Americans are getting a much needed tax break in 2011 – a 2% cut in their payroll taxes. Congress has set that tax break in stone, but consumers should be aware of some unintended consequences that could affect them, for better or worse.

The deal stems from a bi-partisan agreement between Republicans and Democrats in Washington. Both parties have agreed to extend the tax cuts put in place by President Bush back in 2003. The payroll tax, more formally known as the FICA, takes 2% off the 6.2% of your total gross compensation that falls under the levy. Only the first $106,800 earned is impacted by the tax cut. The cut is only good for 2011.

Let’s take a look at some interesting aspects of the new payroll tax holiday and see how it might affect Americans.

  • How much can you save on the payroll tax? Plenty – especially if you earn the full $106,800. Under that scenario, you’d have an extra $2,136 in your back pocket thanks to the payroll tax cut. (That would be $4,272 for dual-income earners). For an employee earning $70,000, the savings go down, to $1,400. Not a bad chunk of change.
  • Do the self-employed get the tax break, too? Yes, but only by half. By law, self-employed Americans have to pay the “other half” of the FICA tax that employers normally pay for employees (6.2%). So the self-employed only earn the 2% tax break from one-half of their total payroll tax obligations.
  • How much is the payroll tax costing the federal government? By most estimates, the payroll tax holiday will put $120 billion into the hands of consumers direct from U.S. government coffers.
  • When can you expect to see the tax cut hit your paycheck? Congress passed the payroll tax in a rush, leaving little time for accounting departments to comply. To spur things along, the government requires all employers to have the payroll tax popped into place by Jan. 31, 2010. If there are any accounting errors, private companies have until the end of March to correct them.
  • How will the payroll tax reduction impact Social Security? It could shorten the time that Social Security runs out. According to an op-ed in the Dec. 22 Palm Beach Post by tax policy analysts Jonathan Battaglia and Robert Weiner, the impact on Social Security could be “devastating”. Writes the duo: “If made permanent, a new Social Security "payroll tax holiday," reducing the 'match' employers pay from 6% to 4% of salary, will drop the solvency of the program 14 years, from 2037 to 2023, according to the Congressional Budget Office.”

Clearly, the White House and Congress wanted a fresh way to stimulate the economy, and the 2% payroll tax is their latest effort to do just that. This time, at least, the stimulus is meant for Main Street and not Wall Street. Whether consumers save or spend the tax cut, the payroll tax cut represents a rare break for the average American.

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