Employee Withholding Taxes Likely to Increase in 2011

There are many reasons why employees are likely to see more taxes withheld from their paychecks in 2011.

Higher tax brackets. Unless Congress acts, the provision in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, PL 107-16) that provided for lower income tax rates will no longer be in effect beginning in 2011. Income tax brackets would change as follows:

1. The 10% bracket would disappear (the lowest tax bracket would be 15%).

2. The size of the 15% tax bracket for joint filers and qualified surviving spouses would be 167% (rather than 200%) of the 15% tax bracket.

3. The top four tax brackets would rise from 25%, 28%, 33%, and 35% to 28%, 31%, 36%, and 39.6%.

Making Work Pay credit. The American Recovery and Reinvestment Act of 2009 (ARRA) included a provision that provides a refundable income tax credit (the Making Work Pay credit) to individuals below a certain income tax level on their 2009 and 2010 personal income tax returns. Employees receive the credit incrementally through a reduction in the amount withheld from their paychecks. The credit expires after the 2010 tax year. Withholding tables will need to be adjusted in 2011 to take into account the fact that employees will no longer be able to claim this credit.

Advance earned income credit. This credit allowed certain low-income employees to receive an advance payment of the earned income credit in their paychecks. Their withholding was lowered to take into account the payment. The advance earned income credit has been repealed beginning with the 2011 tax year.

Supplemental wage rates. Unless Congress acts to extend this EGTRRA provision, the supplemental wage rate on compensation paid to employees in addition to their regular wages (e.g., bonuses, commissions, severance pay) will increase from 25% to 28% on supplemental wages totaling $1 million or less in the calendar year. For supplemental wage payments totaling more than $1 million in a calendar year, the rate will increase from 35% to 39.6%.

Backup withholding. Backup withholding is required on certain non-wage payments made to payees for whom an information return was filed which had either a missing or an incorrect taxpayer identification number. The backup withholding rate is currently 28%. It will increase to 31% in 2011 unless Congress acts to extend this EGTRRA provision.

Employer-provided educational assistance. Current law allows employers to reimburse up to $5,250 of an employee's non-job-related educational expenses on a tax-free basis if the reimbursement is made through an educational assistance program that meets the requirements in IRC §127. This fringe benefit is no longer available beginning in the 2011 tax year unless Congress acts to extend this EGTRRA provision. The educational assistance exclusion will also no longer be available on payments for graduate level education after 2010 unless Congress acts to extend this provision.