There are many open questions about federal income, estate, and payroll taxes for 2013. Will the Bush-era tax cuts be extended for all taxpayers? Will the 2 percent reduction in the Social Security tax on employees and self-employed individuals that applies for this year also be extended? While these questions cannot be answered at the present time, what is certain is that some tax rules are set to change in 2013 and your business can prepare for them now.
Withholding for the additional Medicare tax
There is a new additional Medicare tax of 0.9 percent on workers that takes effect in 2013. It applies only to earned income over a threshold amount:
- $250,000 for married persons filing jointly
- $200,000 for singles, heads of households, and qualifying widow(er)s
- $125,000 for married persons filing separately
The additional Medicare tax is on top of the basic Medicare tax of 1.45 percent on all compensation earned by employees (2.9 percent on all net earnings from self-employment).
Self-employed individuals. The same additional Medicare tax of 0.9 percent applies to net earnings from self-employment (i.e., profits). However, as a self-employed individual, there is no withholding. The tax must be included in estimated tax payments to avoid underpayment penalties. Those who have working spouses can have them request additional income tax withholding from their wages; this withholding can then be applied to the additional Medicare tax when they file their joint returns for the year.
Because of the new tax, the deduction from gross income for self-employment tax will not be exactly one-half of all self-employment tax paid. The deduction is limited to the so-called employer portion, which will be something less than half of the total amount of self-employment tax paid by those with net earnings over their applicable threshold amount.
Employer responsibilities. The law does not require a company to notify employees about the new tax, but it might be a good idea to do this so high earners will not be surprised. Here are other points employers should know:
- There is no employer matching of this additional tax; the tax falls exclusively on employees. However, there may be additional administrative costs for compliance with withholding for the tax—whether you handle payroll in house or outsource this function.
- As in the case of the basic Medicare tax, it applies to all taxable compensation, including bonuses, tips, and taxable fringe benefits.
- Withholding begins in the pay period in which an employee’s earnings first exceed the applicable threshold amount.
- Withholding applies only to the portion of earnings over the threshold amount. For example, say late in December 2013, an unmarried employee who had earned $175,000 receives a year-end bonus of $30,000. In the pay period in which the bonus is paid, withholding must be taken for the additional Medicare tax on $5,000, which is the portion of earnings over the employee’s $200,000 threshold amount.
Adjusting for the new FSA cap
Companies offering medical flexible spending accounts (FSAs) must limit employee salary reduction contributions for 2013 to $2,500. Up until now, the cap on employee contributions had been set by employers, not the tax law, with the cap averaging around $5,000 in most companies.
What to do:
- Inform employees about the change in the law. The $2,500 cap will be adjusted for inflation after 2013.
- Amend FSAs to reflect the tax law’s limit on employee contributions. While the deadline for making amendments is the end of 2014, plans must be operating under the new rules in 2013.
There are some nuances in the new rule that may affect your benefit plans:
- The cap applies only to medical FSAs. It does not apply to dependent care FSAs or other employee contribution plans, such as health savings accounts.
- If a married couple work for the same employer, each can contribute up to $2,500 to a medical FSA.
Accommodating employee withholding changes
There are other tax rules set to take effect in 2013 that could raise taxes for individuals. In order for employees to avoid paying estimated taxes, some workers may prefer to have employers withhold more from their paychecks to cover the anticipated tax liability. Employers can furnish employees with Form W-4, Wage Withholding Certificate; employees can ask that additional withholding be made (by reducing withholding allowances or requesting that a specific amount be withheld). New law changes that could impact employee taxes in 2013 include:
- Additional Medicare tax on net investment income of 3.8 percent.
- Higher threshold for itemizing medical deductions.
Now is a good time for business owners to meet with their tax advisors. Discuss which tax rules need to be addressed now and how to proceed.
Barbara Weltman is an attorney, author (with such titles as J.K. Lasser’s Small Business Taxes and The Complete Idiot's Guide to Starting a Home-Based Business), and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® at www.barbaraweltman.com, and host of Build Your Business radio. Follow her on Twitter: @BarbaraWeltman.