The Federal Government giveth, Illinois taketh away….

The Federal Government giveth, Illinois taketh away….

This posting is the good news/bad news of the 2011 tax year, particularly for Illinois residents.

The good news?  As part of the tax compromise passed during the lame duck session, Congress included a 2% reduction in the rate of Social Security tax collected from individuals.  Normally, 6.2% of your pay up to a maximum level of $106,800 goes to Social Security Retirement funding.  In 2011, this rate is reduced to 4.2%.  You should already see this reduction in your paycheck.  If your earned income is $80,000, you’ll “save” $1,600 in taxes this year.

But, if you live in Illinois, you’ll also see the bad news – a 2% increase in State Income tax.

In essence, the two offset, up to the Social Security maximum, for the regular income that you earn from a paycheck.  (Okay, I’m ignoring things like IL state exemptions and deductions, but that’s fine for our purposes here. I’m also ignoring that there is an increase on Illinois non-wage income tax that is not offset by a reduction in Social Security taxes.  But let’s move on…).  If you didn’t get a raise at the end of the year and paid Social Security taxes as part of your final paycheck, your net pay will be the same after the first of the year as it was before the end of the year.

Unfortunately, in 2012, Social Security taxes go back to the old level, and Illinois state income taxes stay at the new, higher level.

What should you do for planning purposes?

Start adjusting now to next year’s tax increase, but put the money into savings this year.  Assume you need to pay an additional 2% of your income in total taxes. Take that 2% and put it in your IRA, your 401(k), or your taxable account, whichever makes sense for you; ask your advisor if you’re not sure.  Then, next year when taxes go up, you can see if you need to reduce your 2011 savings rate to help pay for the taxes.  Quite possibly, you’ll adjust to the lower spending again in 2012.

If you can’t swing the 2% all at once, start at 1%. If you get a raise this year, increase your savings rate by another 1% once your raise goes into effect.

Practice now for that tax increase that’s coming next year!  You’ll know that you’re able to adjust your spending, and you’ll end up with more money in your savings account.  Make the best of this upcoming increase by using the advance notice to prepare.

And if you don’t have Illinois taxable income, start saving that 2% now, it’ll be gone in 2012!