What Employers Need to Know
New Medicare tax
The new 0.9% Medicare tax – or the Additional Hospital Insurance Tax – applies to earned income over $200,000 for single taxpayers, and $250,000 for joint filers, for 2013 and beyond. The employer portion of the Medicare tax remains the same.
The IRS has issued guidance for employers on withholding requirements for the Additional Medicare Tax. Employers are required to withhold the additional 0.9% on wages over $200,000 during the calendar year. This withholding requirement results in two potential risks to the employee.
The first risk is underwithholding related to the the individual employee in instances where the employee’s salary and their spouse’s salary is each less than the $200,000 threshold, but the couple’s combined salary exceeds $250,000. In this instance, the employee and spouse may owe additional taxes and penalties on their individual income tax return. For example, Employee A has a salary of $185,000 and Spouse B’s salary is $115,000, each spouse’s employer will treat its employee as earning below the Medicare tax threshold. The couples combined income is $300,000, which means they are subject to the additional 0.9% Medicare tax on $50,000. Couples in this situation may either request additional withholding from their employers or make an estimated tax payment during the year.
The second risk is overwithholding. If one spouse has earned income of $225,000 and the second spouse has no earned income, $25,000 will be subjected to the employer withholding requirements. Since their combined income is less than the $250,000 married filing jointly threshold, they are not subject to the additional Medicare tax. In this instance, the couple will claim a credit on their individual income tax return for the 0.9% Medicare tax withheld from wages.
Sole proprietors and partners with self employment income over the threshold amounts will calculate and owe the additional medicare tax when filing their individual tax returns. The additional Medicare tax should be considered when calculating 2013 estimated tax payments.
Social Security tax holiday expired
The Social Security payroll tax cut expired at the end of 2012. The Social Security tax reverts to 6.2% beginning January 1, 2013. The combined employer and employee Social Security tax rate returns to 12.4%.
Restrictions removed on Roth §401(k) in-plan transfers
Beginning January 1, 2013, plan participants may move their account balances — including employee contributions made prior to 2013 and earnings — to a Roth account within the plan regardless of the participant’s age. Prior law restricted in-plan Roth transfers to participants who were eligible for distributions, such as individuals who are age 591/2 or older. The expanded availability of in-plan Roth transfers includes §§403(b) and 457 plans, as well as §401(k) plans.
If your existing 401(k) plan does not permit Roth transfers within the plan document, you will need to amend your plan to allow for these transfers. A Roth transfer may be a useful tax strategy to help some employees plan for tax-free income in retirement. The employee will pay income tax on the amount transferred, then the Roth account will grow tax free and distributions will be tax free. Some employees may prefer to transfer only part of their account balance or to transfer the entire amount in stages to avoid a large one-time tax hit.