What Does the Payroll Tax Increase Mean for You?
While the fiscal cliff legislation passed by Congress on New Year’s Day preserved Bush-era income tax rates for 99% of Americans, a temporary 2 percent reduction in the Social Security portion of the FICA (Federal Insurance Contributions Act) payroll tax was not extended. As a result, the tax increased from 4.2% to 6.2%, its’ pre-2011 level, as of January 1. Keep in mind, the reduction – in effect for 2011 and 2012 – was never meant to be permanent. It was intended to put more money in workers’ paychecks during the economic downturn; in fiscal cliff negotiations it was agreed by both political parties that it would expire at the end of 2012.
What does the tax increase mean for wage earners? Generally, most workers will see a 2 percent decrease in their take-home pay. As an example, those earning $100,000 will receive $2,000 less per year, equating to a monthly reduction in pay of about $167. Keep in mind, other FICA provisions remain unchanged: earnings above the Social Security Wage Base ($113,700 in 2013) are not subject to the 6.2% Social Security tax, and there is no limit on the amount of earnings subject to the Medicare portion of the FICA tax, which is 1.45% of earnings.
Because FICA taxes are imposed on gross wages, there are limited opportunities to lessen the impact of the tax increase. The amount you contribute to your 401(k) plan, for instance, does not reduce your payroll tax liability, as 401(k) contributions are subject to both the Social Security and Medicare portions of the FICA tax. As for Health Savings Account (HSA) contributions, if they are made through an employer’s Section 125 or cafeteria plan, they are not subject to FICA taxes. But when made directly (outside of a cafeteria plan), they are considered wages and FICA taxes apply. Keep in mind, both pre-tax 401(k) deferrals and HSA contributions reduce your earnings for income tax purposes, so maximizing your contributions is one way to manage your overall tax burden.
And if you generally receive an income tax refund, you should consider adjusting your withholding amounts to improve your cash flow. Use the IRS Withholding Calculator to determine the correct amount to have withheld from your pay, and complete a new Form W-4, Employee’s Withholding Allowance Certificate, for your employer. As a wage earner, the FICA tax increase is unavoidable. But you can use this as an opportunity to review and adjust other payroll deductions.