Just in Time for the Holidays: A Temporary Tax Compromise

Early Friday morning, December 17, 2010, the U.S. House of Representatives took the final step required to seal the fate of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, H.R. 4853 (see 2010 Bill Tracking H.R. 4853).  An $801 billion package of tax cuts and $57 billion for extended unemployment insurance coverage, the Act represents a compromise negotiated between President Obama and Congressional Republicans.  Before its midnight approval by the House, the bill was approved by the Senate and will inevitably be signed by President Obama, who was calling for the package's prompt approval by both houses.

The Act includes a two-year extension of Bush-era tax cuts at all income levels as well as a two-year extension of the estate tax with a $5 million threshold.  The Act also enacts a one-year payroll tax cut for most American workers and extends the following benefits:  unemployment benefits for 13 months, stimulus tax provisions for middle-income earners, and most of the expiring tax extenders through 2011.  

Let's look closely at one of the provisions in the Act.  The payroll tax cut will provide a one-year two percent decrease in all employees' Social Security payroll taxes for 2011 (to 4.2 percent from 6.2 percent on the first $106,800 of earned income).  The hope is that the payroll tax cut will stimulate the economy by increasing the take-home pay of American workers (the employers' portion of the tax is unaffected by the new legislation).  Interestingly, the lowest income earners, individuals earning less than $20,000 and married couples earning less than $40,000, will actually receive less under the new Act than they did via the Making Work Pay credit that will expire this year with no extension.  See IRC Sec. 36A. Critics of the payroll tax cut expressed concern that the reduction in Social Security taxes could undermine the stability of the Social Security system mainly because proponents could insist on a permanent cut.  This year the Social Security system has paid out more in terms of benefit than it took in via payroll taxes.   Social Security had accumulated a trust fund of over $2 trillion since the 1980s, but the government borrowed that money to pay for other programs. The Treasury Department issued bonds to the Social Security Administration, and guaranteed that the money will be repaid, with interest.  Yet in order to fund the recent payroll tax cut, the federal government will borrow about $112 billion. 

It is concerning to this tax professional that the Act was approved with most legislators conceding that despite the fact that overall cost of the package was high and there was no agreement on how we might deal with the resulting and rising deficit, they would just worry about that later.  Perhaps optimistically, the overarching theme of the negotiations and deliberations preceding the vote on the package of temporary provisions was that more permanent and significant tax changes may be ahead.  Let's hope this item makes it on the New Years' resolution lists of our legislators.