2%.  The Social Security tax for self-employed individuals was 10.4% (6.2% employer portion plus 4.2% employee portion).  In December 2011, when Congress couldn’t agree on how to fund a full-year extension of the payroll tax cut, it passed the Temporary Payroll Tax Cut Continuation Act of 2011 that provided a two month extension of the 4.2% employee Social Security rate.  On February 17, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012.  This new law extended both the 4.2% Social Security employee portion and the 10.4% Social Security portion of self employment tax until December 31, 2012.

The maximum savings for 2012 will be $2,202 (2% of $110,100) per taxpayer.  If both spouses earn at least as much as the wage base, the maximum savings will be $4,404.

An additional change is made for the above the line deduction for self employment tax.  The deduction is normally one half of the self employment tax to reflect the half that represents the employer portion of the tax.  However, the employee portion of the Social Security tax is 4.2% while the employer portion of the Social Security tax is 6.2%.  Thus, the deduction for Social Security tax is now 59.6% [6.2% employer portion divided by combined employer and employee Social Security tax of 10.4%].  The deduction for the Medicare portion of the self employment tax remains at 50% since the 2% reduction applied only to the Social Security Tax.

Example:  It is now 2012 and Joan still has $100,000 in self employment income.  The first adjustment is still to multiply her $100,000 income by 0.9235.  The product of $92,350 is multiplied by the Social Security portion of self employment tax of 10.4% to arrive at $9,604.40.  The $92,350 is also multiplied by the Medicare portion of self employment tax of 2.9% to arrive at $2,678.15 for a total self employment tax of $12,282.55.  Notice that the self employment tax is less than the first example by $1,846.45.  This difference is due to the 2% reduction in the Social Security portion of self employment tax times the self employment income of $92,350.

To calculate Joan’s above the line deduction:

  • multiply the Social Security portion of self employment tax by 59.6% ($9.604.40 times 59.6% equals $5,724.22)
  • multiply the Medicare portion of self employment tax by 50% ($2,678.15 times 50% equals $1,339.08)
  • Joan’s total above the line deduction for self employment tax is $7,063.30.
Thus, Joan has to cut a check for $12,282.55 to cover self employment tax.  The $7,063.30 above the line deduction for self employment tax is multiplied by her individual tax rate to determine its value.  If Joan is in the 30% bracket, the $7,063.30 deduction will reduce her income taxes by $2,118.99.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

 

Changes to Federal and Michigan Unemployment Taxes for 2012

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There have been a number of changes to federal and state unemployment taxes over the past year.  This post will describe some of those changes.

Federal Unemployment Tax

As you may have noticed on your Form 940 (Federal Unemployment Tax) for 2011, there were two federal unemployment tax rates during 2011.  A 0.8% rate applied to wages through June 30, and a 0.6% rate applied to wages paid from July 1 to December 31.  This 0. 2% FUTA tax reduction was due to the repeal of the FUTA surchage.  The 0.2% surcharge was originally added to the FUTA tax rate in 1976 to shore up the federal unemployment tax system.  The surcharge is not tied to unemployment benefits workers receive, so the elimination of the surcharge will not affect unemployment benefits.  The FUTA tax rate for 2012 remains at the lower 0.6% FUTA tax rate.

State Unemployment Tax

As of last year, the State of Michigan owed $3.267 billion to the federal government to finance unemployment tax payments to the unemployed.  To help pay off this federal debt, the State imposed a 0.75% increase in state unemployment taxes.  Additionally, when a state is unable to repay federal debt used to finance unemployment benefits, businesses located within that state have to pay a higher FUTA tax rate.  Since Michigan was one of those states in 2011, it had to pay an additional 0.9% FUTA tax rate.  This 0.9% rate was in addition to the 0.8% and 0.6% tax rates explained above.

The 0.75% Michigan solvency tax was insufficient to repay the federal debt.  As a result, the State of Michigan issued $3.323 billion in bonds in December 2011 to repay the federal debt.  Since the federal debt is now repaid, the additional 0.9% FUTA rate will no longer apply in 2012.  Additionally, the 0.75% Michigan solvency is also repealed.  However, the Michigan solvency tax has been replaced with an Obligation Assessment which will be used to repay the Michigan bonds that were used to repay the federal debt.  This Obligation Assessment will be an increase to your state unemployment tax rate beginning in 2012.  In Michigan, 100% of unemployment insurance is employer-funded, so Michigan employers will be responsible to repay the bond issue.  The Obligation Assessment is based on your current state unemployment tax rate and will be roughly one-half to three-quarters of a percent.  Bottom line:  the Obligation Assessment will be roughly equal to the state Solvency Tax, but employers are slightly better off because the additional 0.9% FUTA tax rate will no longer apply.

There are other changes (i.e., tax increases) to Michigan unemployment taxes as a result of the bond issue:

  • the tax base is increased from $9,000 to $9,500 (In 2011 employers paid state unemployment taxes on the first $9,000 of wages.  Starting in 2012, employers will pay state unemployment taxes on the first $9,500 of wages.)  However, if the state Unemployment Trust Fund reaches a certain surplus amount, the tax based will be lowered to $9,000.
  • The part of your unemployment tax rate that is based on your employees’ unemployment claims is changing.  Prior to 2012, the tax rate was based on the past 5 years of unemployment claims.  In 2012, the unemployment claims experience component of your tax rate will be based on 4 years of unemployment claims and in 2013, 3 years of unemployment claims.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.