Paychecks Could Shrink Even if Cuts Don't Expire

The IRS needs time to prepare tax tables so employers are being told to increase withholding whether or not Congress lets tax rates rise

(Bloomberg) — Americans' paychecks may shrink next year, at least temporarily, even if Congress decides not to let tax rates rise. Unless Congress votes by November to extend tax cuts enacted under President George W. Bush, the Internal Revenue Service will advise employers to increase deductions from paychecks beginning Jan. 1, payroll experts said. The reason: The IRS needs time to prepare and distribute tables used to calculate withholding taxes, and employers need time to implement them. Even though the Bush-era tax cuts don't expire until Dec. 31, the bureaucracy has to act sooner.

"It could be a paycheck or two until the new tables are implemented," if the IRS notices come later than November, said Scott Mezistrano, senior manager of government relations at the American Payroll Association in Washington. Last year, payroll departments were alerted in November, Mezistrano said.

The political debate over extending the tax cuts, enacted in 2001 and 2003, is intensifying as Nov. 2 congressional elections approach. President Barack Obama and most Democrats want the tax cuts extended for middle-income earners and to expire for the wealthiest Americans, the top 2 or 3 percent of earners. Republicans want the cuts extended for everyone. When the current law expires, income tax rates will revert to higher levels dating from June 2001. Rates now are at 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. If Congress doesn't act, they'll revert to 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent.

Treasury, IRS

Treasury Department spokeswoman Sandra Salstrom said the agency works with the IRS to release the withholding tables by mid-November. If Congress doesn't act by then, "Treasury will then make an appropriate determination about how to proceed," she said.

Any reduction in after-tax income, even if it's temporary, could depress consumer spending, which accounts for 70 percent of the economy, economists said. Confidence among U.S. consumers unexpectedly dropped to a one-year low in September, a report today showed. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment fell to 66.6 from 68.9 in August, the group said.

All of the decrease in the consumer sentiment index was recorded among households with annual incomes above $75,000. The decline in that group reflected a decrease in sentiment about personal finance, buying plans and prospects for the U.S. economy. Confidence rose among lower-income households.

Detrimental to Recovery

The disparity between income groups may center around the debate over the Bush-era tax cuts, the report said. A prolonged delay in extending the reductions would be detrimental to the economic recovery, it said.

Chris Low, chief economist at FTN Financial in New York, said many upper-income earners are assuming their taxes will rise. For other income brackets, even a temporary tax increase would be a surprise, he said. "The middle-class is not prepared," Low said before today's confidence report.

Alec Phillips, a Washington-based economist at Goldman Sachs Group Inc., said Congress is unlikely to vote on taxes until December because of breaks for the election and the Thanksgiving Day holiday. A failure to meet the deadline "would have a significant impact on low to middle-income people," he said. "To the extent they don't have the access to credit that they had a few years ago, then the cash-flow disruption would have a pretty big impact" on their spending.

Mike Aitken, director of governmental affairs for the Alexandria, Virginia-based Society for Human Resource Management, said "absent something from Treasury or absent congressional action, if these provisions expire, employers are required to start withholding money."

'Difficult Process'

When Congress does vote to restore some or all of the cuts, employers will "go through this very difficult process of individually, person by person, reimbursing" employees for the excess taxes that have been withheld, he said. There have been times when the federal government acted quickly to issue new tax guidelines for employers. In February 2009, the IRS issued withholding tables three days after Obama signed into law the stimulus package that included federal tax relief, Mezistrano said.

"I'm sure the IRS is poising itself and saying, 'Let's get rough drafts of tables out for whatever might happen,'" he said. Still, "the longer things go on, the tighter the turnaround for the IRS and for employers."

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