A major tax bill was passed by Congress on December 16 and was signed into law today by the President. With the ink barely dry on the bill, this is an analysis of the provisions that will impact nearly all ECFA members—including a significant change in payroll processing effective January 1, 2011.
Those who generously give to support Christ-centered organizations will be heartened by the extension of federal income tax rates at their current levels for two more years. This provides some short-term certainty that may encourage giving.
The extension of the provisions for tax-free charitable distributions up to $100,000 per tax year from Individual Retirement Accounts (IRA) retroactive to January 1, 2010 and through December 31, 2011 may be helpful for givers 70-1/2 or older on the date of the distribution from an IRA.
The most immediate impact of the new law will be the social security tax cut that impacts:
Employee social security taxes
- For one year, 2011, the OASDI portion of social security tax on employees is reduced from 6.2% to 4.2% on wages earned up to $106,800. The Medicare rate remains 1.45% for 2011.
- The change in the law does not save any money for the organization but it does save dollars for employees. This 6.2% to 4.2% social security rate change only applies to employees.
- The change does not apply to the employer social security tax rate of 6.2%. So for 2011 only, an employer will withhold 4.2% social security tax and 1.45% Medicare tax (total of 5.65%) from employees (up to $106,800 of compensation) and the employer will pay 6.2% social security tax and 2.9% Medicare tax (there is no maximum threshold on the Medicare tax).
- More good news: this social security rate reduction does not have to be repaid when the employee files their tax return—this is a one-year savings with no repayment.
- Example: Employee A receives $50,000 of FICA wages in 2011. A’s FICA tax for 2011 is $2,825. This is $1,000 less than it would have been without the payroll tax reduction ($50,000 x .02).
Self-employed (including ministers) social security taxes
- The Self-Employment Contributions Act (SECA) imposes two taxes on self-employed individuals: a social security tax and a Medicare tax. These SECA taxes apply to net earnings from self-employment above a $400 minimum for the tax year. There is an annually-adjusted ceiling limitation on the amount subject to social security ($106,800 for 2011) but no limit on the Medicare tax.
- For 2011 only, the self-employed social security tax rate is reduced from 12.4% to 10.4%. This parallels the two-percentage-point reduction in the social security portion of the employee’s FICA tax, from 6.2% to 4.2%.
- So the SECA tax rate for 2011 on net earnings from self-employment up to $106,800 is 13.3% (10.4% social security tax and 2.9% Medicare tax).
- Example: Taxpayer B has $50,000 of net earnings from self-employment in 2011. B’s SECA tax for 2011 is $6,650 ($5,200 social security tax and $1,450 Medicare tax). This is $1,000 less than it would have been without the payroll tax reduction ($50,000 x .02).
- Another interesting point—the SECA tax deduction allowed on Line 27 of Form 1040 is not impacted by the reduction in the social security rate. For 2011, the one-half of self-employment deduction on Line 27 remains at 7.65%.
- Ministers who have opted out of social security will not benefit from the payroll tax cut.
What to do to prepare for the social security tax rate changes. Nonprofits should make the following preparations:
- Payroll processing for non-ministerial staff. Nonprofits will need to change their payroll processing for non-ministerial employees effective January 1, 2011 to reflect the new combined social security and Medicare withholding rate of 5.65% (the old rate was 7.65%).
- Voluntary withholding of income taxes for ministerial staff. Your organization may have a voluntary arrangement with ministerial staff for federal income tax withholding. Many ministers have enough federal income tax withheld to cover their social security tax obligation. If so, ministerial staff may wish to decrease their federal income tax withholding as of January 1, 2011 since they will owe 2% less SECA tax for 2011, on earnings of up to $106,800.