Congressional uncertainty brings taxing challenges

January 9, 2012
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Yet another Congressional case of uncertainty could affect the financial plans of businesses and the self-employed this year. This time, the focus will be on a portion of the payroll tax, as Congress only extended last year’s reduced rate for employee Social Security tax last month for two months after the cut was in place for a full year.

Chances are Congress will grudgingly slog its way to a year-long extension, but probably not until the deadline nears — the usual time when most of its decisions are made. There isn’t a guarantee that will happen, however, based on the outcome the appointed debt-reducing Super Committee had last fall and with 2012 being an election year.

As it now stands, employers will continue to withhold 4.2 percent from workers’ paychecks for their portions of the Social Security tax that covers the retirement benefit, but only through Feb. 29. Unless the U.S. Senate and House agree on an extension before that date, businesses will then revert to withholding the full 6.2 percent from those paychecks March 1.

At the same time, the annual wage ceiling for the tax has risen to $110,100 this year, up from $106,800 last year. So employers have a new prorated payroll amount they should track over the year’s first two months. Congress arrived at that figure by taking one-sixth of the full base wage of $110,100 for the extension period, which is $18,350 for January and February.

But Dan Lynn, a CPA and tax partner at BeeneGarter LLP, said employers don’t have to implement a cap of $18,350 on wages that are earned during the two-month extension period.

“If an employee’s wages during the first two months of 2012 exceed $18,350 and the payroll tax is not extended for the remainder of the year, then an amount equal to 2 percent of those excess wages would ultimately be required to be paid on the employee’s individual tax return for 2012,” said Lynn, who has more than 20 years of experience in this area.

There are a few other things of which Lynn felt companies should be aware. All employers will continue to pay their full 6.2 percent share of the 12.4 percent tax through the extension and beyond, while the Medicare portion of the tax remains at 2.9 percent. The Medicare portion doesn’t have a ceiling like the retirement part does, so that tax must be paid on every dollar earned.

Lynn also pointed out that most employers use payroll software to calculate paychecks and may need to update those programs to get through at least the extension period.

“There is a little bit of catch-up time for the software vendors to incorporate all this into their software. Depending on the software vendor, January could be a tough month for a lot of employers because if the software vendors haven’t updated their programs, there could be some issues there,” he said.

“The IRS has recognized that there could be issues the first month or two of the year and, consequently, some employees could be over withheld. So the IRS is giving employers until March 31 to correct those types of issues,” he added.

Lynn said employers who use outside firms to compute payrolls may have fewer concerns, but they should check with those companies to see if their software has been upgraded. On the other end of the spectrum, however, are small businesses that use popular accounting software programs like Intuit’s QuickBooks to handle payroll.

“One thing about QuickBooks is you have to update that software because you only get the payroll tax updates when you update the software. So if small employers that use programs like QuickBooks aren’t getting the updates right away, they could run into some particular compliance issues. So if we’re going to see issues, that is where they’re probably going to be,” he said. “They are really going to have to be sure to keep their software up-to-date.”

As for the self-employed, Lynn said they have parallel rules to follow. Although they normally pay the full Social Security tax of 12.4 percent, they enjoyed the same 2 percent cut that employees received last year and will receive through February, which lowers their levy to 10.4 percent. But if an extension isn’t approved, they go back to paying 12.4 percent March 1.

“I think it’s going to be particularly important for self-employed individuals to make sure they have good records as far as what their earnings are for the first two months of the year. Because for self-employed individuals, the way the law stands right now, they could be taxed at one rate on income for the first two months of the year and at a different rate on their income through the rest of the year,” said Lynn.

“If you’re an employee, it’s easy to show a paycheck stub to show what you’ve earned the first two months of the year. But if you’re self-employed, you need to be able to demonstrate to the IRS what your income for the first two months of the year was. So if you want to talk about challenges, there is a challenge right there.”

The Business Journal presented Lynn with a possible worst-case scenario: if Congress doesn’t extend the tax-reduction extension before the end of February and the tax rate rises in March, but then Congress reaches an agreement on an extension in, say, April — which would mean employers would have to change their withholding rate three times in a matter of a few months.

“It could happen. As far as prorating this ceiling amount, they addressed a potential issue there so they actually thought of that. But often it seems like legislation happens without regard for what it’s going to do from a compliance standpoint,” Lynn said.

“So if Congress were to do what you just described, all of these issues that we talked about with the payroll vending companies and people calculating their payroll, it would create a tremendous amount of uncertainty and confusion — particularly, in the months of March and April.”

As a bottom-line remedy for a situation that could go from being mildly uncertain to wildly confusing, Lynn suggested that companies contact a CPA for advice.

“There may be some additional issues with highly compensated employees, like the FICA ceiling,” he said. “But I think for the most part, pretty much most employers out there are going to face similar challenges.”

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