Be Prepared for Paycheck Shrinkage on January 1, 2013

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Paycheck ShrinkageSorry to break the news to all of my American friends but starting January 1, 2013 your paycheck will likely be 2% smaller and that is on the conservative side. It could be even smaller than that! So what am I talking about and why should you care?

*UPDATE* I have written a new post “Why is My Paycheck Smaller? Understanding Your 2013 Paycheck” which explains exactly what happened after Congress passed the fiscal cliff legislation in early 2013. Make sure to check it out after you read this post if you want to know why your paycheck is (or likely will be) smaller in 2013. *UPDATE*

Payroll Tax Break Set to Expire

Way back in the beginning of 2011 a tax cut was enacted to stimulate the economy by increasing the take home pay of any employee who paid payroll taxes. The employee portion of the social security (FICA) tax was reduced from 6.2% to 4.2%. Employers still had to pay their full portion at 6.2%. If you were self employed and paid both sides of the social security tax it was reduced from 12.4% to 10.4%. It was originally supposed to last one year but was extended to last until the end of 2012.

Over this time period many people have forgotten about this extra money in their paychecks and it has become just like any other income. People have figured it into their budgets and don’t expect it to disappear. The problem with this is that it was a temporary cut that was extended. It was never meant to be permanent but most people probably expect it to never go away.

It is unfortunate for your paycheck but it sounds like this temporary tax break is not going to be renewed this year. Congress doesn’t seem to want to extend it and they have enough other issues to deal with in regards to the “fiscal cliff”. Paying more taxes is never fun at least you’re now aware of your pending smaller paychecks starting in 2013.

Other Tax Provisions

There are many other tax provisions set to expire at the end of 2012 that have not yet been dealt with. Income tax rates will revert to an older structure among many, many other changes. If you care to read up on it here is a report from Congressional Research Service that explains an overview of tax provisions expiring in 2012. I wouldn’t count on Congress fixing all of these problems before the end of the year, if any, so you need to be prepared.

How to Prepare

If you assume the worst case scenario (for your paycheck) that none of these measures get extended you must now face the reality that your paycheck will be smaller next year. Bummer. So what do you do? You make a new budget and prepare to cut back. To be as accurate as possible you’ll need to study all of the tax law changes and see which changes will affect your paycheck.

You’ll at least be taking a 2% hit if you are an employee that is paid wages that are equal to or below the social security wage base ($113,700). Figure out what this 2% (or total change if you’ve calculated it) equates to and draft a new budget with your new lower income. If you’re lucky enough to get a raise this year you might just come out even… if Congress can fix everything but the temporary payroll tax cut extension.

They key is to be prepared. You are now aware that your paycheck will likely be smaller next year so start planning now!

Were you aware your check was going to be smaller? Have you planned for it?

photo by: orphanjones

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.

Comments

  1. Thanks for the heads up! I remember when this tax cut was enacted. It was a few extra dollars on my paycheck, which I adjusted my budget to accommodate. I definitely enjoyed having any amount of extra money in the bank, but it’s not enough to really affect me too badly. I’ll simply adjust my discretionary spending budget down to accommodate.

  2. We were just talking about this. I hope that we at least get the usual raise (5%) to offset our new tax increases. Ugh.

  3. Oh No! I had forgotten all about this. Here I am with no raise in sight and now my paycheck is going to decrease. I better get to figuring up a new plan. Thanks for the heads up! :)

  4. Great point on being prepared, that really is key. We’re very aware of this as we’re self-employed so we get to pay in the whole thing. You just have to look for other ways to save on that now so you hit the ground running next year.

  5. I was always against the payroll tax break for the exact reason that I knew people would ‘get used’ to having that money and would not be able to easily give it up. When they extended it last year, I thought the prudent thing would have been to come up with a plan to gradually phase it out, maybe 0.5% of the 2.0% in semi-annual increments. This would be a lot less of an impact on paychecks than a one time jump, especially with all the other stuff that would change if they don’t come to some agreement before the end of the year (I think they will).

  6. I definitely forgot that I had extra money coming in. Hopefully, I’ll be getting a nice raise (and new job) so that it will more than compensate for the drop in net income. The good thing about not making much money is that you don’t pay as much in taxes. :)

  7. Funny how quickly you get used to it! My wife received it, but I did not. I am on the stae pension program that withholds 8% instead of 6.2%. Actually I am getting an increase because the California voters passed Prop 30. For two years, I had to take furlough (unpaid time off) days thanks to the budget crisis. It has a value of 5% which more than offsets the hit.

  8. Thought my paycheck was small enough!

  9. A great reminder! My husband and I have to redo our budget this month so we are setting aside that 2% because we fully expect the break to end. We are also going to decide on additional cuts we could easily make if the fiscal cliff resolves with more taxes in place.

  10. Because you can’t control tax laws it’s best to remain updated and adjust you core of actions. The 2% temporary reduction shouldn’t through you off course. One of the best financial advice I’ve received is “be aware and adjust your plan, accordingly.”

  11. I knew my paychecks would be smaller, but I also (erroneously) thought that they’d ultimately all be reinstated after a tax/debt deal, and that I’d get it all back (eventually). I guess I didn’t realize Congress wasn’t planning on renewing the payroll tax relief, though, so thanks for bringing it to my attention!

  12. Fortunately for me I don’t get taxed on each check as I’m a 1099 employee, however there is no doubt that I’ll have to pay extra taxes at the end of the year! Thankfully 2% isn’t the end of the world for most people…cut back on cable or eating out and they’ll be fine.

  13. Mandy @MoneyMasterMom says:

    I would hope that people could adjust to a 2% pay difference with relative ease, but I know the vast majority of people live pay cheque to pay cheque, and this will require sacrifice and planning. Oh I guess I outed myself as a Canadian with Pay cheque instead of pay check eh? haha

  14. I think the 2% won’t be too bad. My husband should get a raise to counteract it, so I don’t see a net decrease. If the other taxes change, that will mean we need to earn more/spend less.

  15. Ugh that’s going to suck. I’ve got my fingers crossed the increase doesn’t happen.

  16. Most people won’t notice it the same way they totally didn’t notice the tax break in the first place. I agree with Money Beagle: a phase out would go a long way for people who are big budgeters. Maybe that’ll be the compromise Congress goes with?

  17. Hmm. We have had a number of tax changes over here – raising VAT from 17.5% to 20% for one, removal of child support where either parent is on higher rate tax for another which will actually cost quite a bit over time, all in a supposed effort of austerity. I say supposed because I suspect there is a hidden and rather nasty agenda. But overall these changes are often masked by others, such as pay rises, changing jobs etc. Whatever it is, we all need to get our heads round how to deal with this financial crisis, one that seems never to be solved and the centre has moved from the US sub-prime to the Eurozone, pulling everyone down with it.

    What we do know is that the ordinary folk are not really guilty – it is only a few financiers and politicians who are the villains. Yet it is the people who are being ask – no made – to pay while the guilty retire to their yachts.

    In the US, Dubya Bush’s slashing of taxes on the uber-rich didn’t do any good – it just moved from Clinton’s fairly balanced budget to a massive deficit. This is a mess that Obama has to clear up. To us he doesn’t seem to be doing too bad a job but we are not in the US nor are we voters!

    Suffice to say that in the recent US election, the BBC (which gave it massive coverage) polled people all over the world as to whom they would like to see as US President. Only in Pakistan was Romney favoured. I leave it to you to wonder why…..

  18. My decrease effective 1/1/13 ended up being 2.5%. Not happy. Was one of those who had “forgotten” about this “extra money” being “temporary”.

    • So Sorry Kris. I don’t even know what my effective decrease will be so at least you know and can prepare.

    • Donna speranza says:

      My net just decreased by $25 a week and when every dollar is committed already that is a lot of money. I frankly don’t know what else to cut.

      • Sorry Donna. My best advice would be to look at the nonessential things that you enjoy the least and cut those. If your money priorities aren’t in line with what you think your real priorities are maybe that’d be a source of a place to start.

  19. Wintefaeri says:

    I work for a small company that has been struggling. I haven’t had a pay raise in 5 years and I’ve been working most weeks just four days a week for just over 2 years. I have looked for a new job, but no luck so far. To adjust to the tax increase I suppose I will eat less. I have a minimal budget on everything else. Oh, well, I could stand to lose a few pounds. This economy is getting tiresome though!!

  20. My wife just got her first paycheck of 2013, and it was 6.5% lower than it was last year. I won’t get mine until January 31st and am not looking forward to the change.

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