Get Ready for Payroll Changes in 2011

Barbara Weltman

Now is the time to get ready for new rules impacting your payroll practices for next year. New tax rules, combined with the expiration or repeal of existing tax rules, make for a perfect storm for employees: Their 2011 take home pay will be smaller. It may be wise to communicate changes to your staff so they don't get "sticker shock" when they receive their first paycheck of the year and their take-home pay is lower than it was in 2010.

Expiration of favorable rules
The sunset of the so-called Bush tax cuts, made in 2001 and 2003, means higher income taxes on your employees. The tax cuts could be extended in whole or in part, but this may not happen until the lame-duck session after the November election, or some time in 2011 when a new Congress is seated. Examples of tax increases and changes that result if the Bush tax cuts are not extended include:

  • Elimination of the 10% tax bracket, so that the first bracket becomes 15% (this is effectively a 50% tax increase on a portion of earnings).
  • Reinstatement of the marriage penalty. Married employees will no longer have relief through the 15% tax bracket but will pay more than two single individuals with the same income as one married couple.
  • Cut in the child tax credit. The current $1,000 tax credit for having a child under 17 drops to $500; a lower credit means a higher income tax on the parent-employee.

New withholding tables
The IRS is now working on the withholding tables that will likely be used, at least for the first payroll period in 2011. If Congress extends the Bush tax cuts, then the IRS will release updated withholding tables.

Idea: Employers who use payroll services can eliminate the internal headaches of updating and reprogramming withholding changes.

Increase in the supplemental tax rate
If you pay bonuses, commissions, or other types of supplemental pay, change your payroll withholding. Instead of the flat 25% rate that applies in 2010, the withholding rate on supplemental pay increases to 28% (unless the Bush tax cuts are extended).

W-2 reporting on health coverage
Starting in 2011, you were supposed to include on employee W-2 forms the value of health coverage, but the IRS has now made this voluntary. This includes coverage paid by you, the employee, or a combination of both. You can preview a draft of the 2011 Form W-2.

End of the advanced Earned Income Credit
Certain low-income earners could have enjoyed the Earned Income Credit throughout the year by having a portion of it included in their pay check. This option has been repealed, effective in 2011.

This means you no longer are required to inform potentially eligible workers about the earned income credit.

Change in FSA reimbursement rules
Starting next year, flexible spending accounts (FSAs) cannot make tax-free distributions for medications unless they are prescribed by a doctor. Employees should be informed of this change so they can adjust their salary reduction commitment to FSAs for 2011.

Expiration of Making Work Pay credit
For almost two full years, most employees have been receiving additional money from Uncle Sam in their pay checks due to the Making Work Pay credit. This credit runs only through December 2010 (unless Congress extends it).

You may recall that withholding tables were changed in April 2009 to reflect the making work pay credit; new tables will no longer include the credit.

What's not changing
According to the Social Security Administration, Social Security and Medicare taxes will remain the same in 2011 as in 2010. This means that wages up to $106,800 are subject to a Social Security tax rate of 6.2% on employees and employers; all wages without limit, are subject to Medicare taxes.

Barbara Weltman, author of several books including her most recent, 1001 Deductions & Tax Breaks 2009
Copyright 2010 Author retains ownership. All Rights Reserved.

Print page