Keeping Americans in suspense until the very last minute, Congress narrowly averted the "fiscal cliff" by passing the American Taxpayer Relief Act of 2012 (ATRA), H.R. 8, late in the evening on New Year's Day. President Obama signed the tax package into law the following night. ATRA permanently extends certain expiring Bush-era tax provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (EGTRRA), and the Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-237 (JGTRRA), temporarily extends other payroll related provisions that expired at the end of 2011 and 2012, and increases the top marginal income tax rate on the wealthiest one percent of Americans. As a result, the withholding rate on supplemental wages over $1 million is also increased.
ATRA does not extend the temporary two percent cut in the employee portion of the Social Security tax rate that was in effect in 2011 and 2012. Consequently, most employees' net pay will be lower due to the significantly higher Social Security taxes that will now be withheld from their pay.
Increased Social Security Tax Rate
Employers should begin withholding Social Security tax at the rate of 6.2 percent of wages paid on or after January 1, 2013, as soon as possible, but not later than February 15, 2013, the Internal Revenue Service (IRS) advises. After implementing the new 6.2 percent rate, employers should make an adjustment in a subsequent pay period to correct any underwithholding of Social Security tax as soon as possible, but not later than March 31, 2013.
The total 2013 FICA tax rate, which is the Social Security tax rate of 6.2 percent plus the Medicare tax rate of 1.45 percent, which must be withheld from employees' wages paid on or after January 1, 2013, is 7.65 percent up to the $113,700 Social Security taxable wage base. As in prior years, there is no limit on the amount of wages subject to Medicare tax withholding; all covered wages are subject to Medicare tax at 1.45 percent.
2013 Withholding Tables
On January 3, the IRS issued much anticipated 2013 income tax withholding percentage method tables reflecting the new rates and new withholding allowance amounts by payroll period. Note that the tables supersede early release percentage method tables issued on December 31, 2012, in IRS Notice 1036. The correct tables to be used in 2013 are now included in an updated version of Notice 1036 on the IRS website and will appear in IRS Publication 15 (Circular E), Employer's Tax Guide (For use in 2013). Publication 15 should be released by the IRS early in 2013. The wage-bracket withholding tables for wages paid in 2013 have not yet been released. Employers should implement the 2013 tables as soon as possible, but not later than February 15, 2013, the IRS advises. The 2012 withholding tables should be used until the 2013 withholding tables are implemented.
Employees' Forms W-4
The issuance of new withholding tables does not require employees to fill out a new Form W-4, Withholding Allowance Certificate. However, as is advisable at the beginning of every year, employers may wish to remind employees to review their withholding and fill out a new Form W-4 if necessary. Some examples of employees who may need to submit a revised Form W-4 include individuals and couples with multiple jobs, employees who are expecting or who have just had a child, those getting married or divorced, those buying a new home and those who typically have a balance due or large tax refund at the end of the year. The IRS has not yet released the 2013 Form W-4.
ATRA includes the following payroll related provisions.
Personal Income Tax Rates and Personal Exemption Phase-Out
The current tax rates of 10, 15, 25, 28, 33 and 35 percent on income at or below $400,000 are permanently extended. A new rate of 39.6 percent is added for taxable income over $400,000 for single filers, $425,000 for head-of-household filers and $450,000 for married couples filing jointly (or $225,000 for married couples filing separately).
The personal exemptions and itemized deductions phase out at a higher threshold of $250,000 for single taxpayers, $275,000 for heads of households and $300,000 for married taxpayers filing jointly for tax years after December 31, 2012. The limitation on itemized deductions is also extended on income at or below these amounts.
Increased Supplemental Withholding Rate
The mandatory flat rate for federal income tax withholding on supplemental wage payments (e.g., bonuses) that exceed $1 million, made on or after January 1, 2013, increases to the new top rate of 39.6 percent, from 35 percent. The optional flat rate for federal income tax withholding from supplemental wages up to $1 million remains at 25 percent since the 25 percent income tax bracket is unchanged.
Backup Withholding Rate
The backup withholding rate for payments made to independent contractors who fail to provide a Taxpayer Identification Number (TIN) stays at 28 percent because the fourth lowest income tax rate remains at 28 percent under ATRA.
The following payroll tax provisions, which would have expired on December 31, 2012, are now permanent:
The income exclusion for employer-provided educational assistance (under Internal Revenue Code (IRC) § 127), which allows employers to provide employees with up to $5,250 per year in nonjob-related graduate and undergraduate educational assistance on a tax free basis;
The income exclusion for amounts paid to employees under +IRC § 117(c) for certain health professions scholarship programs for qualified tuition and related expenses;
The $10,000 income exclusion for employer-provided adoption assistance (+IRC § 137); and
The employer credit of up to $150,000 for acquiring, constructing, rehabilitating or expanding property used for a child care facility.
The following expiring payroll tax provisions are temporarily extended, through the dates indicated:
The 45 percent Earned Income Tax Credit (+IRC § 32(b)) applicable to families with three or more children and the phase-out range for all married couples filing a joint return is extended for five years, through 2017.
Parity for pre-tax treatment of employer-provided mass transit, vanpool and parking benefits (+IRC § 132(f)) is retroactively extended from January 1, 2012 through December 31, 2013. Before 2012, employers could withhold up to $230 per month on a pre-tax basis for employee mass transit benefits. The amount decreased to $125 on January 1, 2012, while the amount for parking expenses increased to $240.
The business tax credit for employers of qualified employees who work and live on or near an Indian reservation (+IRC § 45A), which expired December 31, 2011, is extended retroactively for payments made from January 1, 2012 through the end of 2013. The credit amount is 20 percent of the excess of wages and health insurance costs paid to qualified employees, up to $20,000 per employee, in the current year over the amount paid in 1993.
The employer wage credit (+IRC § 45P) for differential wage payments made to activate military reservists, which expired December 31, 2011, is extended retroactively for payments made from January 1, 2012 through the end of 2013.
The Work Opportunity Tax Credit (WOTC) (+IRC § 51(c)(4)), which allows businesses to claim a tax credit of 40 percent of the first $6,000 of wages paid to newly hired employees in one of eight targeted groups, and the WOTC for hiring qualified veterans in certain targeted groups, are extended through the end of 2013.
The special tax incentives for employers within certain designated Empowerment Zones (+IRC § 1391(d)(1)(A)) are extended through the end of 2013.
Tax exempt bond financing for employers operating in the New York Liberty Zone (+IRC § 1400L(d)(2)) is extended through January 1, 2014, for bonds issued after December 31, 2011.
Effect on State Taxes
Many states' income tax withholding calculations are tied to the calculation of federal income tax withholding and may change due to ATRA. Continue to check XpertHR regularly for any ATRA-related developments issued by state taxing authorities.
Additional IRS Guidance Still Needed
The IRS must now issue the following 2013 items and information in order for employers to correctly process 2013 payrolls:
Wage-bracket withholding tables;
Form W-4, Employee's Withholding Allowance Certificate;
IRS Publication 15 (Circular E), Employer's Tax Guide;
IRS Publication 15-A, Employer's Supplemental Tax Guide;
IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits;
IRS Publication 1494, Table for Figuring Amount Exempt from Levy on Wages, Salary, and Other Income (Forms 668-W(ACS), 668-W(c)(DO), and 668-W(ICS));
The inflation-adjusted qualified adoption assistance and income phase-out amounts; and
The inflation-adjusted amount for qualified transportation fringe benefits.
Continue to check XpertHR regularly for the release of these 2013 items.
Payroll > Withholding Taxes
Payroll > Taxation of Employee Compensation