Tax Increase? What Tax Increase? Or, the No Accountant Left Behind act

Congress reached a compromise over extending the Social Security tax reduction and unemployment insurance.  In the process, Republicans did the thing they vowed never to do (raise taxes on the rich), President Obama broke his promise (raised taxes on those making under $250,00 per year), and it appears to have been done it in one of the worst ways possible.

Included in the two month extension of the reduced Social Security payroll tax is a tax increase.  For those making more than the Social Security limit ($110,100 in 2012), all income over that limit is subject to a 2% surtax.  This surtax is on the gross income, not reduced by deductions, exemptions, etc.  As written, it is on income over $18,350 received in January and February.

I'm writing this over a week after the bill passed.  I thought that by this time the tax increase would be all over the news, yet I've heard very little about it.  This is unfortunate, because the surtax is likely to have a much more significant effect than the other provisions of the law.

As far as I can tell, this bill raises the marginal tax rate of high earners between two and four percent for earnings above $18,350 over two months (those making over the social Security limit averaged over the year).  After all of the Republican rhetoric about the harm of higher tax rates, we have a higher tax rate.  After all of President Obama's rhetoric about only increasing taxes on those making over $250,000 per year, we have a tax increase for which also affects those making between $110,100 and $250,000.

What are the problems with this tax increase?

1. The change isn't clear.  The IRS notice, IR-2011-124, was confusing when I received it.  I looked at the bill itself, and the IRS notice doesn't accurately reflect the new law.  I think the IRS is going to need some time to digest the implications of this law, then the rest of us get to figure it out.
2. The tax reduction is only for income up to $18,350.  As best I can tell (the IRS gets to try to figure out for sure), Social Security tax is 4.2% up to $18,350 in January and February, then 6.2% for any income above that.  Companies will have to track income for the first two months of the year, something they don't do today.
3. The 2% surtax is for income over $18,350 in January and February.
4. As written, employers will have to provide employees with income over $18,350 in January and February with a report of income received during those months in addition to the usual W-2 statement of income for the year (so they can compute the 2% surtax).
5. If the lower, 4.2% Social Security payroll tax is extended for the full year, will those making over $18,350 for the first two months will have paid at a 6.2% rate for part of their income.  Will companies have to reduce Social Security withholding later in the year so it balances out to 4.2% overall, will taxpayers have to figure out a couple new lines on their tax form, or will the extra withholding just be left as-is?
6. Because the surtax is on "wages and compensation", it will be computed based on raw W-2 income.  I can think of several ways this might be interpreted (does it include income normally not subject to Social Security tax or not?), and it will be assessed on at best a line of the tax form which is currently not used in tax computations (W-2 income) and at worst on only part of the income on that line (since it can include various miscellaneous income).  Thus, the tax form will become more complex.

I will state up front, my concerns above may be completely unfounded.  The actual law will depend on how the IRS interprets it, and I am probably wrong.  But I think this shows the confusion and complexity around this simple provision (a few paragraphs in total).

The complexities of this law is why it might be better named the "no accountant left behind act".  Tax accountants, payroll providers, and computer programmers dealing with payroll are going to be in big demand to sort this mess out.

At this point, the question is what Congress does next.  If they extend this bill for the full year, it will eliminate some of the complexities I mention above (though introduce a few others for very highly paid persons).  If (could well happen) they extend the bill in units of a couple months through the year, things could become even more complex.

Regardless, I think a strong buy on companies like ADP (payroll services) and Intuit (Quickbooks software) might be appropriate.  I can see a lot of payroll outsourcing to deal with this latest morass.