New law includes a payroll tax cut

There’s a new tax break this year, and you’ll want to update your budget to accommodate it. The compromise tax legislation passed in December included a payroll tax cut for 2011.

  • How it works when you’re an employee. Your employer will deduct less social security tax from your wages during 2011.Prior to the change, your employer was required to withhold social security tax from your paycheck at a rate of 6.2% of the first $106,800 of your wages. That rate was reduced to 4.2% for 2011, meaning your take-home pay will go up — with no impact on your eventual social security benefits and no payback required.The Medicare tax rate remains unchanged at 1.45%, which your employer will continue to deduct from your check.
  • How it works when you’re self-employed. You’ll pay less self-employment tax.In the past, you calculated self-employment tax using a 12.4% rate for the social security portion. For 2011, the rate you’ll use is 10.4%.Your income tax deduction — that is, the amount of self-employment tax you subtract from ordinary income — will not be affected.
  • How it works when you’re an employer. The reduced rate only applies to the social security tax you deduct from employee wages in 2011. To calculate your expense, you’ll continue to use the 6.2% rate for social security tax, plus Medicare tax of 1.45%, for a total of 7.65%.You have until January 31 to implement the change, and until March 31 to refund any overwithheld social security tax to employees.

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