What You May Not Know About the Payroll Tax Cut (Social Security Funding Decrease)


If you were following the news at all before Christmas you probably know that the Republicans once again put politics before their principles and agreed to a two-month extension of the payroll tax holiday.  As is a Republican tradition, they of course did this only after doing as much damage as possible by saying they would not extend the tax holiday.  They thereby managed to irritate both their base who was calling for an end to the holiday and the general public who wanted the holiday extended.

Here are somethings that were not widely reported about the deal, however:

1.  The “Payroll Tax” is the funding paid by workers and businesses to fund Social Security.  Up until about a year ago, workers and their employers each paid 6.2% of the worker’s salary into the system.  Since the holiday, the worker is paying only 4.2%.  This means that the funding for Social Security has been reduced, increasing the rate of demise of the system.  To protect yourself, all SmallIvy readers should put the $1000 not paid into Social Security this year into an IRA.  You have until April 15th.

2.  The bill also included an extension of unemployment benefits and the “Doc Fix.”  The Doc Fix is a provision that keeps the payment rates from Medicare to doctors from being lowered as is written in the law.  The lower payment rates are often cited as a cost reduction (as they were in the scoring of the Obama Health Care Law, allowing it to appear to reduce costs), but it is widely known that they will never take effect since doing so would cause a lot of doctors to stop seeing Medicare patients.  Each time the lower rates are about to go into effect, a temporary stop is passed.

3.  The bill from the Democratic-controlled Senate to the Republican-controlled House included income level phase-outs.  This meant that those at the higher end of the middle class income spectrum would see some of their income being taxed at the higher 6.2% rate, while those at the lower end would be paying 4.2%.  This would make Social Security more of a welfare program than it currently is since individuals at the lower-end of the income spectrum would be paying less for benefits than those in the upper-middle class.  Note that most wealthy individuals have little payroll income (or realized income at all) compared to their wealth and therefore would be unaffected.  This is a good reason to save and invest to become wealthy rather than working for all of your income.

4.  To pay for the 2% payroll tax extension, an additional charge would be created in the fees charged by Fannie Mae and Freddie Mac to loan originators.  These fees would be passed along to the home buyer, resulting in an increase of about $15 per month in the mortgage payment.  Note that this would be about $180 per year or $5400 over the life of a 30-year loan.  Including interest, a home buyer would pay somewhere north of $10,000 over the life of the loan.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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