Surprise! Surprise!

I’m sure you’ve heard in the news that just before Chrismas, Congress finally passed, and the President signed, a two-month extension of the payroll tax cut that was enacted earlier this year. That means that at least for two months the employee social security withholding rate will remain at 4.2% (instead of 6.2% that the employer pays). Who knows what will come in March – whether it will be re-extended or repealed.

One item in the law that the news hasn’t really covered may affect many businesses normal practice as it relates to employees and yearly bonuses. The law has a “recapture” provision that applies to employees that earn more than $18,350 during the first two months of 2012 (that’s one-sixth of the $110,100 social security wage base this year.) The new rule imposes an extra 2% income tax on the excess wages earned during the two month period. The tax doesn’t affect withholding and payroll; it’ll be applied when the affected employees file their 2012 income tax return.

The main reason I’m bringing this to your attention is that many businesses pay bonuses to employees in the early part of the year, based on the previous year’s results. Presuming they will be paid more than the maximum for that two-month period, they would only have 4.2% social security withheld – but when they file their 2012 return, they’ll pay 2% more income tax on the excess earnings. Don’t have a clue how THAT’s going to be reported; IRS is to issue regulations on how to deal with it later. But unless Congress acts to extend the cut for a longer period, and to repeal this recapture provision too, W-2s are likely going to be harder to prepare for 2012!

Of course, there’s not much time before calendar year-end, but you may want to discuss the possibility of timing the bonus in 2011 – to avoid the recapture issue.Call me if you have any questions.