0.9% Medicare Tax -
Bonuses & Year End Tax Planning
Convert to a Roth Before 12/31/12?
- Jumping Off The Fiscal Cliff
Obama’s health care package enacted two new taxes that
take effect January 1, 2013.
One of these taxes is the additional 0.9 percent Medicare tax
on earned income; the other is the 3.8 percent tax on
net investment income.
The 0.9 percent tax applies to individuals; it does not
apply to corporations, trusts or estates.
The 0.9 percent tax applies to wages, other compensation, and
self-employment income that exceed specified thresholds.
tax on higher-income earners
There is no cap on
the application of the 0.9 percent tax. Thus, all earned
income that exceeds the applicable thresholds is subject to
the tax. The thresholds are $200,000 for a single individual;
$250,000 for married couples filing a joint return; and
$125,000 for married filing separately. The 0.9 percent tax
applies to the combined earned income of a married couple.
Thus, if the wife earns $220,000 and the husband earns
$80,000, the tax applies to $50,000, the amount by which the
combined income exceeds the $250,000 threshold for married
The 0.9 percent tax
applies on top of the existing 1.45 percent Hospital Insurance
(HI) tax on earned income. Thus, for income above the
applicable thresholds, a combined tax of 2.35 percent applies
to the employee’s earned income. Because the employer also
pays a 1.45 percent tax on earned income, the overall combined
rate of Medicare taxes on earned income is 3.8 percent (thus
coincidentally matching the new 3.8 percent tax on net
For partners in a
general partnership and shareholders in an S corporation, the
tax applies to earned income that is paid as compensation to
individuals holding an interest in the entity. Partnership
income that passes through to a general partner is treated as
self-employment income and is also subject to the tax,
assuming the income exceeds the applicable thresholds.
However, partnership income allocated to a limited partner is
not treated as self-employment and would not be subject to the
0.9 percent tax. Furthermore, under current law, income that
passes through to S corporation shareholders is not treated as
earned income and would not be subject to the tax.
Withholding of the
additional 0.9 percent Medicare tax is imposed on an employer
if an employee receives wages that exceed $200,000 for the
year, whether or not the employee is married. The employer is
not responsible for determining the employee’s marital status.
The penalty for underpayment of estimated tax applies to the
0.9 percent tax. Thus, employees should realize that the
employee may be responsible for estimated tax, even though the
employer does not have to withhold.
One planning device
to minimize the tax would be to accelerate earned income,
such as a bonus, into 2012. Doing this would also avoid any
increase in the income tax rates in 2013 from the sunsetting
of the Bush tax rates. Holders of stock-based compensation may
want to trigger recognition of the income in 2012, by
exercising stock options or by making an election to recognize
income on restricted stock.
device would be to set up an S corp, rather than a
partnership, for operating a business, so that the income
allocable to owners is not treated as earned income. An entity
operating as a partnership could be converted to an S corp
If you have any
questions surrounding how the new 0.9 percent Medicare tax
will affect the take home pay of you or your spouse, or how to
handle withholding if you are a business owner, please contact
me at the office.
Bonuses and Year End 2012 Tax Planning
the end of the calendar year approaches, taxpayers ordinarily
prefer to minimize current-year income by deferring the
inclusion of taxable income to the following year, while
accelerating deductions to the current year.
However, as many
taxpayers are aware, individual income tax rates may
increase in 2013, with the potential for dramatic
increases for higher-income individuals (if not all
While it is unclear
how many taxpayers will see tax increases in 2013, it is
certain that rates will not be any lower than they are in
2012. Thus, some, if not all, individuals will have an
incentive to accelerate income into 2012.
bonuses for 2012
annual bonuses for services performed in 2012 ordinarily would
receive the bonus in 2013. And generally the employer would
take the deduction in 2013. However, some employees may prefer
to receive the bonus in 2012, to take advantage of the lower
current tax rates. An employer may want to deduct the bonus in
the earlier year, to reduce taxable income. The IRS recently
issued Chief Counsel Advice (CCA 201246029) on the treatment
of a bonus that illustrates some of the practical obstacles to
accelerating bonus income.
In the CCA, the
employer awarded bonuses for the calendar year (the year of
service) based on company performance. The total bonus amount
accrued for financial accounting purposes at the end of the
year. The bonuses were paid early in the following year, after
the employer finalized the amounts, provided that the employee
still worked for the company.
In Rev. Rul.
2011-29, the IRS determined that the employer can accrue
liability, and take a deduction, for bonuses in the earlier
year, where the employer can establish the fact of the
liability for bonuses paid to a group of employees, even
though the recipients’ identities and amounts payable were
determined in the following year. In contrast, in the CCA, the
IRS concluded that the taxpayer’s liability to pay bonuses was
not fixed until the contingency was satisfied – the employee
had to be still employed on the date of payment. Therefore,
the bonuses were not deductible until the following year, when
they were paid.
While the CCA does
not discuss it, presumably if the employer paid the bonuses in
the year of service (2012), they would be deductible in that
same year. The employees would take the bonuses into income in
2012, when tax rates were lower. Furthermore, the income would
avoid the new 0.9 percent additional Medicare tax on earned
income, which takes effect in 2013.
In the CCA, the
timing was identical for the employer and the employee. Under
Code Sec. 404, concerning deferred compensation, the employer
may not deduct the bonus until the same time that the employee
takes it into income. Under an exception, however, if the
employer pays the bonus in 2013 but within 2 ½ months after
the end of 2012, an accrual basis taxpayer can deduct the
payment in the current year, even though the employee would
not include it in income until it is paid in 2013. This
presumes that the bonuses are fixed at the end of 2012 and
that the employer does not use a plan like the one described
in the CCA.
Should I Convert to a Roth IRA Before 2012 Ends?
2013 bearing down on us, we hope you have a moment to spare
from holiday preparation for some good old-fashioned year-end
tax planning. By now you must be familiar with the term
“fiscal cliff” and how the expiring provisions, tax rates, and
budget appropriations may affect small business, big business,
and politics in Washington, DC.
looming expiration dates for the Bush-era tax cuts and other
tax provisions set to become effective in 2013 may also have
consequences for how you save for retirement. This year we
have advice for IRA account holders in particular:
increased tax. If you have a traditional individual
retirement account (IRA) and you are thinking about converting
to a Roth so you can accumulate tax-free earnings, you might
want to do it before the year ends. First, if you are in a
high-income tax bracket, your taxes are likely to increase if
the Bush-tax cuts expire. Converting from a traditional IRA to
a Roth IRA creates a taxable event, and you may lose more
money to the government by converting in 2013 than you would
if you convert before 2012 ends.
whose projected 2013 adjusted gross income (AGI) will approach
$250,000 (or $200,000 for single filers) may want to avoid
converting their traditional IRA in 2013. The addition of
their IRA assets to their AGI may push them within the income
range limits for taxpayers subject to the 3.8 percent tax on
net investment income that goes into effect in 2013.
Please note that
the converted IRA assets would not themselves be subject to
the 3.8 percent surtax. However the surtax would
apply to any investment income the taxpayer has. Such
investment income would include items such as (but not limited
to) dividends, rents, royalties, interest, except
municipal-bond interest, capital gains, and income from the
sale of a principal residence worth more than the
conversion. You might be asking what would happen if
you convert to a Roth IRA in 2012 and then Congress extends
the current tax rates. In such cases, you would have until
October 15, 2013 to undo the transaction. You could put the
money back into your traditional IRA as if you had never
converted in the first place. In other words, there would be
no taxable event.
conversion and deferral. Taxpayers who already
converted their traditional IRA to a Roth IRA in 2010 were
given a one-time privilege of deferring half of the income
from the conversion to 2011 and the other half until 2012. If
taxpayers elected to defer their IRA conversion income in this
way, the 2012 tax year has arrived. They must report that
second half of their conversion income on their 2012 tax
returns. If you are a taxpayer who must report income from a
previous Roth IRA conversion in 2012, it might not be in your
best interest to generate additional income by converting yet
another IRA before the year ends.
Contributions. The 2012 year-end will also bring
several changes to the rules on IRA contributions, which may
affect your planning. In 2013, the limits on maximum annual
contributions to an IRA will go up from $5,000 to $5,500
($6,500 for contributors age of 50 and over, up from $6,000 in
2012). This increase in contribution limits is the first time
the IRS has adjusted the limit since 2008.
The adjusted gross
income level at which taxpayers must begin to phase-out their
contributions will also go up in 2013.
Income levels for a traditional IRA
$59,000 to $69,000
$58,000 to $68,000
Married (filing jointly)*
$95,000 to $115,000
$92,000 to $112,000
Married (filing jointly)**
$178,000 to $188,000
$173,000 to $183,000
*If the spouse who makes the IRA contribution is covered
by a workplace retirement plan.
**If the contributing spouse is not covered by a workplace
retirement plan, but is married to a spouse who is
Income levels for a ROTH IRA
$112,000 to $127,000
$110,000 to $125,000
Married (filing jointly)
$178,000 to $188,000
$173,000 to $183,000
planners should note that the deadline for making IRA
contributions for the 2012 tax year remains unchanged. You
still have until your filing date, which is April 15, 2013, to
make contributions for 2012.
The Fiscal Cliff,
Are There Rocks
you ever watched those people dive off cliffs? Wow, they look
graceful. I always thought it looked really scary. Heck, I'm
not so sure I would go feet first. On the way down it looks
like you would scrape the side of the cliff. However they do
it, it looks great.
account, in Washington, neither party Democrats or Republicans
look very graceful as they are getting ready to jump off the
believe it is the jump that worries me, it is how far down in
the water we go. Will we be able to catch our breath and swim
to the top? What kind of rocks are down there? Are there
sharks in the water? If we are talking about Washington,
there are sharks, piranha, whales, and mermaids, unicorns, ok,
off topic.... Washington is filled with obstacles. This is
why I am unconvinced the right thing will happen.
wind our clocks back to 2011 and look at the debt-ceiling
battle. I know many think the markets will sprint forward
when they get the cliff resolved. In 2011 stocks traded
sideways and jumped around a bit much like today as the debt-ceiling
debate got under way. The sharpest drop came though once the
debt-ceiling bill cleared on August 2, 2011. In fact
it dropped 10.6%, just seven days later.
the same thing will happen when the fiscal cliff gets
"resolved." If the sausage is made favorably and there are
REAL cuts in budgets and similar tax increases, then stocks
could soar. On the other hand, if their is just tax increases
and few cuts or cuts coming later (which will never happen)
then the markets will get negative as they look out to Q2 in
2013 with a likely recession.
is, I don't know which will prevail. You have to invest
thinking both scenarios are possible. This is why a balanced
approach to investing always makes sense. There are always
some bargains out there. I will keep in touch when news hits
(likely before the 17th when Obama is going to Hawaii for an
To read this & my other articles online go to
and click on the Newsletter section.
always you can call me at 714-619-0667 if you have any
questions about investing, retirement or any other tax &
accounting related issues.
Regards, Monica Rebella, CPA/IAR
President, Rebella Accountancy