After lawmakers were unable to agree on whether to extend the reduced payroll tax rate for another full year, Congress approved a continuation of the two percentage point cut in the employee portion of the payroll tax, which had been set to expire at the end of 2011, through the first two months of 2012.

On December 23, the Senate and the House passed by unanimous consent the Temporary Payroll Tax Cut Continuation Act of 2011, and President Obama signed the bill into law the same day. Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the employee share of the Social Security tax had been lowered from 6.2% of the first $106,800 of wages to 4.2% for 2011 only. After this year-long reduction, the payroll withholding for employees had been scheduled to revert to the normal rate of 6.2% on January 1, 2012. Under the new law, the 4.2% rate for employees will be in effect through February 29, 2012. The employer portion of the payroll tax will remain at 6.2%, while the self-employed rate will be 10.4% through the end of February.

The legislation also includes a two-month extension of emergency Federal unemployment benefits, and a provision that prevents a scheduled payment cut for physicians who treat Medicare patients from taking effect until March 1.

In announcing these temporary extensions, Congressional leaders said a conference committee made up of members of both the House and Senate will convene in early 2012 to negotiate a possible continuation of the payroll tax reduction through the end of 2012, as well as of Federal unemployment benefits and higher Medicare reimbursement rates. Members are expected to debate whether additional payroll tax relief should be offset by raising income taxes on higher earners, or by reducing Federal spending.

Because the adjustment of the payroll tax rate for the first two months of 2012 was enacted just days before it went into effect, the IRS said in a notice released on December 23 that employers and payroll services are expected to implement the new payroll tax rate as soon as possible in 2012, but not later than January 31, 2012. For any payroll tax over-withheld during January, employers are required make an offsetting adjustment in workers' pay as soon as possible, but not later than March 31, 2012.

The new law also includes a "recapture" provision, which requires employees who earn more than $18,350 during the two-month period, or one-sixth of the 2012 Social Security wage base of $110,100, to pay an additional income tax in an amount equal to 2% of the wages they receive during the two-month period in excess of $18,350. According to the IRS, the recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year. The House Ways and Means Committee has, however, indicated that this provision will only apply if the payroll tax reduction is not extended through the end of 2012.

The IRS also said it will issue additional guidance as needed to implement the provisions of this new two-month extension, including revised employment tax forms and instructions, as well as information for employees who may be subject to the new recapture provision.