The year’s end usually brings advice about how to delay recognizing income until next year, so as to reduce the tax burden this year. This year is different—whether or not we go over the “fiscal cliff”—because under the Affordable Care Act, 2013 will bring additional Medicare taxes for high earners.
Wages over $200,000 will be subject to an additional 0.9% Medicare tax. In addition, unearned income (such as capital gains, dividends, interest) of higher income individuals will, for the first time ever, be subject to a Medicare tax of 3.8%. (This applies only to individuals with AGI over $200,000, and married couples with AGI over $250,000.)
Few people want to pay taxes earlier than strictly necessary, but this year it may be worthwhile. Highly compensated employees may be interested in the strategies listed below. They should keep in mind that these strategies may affect their alternative minimum tax liability, and both employers and employees should seek advice from competent tax professionals.
Steps an employer can take:
- Accelerate vesting (not payment) of deferred compensation in a nonqualified plan subject to Section 409A of the Code—this would trigger the requirement to pay FICA in 2012 before the additional Medicare tax applies (If you are a tax-exempt entity, this may also trigger income taxes.
- Pay bonuses in 2012, rather than 2013
- Vest restricted stock, unvested stock options, or stock appreciation rights
- Consider plan amendments that would permit employees to take certain tax acceleration strategies
Steps an employee can take:
- Take an in-service distribution from your 401(k) plan (may require amending the plan)
- Complete an in-plan Roth conversion in your 401(k) plan, or rollover an in-service distribution to a Roth IRA (may require amending the plan)
- If you reached the age of 70½ in 2012, take your first Required Minimum Distribution from your retirement plan in 2012, rather than delaying to April 2013.
- Realize capital gains income, for example, on stock held pursuant to an option exercise or by making an 83(b) election for restricted stock
It’s important to be very careful when attempting to accelerate income in any plan that is subject to Section 409A of the Code. Always seek legal advice before making changes to any employee benefit plan.