As explained in our prior advisory a variety of tax credits, exemptions and reduced tax rates are scheduled to expire at the end of 2012. Through a series of advisories on the changes most likely to affect you – our clients – Nutter’s Tax Group hopes to provide insight and guidance about ways that you may achieve the greatest tax efficiencies by taking advantage of current tax provisions.
This advisory focuses on several of the tax changes likely to affect employer payrolls – and employees’ net pay – to assist businesses in identifying areas in which tax savings may be achieved and methods for doing so.
Perhaps the most well-publicized tax change scheduled to become effective January 1, 2013 is the increase in U.S. income tax rates.
As a result of this increase, a salary or wage payment in 2013 will yield a lower payment, net of U.S. income tax, than the same amount paid in 2012. For example:
- An employee earning $100,000 or more who receives an annual bonus for 2012 in the amount of $10,000 will pay between $300 and $460 more in income tax if that bonus is paid in 2013 rather than 2012.
- The same employee will save between $500 and nearly $800 more in taxes by maximizing their standard 401(k) contributions in 2013 compared to the savings realized by a similar contribution this year.
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One strategy that employers may wish to consider to address this effect – and its impact on their employees – is to accelerate the timing of payments earned in 2012 but scheduled for payment in 2013, such as year-end bonuses. Factors to be weighed against this approach include the impact on cash-flow, the availability of year-end performance data relating to bonus payments and the preferred year in which to claim the compensation expense deduction. In addition, the acceleration of some payments, such as those made under non-qualified deferred compensation arrangements, may trigger penalties.
A separate strategy – that may be appropriate in lieu of or in addition to the first – is the deferral of compensation otherwise payable in 2013 until a later year in which the applicable tax rate could be lower, such as in retirement. This deferral may be achieved through a variety of arrangements, including tax-qualified programs (e.g., a 401(k) plan) and non-qualified arrangements (e.g., a supplemental executive retirement plan) or through a combination of the two. While the availability of these programs is not new, the tax rate increase warrants a fresh look at the design, availability and utilization of existing arrangements to determine whether they continue to provide effective means for delivering employee compensation in the most tax-efficient manner possible consistent with the organization’s operating needs and goals.
Another change affecting employee pay in 2013 is the scheduled expiration of the so-called “payroll tax holiday” after December 31, 2012.
The sunset of this holiday – which applies to the employee-paid portion of the OASDI (i.e.
, Social Security) portion of the payroll tax (FICA) – will cause employees to pay 2% more in Social Security tax. For employees receiving annual compensation equal to or greater than the OASDI wage base (currently $110,100/year), that means paying more than $2,200 more in Social Security tax in 2013 than in 2012.
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In many respects, the techniques described above with respect to addressing the scheduled increases in income tax rates also apply to the Social Security tax rate increase. However, there are special timing rules that apply to the recognition of income for FICA purposes that may offer additional opportunities for tax savings in this area. For example, certain non-qualified deferred compensation arrangements, such as defined contribution supplemental retirement plans, can change the date on which the deferred compensation is counted for FICA purposes by imposing - or eliminating – a vesting event. Using this rule, if such a plan were amended in 2012 to accelerate vesting, a reduction (or even complete elimination) of the OASDI tax applicable to the benefit accrued under the plan might be achieved. Non-qualified deferred compensation plans are subject to a variety of other rules, including rules that impose penalty taxes on vesting changes that alter the time of payment, that would need to be considered before implementing a technique such as this.
A number of other tax changes affecting employment compensation and benefits bear close review by employers in 2012 to evaluate whether and how they may be addressed to achieve the greatest tax advantage. These include (i) the 62% increase in the Medicare payroll tax rate on annual wages over $200,000, (ii) the imposition of a $2,500/year limit on health flexible spending account contributions and (iii) the elimination of the employer deduction associated with the receipt of Medicare Part D retiree drug subsidy payments.