“Tax the Rich” payroll complexity affects some not-so-rich

On December 23, President Obama signed two-month extension of the reduction of the social security tax. During the first two months of 2012, the employee rate is reduced from 6.2% to 4.2%. In the hoopla of political messages, a new tax on “the rich” failed to get much press.

The two-month law includes a “recapture” income tax for those who make above the prorated two-month Social Security taxable wage base ($110,100) during that two-month period. Stated otherwise, those receiving more than $18,350 during this two-month period will pay a 2% income tax on the amount over that amount (but not greater than $110,100). The recapture tax is payable in 2013 when the income tax return for 2012 is filed.

A challenge arises for anyone who has disproportionately high income during the first two months of the year. For example, this would occur for any employee who gets paid a bonus at the beginning of every year for results in the preceding year that just ended. Those exercising non-qualified stock options in these first two months would have a similar issue.

The recapture provision will not matter if the payroll tax is not extended beyond the first two months of 2012. In such event, one would want to get as much income reported when the lower Social Security rate is in effect. However, if the tax reduction gets extended and one has higher-than normal earnings in the first two months, then the employee would be penalized for being “rich” in those first two months.

The details of how this will be administered in the context of a full-year tax return have not yet been determined. Presumably, employers will need to separately report taxable compensation for the two months so that the additional income tax can be calculated (or not calculated as the case may be) if earnings are above the threshold level.

Two months is way too short a period for rational tax policy and related efficient reporting. Congress made tax reporting unnecessarily complicated by addressing this two months at a time.


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