On January 2 , 2013, President Obama signed the American Taxpayer Relief Act of 2012 (H.R. 8) (the “Relief Act”) into law. While the principal intention of the Relief Act was to avert the key elements of the “fiscal cliff” by staving off widespread tax increases and sizeable spending cuts, the Relief Act contains a significant change regarding Roth conversions within Section 401(k) and certain other retirement plans and other provisions that affect employee benefits, including education and adoption assistance, dependent care assistance, transit commuting and parking benefits and the employer tax credit for child care assistance. The Relief Act also revived a popular charitable distribution alternative for individual retirement accounts. Lastly, the Relief Act raised tax rates for certain highly compensated individuals and couples. Each of these provisions is described in greater detail below.
Expanded Roth Conversions for Retirement Plans
Section 402A of the Internal Revenue Code of 1986, as amended (the “Code”), provides that participants in Section 401(k), 403(b) or 457(b) plans may make “Roth” contributions to the plan. Participants are taxed on such contributions, but if those contributions satisfy certain requirements, including restrictions on the timing of distributions, both the contributions and earnings are distributed tax-free.
Section 402A also permits participants to convert non-Roth accounts to Roth accounts, which subjects the taxable amount converted to income tax at the time of conversion. Prior to the Relief Act, only amounts that were otherwise distributable from the pre-tax account (for example, if the participant was age 59 ½ or older) could be converted to Roth accounts. Participants under 59 ½ were ineligible to make an “in-plan” conversion due to the fact that their accounts were not yet “distributable.”
The Relief Act amends Section 402A to allow any participant to make an “in-plan” Roth conversion, regardless of whether the amount is otherwise distributable. This suggests that all amounts can be converted to a Roth account, including deferrals, matching contributions and nonelective employer matching contributions. The provision is effective for conversions occurring after December 31, 2012.
The Congressional intent in expanding Section 402A was to create a revenue offset, as individuals who make “in-plan” Roth conversions will pay income tax on the amount converted when they choose to convert such amounts. Whether this will actually result in additional revenue in the long term is up for debate, however. While the government will certainly increase revenue in the short term as a result of conversions that otherwise would not have occurred, the lost tax revenue on the earnings that would have accumulated over the course of an participant’s career could result in a net loss for the government over the long term.
Insight: In order to allow participants to take advantage of the expanded opportunity to make Roth conversions, plan sponsors must add this discretionary feature to their plans. Plan sponsors desiring to make this feature available must amend their plan by the end of the plan year in which the expanded “in-plan” conversions will first be effective. For example, if the plan offers in-plan conversions in 2013, the plan must be amended by December 31, 2013.
Education Assistance Programs
Section 127 of the Code allows employees to exclude up to $5,250 from their gross income in conjunction with employer-provided educational assistance programs.
Certain provisions of Section 127 (including the exclusion limit of $5,250 and a provision that allows the exclusion to apply to graduate school education assistance) were set to expire at the end of 2012, but the Relief Act extends those provisions permanently.
Adoption Assistance Programs
Section 137 of the Code provides for an exclusion from gross income of up to $12,970 per year for employer-provided adoption assistance.
The adoption assistance exclusion was set to expire at the end of 2012, but the Relief Act extends the exclusion permanently.
Dependent Care Assistance Programs
Section 129 of the Code allows employees to exclude up to $5,000 from their gross income for amounts received in conjunction with employer-provided dependent care assistance programs. This exclusion phases out depending on the lower level of income of either the employee or his/her spouse. If the spouse is a student or incapable of caring for himself or herself, the spouse is “deemed” to have income of $250 per month (or $500 per month if the couple has two or more qualifying dependents).
The “deemed income” provision was set to expire at the end of 2012, but the Relief Act extends this provision permanently.
Transit Commuting and Parking Benefits
Section 132(f) of the Code allows employees to make pre-tax contributions (or employers to provide the same amount as a tax-free subsidy) for employer-provided commuting vehicles or transit passes (“transit commuting benefits”) or work-related parking expenses. From 2010 through 2011, the limit on the two benefits (transit and parking) was the same. However, in 2012 the limits shifted to $125 per month for transit commuting benefits and $240 per month for work-related parking expenses.
The Relief Act re-establishes parity between the two transportation benefits for 2012 (retroactively) and 2013. The IRS recently issued guidance as to how employers may correct the over-withholding of FICA tax on transit benefits. Employers must repay or reimburse their employees the “overcollected” FICA tax on the excess transit benefits for all four quarters of 2012. Employers who act before the deadline for filing Form 941 for the fourth quarter of 2012 may follow a special procedure to obtain a refund of the employer’s share of the FICA overpayment or, if not, file a Form 941-X for each 2012 quarter to make an adjustment on FICA taxes paid or to request a refund.
The 2013 limit for both transit commuting benefits and work-related parking benefits is $245 per month. This tax-free benefit will expire on December 31, 2013.
Employer Expenses for Child Care Assistance
The Relief Act extends the child care assistance credit of $150,000 per year for qualified childcare facilities permanently.
Distributions from Individual Retirement Accounts for Charitable Purposes
Section 408(d)(8) of the Code permitted taxpayers 70 ½ and older to make tax-free distributions from individual retirement accounts (IRAs) for charitable purposes through 2011.
The Relief Act reinstates this charitable distribution alternative through 2013. The Relief Act provides a transition period to make up for missed opportunities in 2012 by allowing individuals to make qualified charitable distributions from IRAs during January 2013 that will be treated as made on December 31, 2012 (counting as a 2012 tax-free distribution). The Relief Act also allows qualified IRA owners who received an IRA distribution during December 2012 to contribute the amount to a charity, and have the contribution treated as a tax-free distribution. This charitable distribution option will expire again on December 31, 2013.
Tax Rate Increases May Increase Need for Deferred Compensation
The top income tax rate will increase from 35% to 39.6% for single filers with taxable incomes above $400,000 and joint filers with taxable incomes above $450,000. We expect this tax rate increase will result in employees within the top income tax bracket seeking options by which to defer compensation, with the hope that the top tax rate will eventually decline. Employers may want to consider expanding their deferred compensation alternatives for this top-paid group of employees.
King & Spalding is happy to assist you make amendments to allow expanded Roth conversions, to establish or modify deferred compensation arrangements, or to answer any questions you may have regarding the Relief Act.
Authors, Eleanor Banister, Atlanta, +1 404 572 2755, 4930, firstname.lastname@example.org Ryan Gorman, Atlanta, +1 404 572 4609, email@example.com.