Note to the Rich: Don’t Spend All of Your Payroll Tax Cut Yet

After much anguish, Congress finally extended this year’s payroll tax cut for two more months. The final bill passed in nearly empty chambers a couple of days before Christmas.

But this version differed in an important way from the measure passed by the Senate just a few days earlier. The final bill removed a cap on how much high-wage workers could benefit from the tax cut. As a result, they will see their take-home pay rise by as much as $2,202 over the next two months. But those folks shouldn’t spend the whole tax cut right away—they’ll have to give as much as 83 percent of it back if Congress doesn’t further extend the tax cut beyond February.

As explained in an earlier TaxVox post, the Senate’s two-month extension would have capped the value of the tax cut at $367, a prorated share of the full-year savings. That bill’s drafters had recognized that simply extending the tax cut might unfairly benefit high-income workers who earn more than the maximum income subject to payroll tax—$110,100 in 2012. If Congress allowed the tax cut to lapse after February, those workers would get a larger tax cut, relative to their payroll tax liability, than workers who earn less. Capping the benefit at one-sixth of the annual limit precluded that outcome.

But payroll service firms objected that imposing such a cap would make it impossible for them to accommodate the short-term tax cut in time for January paydays. They would have to deal with two caps—one limiting annual payroll tax withholding and another capping the tax cut, and their software wasn’t set up to do that.

The final bill solved that problem by potentially requiring high-earners repay any excess tax savings. If Congress doesn’t further extend the tax cut beyond February, the Treasury Department will have to recoup payroll tax cuts exceeding $367. That means that anyone earning more than $18,350 during the first two months of 2012 will have to repay as much as $1,835 of the $2,202 added to their take-home pay in January and February.

The possibility of facing an unexpected $1,835 bill would keep most of us from spending the money in the first place. But only people earning more than $660,600 annually will have to repay that much. They probably won’t even notice the bill—or the tax cut preceding it.

But a much larger group whose annual earnings exceed $110,100 will have to repay smaller amounts. They might want to think twice before spending their tax savings, just in case Congress doesn’t get its act together enough to extend the tax cut for the all of 2012.