How to Turn Your 2% Payroll Tax Holiday into Greater Tax Savings

The largest new tax break for individuals was enacted on December 17, 2010. The one-year payroll tax reduction is found in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The act provides a 2-percentage-point payroll/self-employment tax holiday for everyone subject to the Social Security tax.

How Social Security and Medicare are Calculated for an Employee

Social security is computed on the first $106,800 of the employee’s wages at 6.2%. Medicare is computed on the entire wage at 1.45%. The employer also pays into the system for each employee utilizing the same rates. Social security plus Medicare is known as FICA. The FICA tax totals 7.65% on wages up to $106,800 and then drops to 1.45% on wages in excess of $106,800.

Under the 2010 Tax Relief Act, for calendar year 2011 the employee (NOT the employer) social security rate will be reduced to 4.2% and the total FICA tax will be 5.65% on wages up to $106,800 and 1.45% on wages in excess.

For example, Louie has wages for 2011 of $50,000. If the Tax Relief Act was not enacted, Louie’s FICA tax for 2011 would be $3,825 (7.65% x $50,000). Under the Tax Relief Act, Louie’s FICA tax for 2011 is $2,825 (5.65% x $50,000). That is a savings of $1,000 ($3,825 - $2,825).

The maximum reduction in FICA tax is $2,136 ($106,800 x 2%). For a married couple, each with wages of $106,800 or more, their maximum reduction would be $4,272 ((106,800 x 2) x 2%).

Use the Tax Saving Calculator to calculate your potential tax savings.

How to Maximize the 2% Payroll Tax Holiday as an Employee

If you are not currently contributing the maximum into your 401K plan or any other defined contribution plan, this is a great opportunity to maximize the 2011 payroll tax holiday.

Let’s catch back up with Louie who earned $50,000 of wages in 2011. He has been contributing 6% of his wages to his 401K plan totaling $3,000 ($50,000 x .06). The contribution is not subject to federal (and possibly state) income tax, so Louie would only recognize $47,000 in income on his 2011 tax return. For 2011, Louie would be in the 25% marginal tax bracket (considering no other adjustments). His $3,000 contribution to his 401K would represent a $750 tax savings ($3,000 x 25% marginal tax rate).

What if Louie increased his 401K contribution by the 2% payroll tax savings to 8% (6% + 2%)? His 2011 401K contribution would total $4,000 ($50,000 x 8%). His $4,000 contribution would now represent a $1,000 tax savings ($4,000 x 25% marginal tax rate); an increase of $250 ($1,000 - $750). The $1,000 savings from the payroll tax holiday calculated above has now increased to a $1,250 in tax savings ($1,000 + $250).

Here is a link to that calculates 401K Tax Savings. You will want to have your tax return available.

What if you are not eligible to contribute to a defined contribution plan or your employer does not offer a plan? You may be eligible to set up a traditional IRA and receive the maximizing benefit.

How Social Security and Medicare are Calculated for the Self Employed

The Self-Employment Contributions Act (SECA) imposes two taxes on the self-employed as mentioned above. SECA taxes apply to “net earnings from self-employment” greater than $400. Social security is computed on the first $106,800 of the net earnings at 12.4%. Medicare is computed on the total net earnings at 2.9%. Social security plus Medicare is known as SECA and the total SECA tax on net earnings up to wages $106,800 is 15.3% and drops to 2.9% on net earnings in excess of $106,800.

Under the 2010 Tax Relief Act, for calendar year 2011, the social security portion of the SECA tax will be reduced to 10.5%. This will reduce the total SECA tax to 13.3% (15.3% - 2%) on net earnings up to $106,800 and 2.9% on net earnings in excess of $106,800.

For example, Buddy has net earnings for 2011 of $50,000. If the Tax Relief Act was not enacted, Buddy’s SECA tax for 2011 is $7,650 (15.3% x $50,000). Under the Tax Relief Act, Buddy’s SECA tax for 2011 is $6,650 (13.3% x $50,000). That is a savings of $1,000 ($7,650-6,650).

The maximum deduction in SECA tax is $2,136 ($106,800 x 2%).

To receive the benefit of the SECA tax rate reduction throughout 2011, the self employed individual must apply the reduction in figuring his or her quarterly estimated tax payments because the IRS will presumably reflect the reduction in 2011 Form 1040ES, Estimated Tax Voucher Coupon for Individuals.

Use the Tax Saving Calculator to calculate your potential tax savings. Instead of entering “Annual Salary,” project your 2011 net earnings from self employment.

How to Maximize the 2% Payroll Tax Holiday as Self Employed

If you are not currently contributing the maximum into your business’s 401K plan/Solo 401K plan or SEP-IRA, this is a great opportunity to maximize the 2% SECA tax holiday.

Let’s catch back up with Buddy who had net earnings of $50,000 in 2011. Buddy has been contributing 6% of his net earnings to his solo 401K plan totaling $3,000 ($50,000 x .06). The contribution is not subject to federal income tax and is an “adjustment to income,” which lowers adjusted gross income (AGI). For 2011, Louie would be in the 25% marginal tax bracket (considering no other adjustments). His $3,000 contribution to his SEP IRA would represent a $750 tax savings ($3,000 x 25% marginal tax rate).

What if he increased his SEP IRA contribution by the 2% SECA tax savings to 8% (6% + 2%)? His 2011 SEP IRA contribution would total $4,000 ($50,000 x 8%). His $4,000 contribution would now represent a $1,000 tax savings ($4,000 x 25% marginal tax rate); an increase of $250 ($1,000 - $750). The $1,000 savings from the 2 % SECA tax holiday calculated above has now increased to a $1,250 tax savings ($1,000 + $250).

Here is a link to that calculates 401K Tax Savings. You will want to have your tax return available.

Other Maximizing Ideas

The payroll tax or SECA tax savings can also be used to pay down credit cards or a mortgage. This would reduce interest paid.

Or, you can go out and buy something and do your part in boosting economic growth, which is the full intention of this new tax savings provision.

Beth Bockenhauer is the owner of Beth Bockenhauer, CPA, a boutique accounting and CPA practice based in southern California. She started her career with five years of military service. She then worked for ten years as a small business owner, and holds a Bachelor of Science degree in accounting. Beth has worked in public accounting for the past seven years. For more information, visit www.bethbcpa.com

1099 MISC – Reporting Requirements & How-to in QuickBooks

On December 15th the Senate passed the 2010 Tax Relief Act and extended the Bush-era tax cuts. However, the House still needs to knock heads for approval. So, I am holding off on presenting the effects of the Tax Relief Act until it has “officially” passed.


Since I get a lot of calls in January about 1099’s MISC, I decided that this would be a great topic for year end. For those who don’t know, a 1099 MISC is a tax form used to report miscellaneous income, including income earned as an independent contractor.

To begin the process, you must obtain a completed W9 from the individual who will be receiving the income. Ensure that the name is the individual’s name, not the business name. The business name has a separate line. However, the business would be correct for a partnership, limited liability company or corporation.

Who gets a 1099? Individuals, partnerships and most limited liability companies would be candidates if they meet the income criteria. S-Corporations and C-Corporations do not generally receive 1099s.

Due dates for the 1099-Misc are:

To the Recipient – File Copy B is due January 31. This due date is extended if you are reporting payments in boxes 8 or 14.

To the IRS – File Copy A is due February 28. If you file electronically, the due date is March 31. To file electronically you must have the appropriate software.

You can order 1099 forms from the IRS and they are FREE!

Box 1 – Rents $600.00 or More:

For real estate rentals paid for office space, machine rentals.

Box 2 – Royalties $10 or More:

For gross royalty payments made, which are usage-based payments made by the Licensee to the Licensor for use of intangible property (music, intellectual property, franchise payments).

Box 3 – Other Income $600 or More:

For award money or merchandise (report at fair market value), sweepstakes prizes or game show winnings received. This would not be used for reporting gambling winnings; a W2G is the form used to report those winnings.

Other Income would also include monies received for participating in medical research studies, punitive damages. There is actually a comprehensive list on the IRS web site..

DO NOT include in box three payments made for services received. This is considered non-employee compensation and would be reported in box 7.

Box 7 – Nonemployee Compensation $600 or more

For someone who is not your employee that you paid for services in the course of your business. This non-employee can be a sole proprietor, a partnership, a limited liability company (LLC) or an attorney. Examples of payments made that would be subject to non-employee compensation reporting would include:

Professional Services: This is your independent contractor: accountants, architects, consultants, computer guy/gal, cleaning person, coach, etc.

Travel reimbursements: Paid to an independent contractor (IC) and IC did not report the expenses under an accountable plan. An accountable plan is when an expense report is completed and receipts are presented for reimbursement.

Bartering of services between individuals in the course of their business: For example, I hired my client, ABC Flooring to install a new floor in my office. In exchange I will prepare his/her tax return. No money is exchanged, but this still holds as a reportable event.

Fringe Benefits to ICs: This may include a company car, health insurance, life insurance, free services, etc.

Legal Services: All attorney fees are reported regardless if the attorney is a corporation.

I only listed a few of the many reasons why you would report non-employee compensation on a 1099. Here is a complete list.

Box 14 – Gross Proceeds Paid to an Attorney

Report all gross proceeds made to an attorney during the course of your business even if the attorney is a corporation. Gross proceeds are different than fees in that gross proceeds are paid when a lawyer wins a settlement (the attorney’s cut).
As you can see, I did not cover every box on the 1099. For comprehensive instructions, visit the IRS web site.

Beth Bockenhauer is the owner of Beth Bockenhauer, CPA, a boutique accounting and CPA practice based in southern California. She started her career with five years of military service. She then worked for ten years as a small business owner, and holds a Bachelor of Science degree in accounting. Beth has worked in public accounting for the past seven years. For more information, visit www.bethbcpa.com