Business As Usual In D.C., Unusual For Everyone Else

The 2-month payroll tax cut extension that the Senate passed is another example of how out of touch D.C. is with the real world.

Payroll taxes are withheld from employee pay checks.  The withholding of those taxes from paychecks is typically done through sophisticated computerized payroll tax systems.  Large employers typically have purchased the software from companies like PeopleSoft or Ultimate Software to process their payrolls.  Smaller firms typically rely on outside companies like ADP or Paychex to provide the service.  Most payroll systems today are highly automated and the systems require significant programming to insure that withholding tables are correct for federal, state and local withholdings.

It is laughable that the Senate of the United States thinks that they are going to pass a 2-month extension of the payroll tax cut at this late date and it will be implemented seamlessly.  There simply is not enough time to program the payroll tax systems that do the withholding on the tens of millions of paychecks in this country.

If the extension was written as a simple 2-month extension of the current rules there would be no significant problem.  The programming is already in place to continue current law.  However, the Senate was placed in a box when they started looking at this compromise.  The regular Social Security Tax is set at 6.2% on the FICA annual wage base.   Wages above the wage base are not subject to the tax.  For 2012, the wage base is $110,100.  The 2-month payroll tax cut extension would continue the rate at 4.2% (a 2 percentage point cut) of the standard rate.

A normal extension would just continue current law and not be a real challenge for payroll tax systems.  However, continuing current law would mean that with a 2-month extension a millionaire would obtain what is effectively the full year of the payroll tax cut while an average wage earner would only receive 1/6 of the annual amount in those two months .  This is due to the fact that a millionaire would earn enough in the first two months to meet the full FICA annual wage base.  ($1,000,000/12=$83,333 X 2= $166,167.  A millionaire would hit the $110,100 wage limit early in February and have their entire $2,202  annual tax benefit in the bank.  Someone making $50,000 would get a tax break of $1,000 for the full year but with the 2-month extension they would only get $167 by the end of February.

This would have been pretty embarrassing to the Democrats in the Senate who have spent most of the last few months trying to implement an income tax surcharge on millionaires. How would they have looked if in the end they delivered a bill that not only did not include a surcharge on millionaires but gave the same group an outsized tax cut for the 2 month extension compared to middle and working class taxpayers?

To insure that this result did not occur, the Senate bill established a FICA wage base for the first two months rather than an annual FICA wage base.  The break only applies to the first $18,350 of wages through February 2012.  This may sound simple to implement to a U.S Senator or a young Congressional staffer in D.C. who has never lived a day in the real world.  However, to someone that needs to program a payroll tax system, this is a pretty big deal.  It is hard to see how this "modification" can be done easily, effectively or efficiently.

The bottom line of all this foolishness?  There will be thousands and thousands of man hours spent re-programming payroll systems and correcting the inevitable mistakes that result from the last minute shenanigans in D.C.  All of that work will not do one thing to improve anything or create any value added for anyone but the payroll tax programmers.  It will just suck more dollars out of the employers who could be using it to create products, services and jobs.  When March comes (whether of not the extension is continued or not) there will have to be an entirely new set of re-programming done again.

This letter from the National Payroll Reporting Consortium describes the practical implementation problems in the Senate's 2-month extension pretty clearly.

The difficulty is in establishing a new Social Security Taxable Wage limit of $18,350 for the two- month extension period. More than ten percent of the workforce1 is likely to meet that limit, and would be subject to the higher 6.2% tax rate for earnings over that amount. However, many payroll systems are not likely to be able to make such a substantial programming change before January or even February. The systems affected tend to be highly complex, normally requiring at least ninety days for a change of this magnitude for software testing alone; not to mention analysis, design, coding and implementation.

NPRC understands Congress’ concern that highly compensated employees not enjoy the full benefit of the 2% tax break because of bonuses or other high compensation falling into the first two months of the year. Nevertheless with the first of January now only two weeks away and payroll departments trying to meet year-end compliance mandates and reconciliation, there simply is insufficient time to implement this major change in withholding requirements. It would also necessary to await IRS regulatory guidance for further details concerning the change.

 All in all, business as usual in D.C keeps business from being anything but usual in the rest of the country.