If widespread news reports are any indication, many people—employers and employees alike—are thinking about increased taxes in 2013 and what can be done to minimize their impact.
Some tax increases in 2013 are a sure thing. For example, the employee share of Medicare taxes will increase to 2.35% for wages in excess of $250,000 (for married individuals filing jointly), $125,000 (for married individuals filing separately), and $200,000 (in any other case).
But, even as the end of the year looms, it is unclear whether other potential tax increases will take effect. If the so-called Bush tax cuts expire, income tax rates will increase. If the “payroll tax holiday” is not extended, the employee share of Social Security taxes will increase to 6.2% from its current 4.2%.
Due to the uncertain tax landscape for 2013, employers may wish to consider accelerating certain payments and awards into 2012 when taxes will generally be lower. However, in so doing, employers should be careful to avoid certain potential pitfalls.
Specifically, employers might wish to consider accelerating payments or vesting awards as follows:
- Pay 2012 bonuses in cash in December 2012 instead of in early 2013 so the payments are subject to income and employment tax in 2012.
- Pay 2012 bonuses in restricted stock, instead of in cash, in December 2012 so that employees can elect to make section 83(b) elections to pay income and employment tax in 2012 rather than in 2013 when the restrictions lapse. (Vesting schedules can reflect what would have been the cash bonus payment schedule.)
- Restricted Stock.
- Vest outstanding restricted stock awards in December 2012 that would otherwise vest in early 2013 because income and employment tax is due on restricted stock at vesting (assuming no section 83(b) election).
- Grant restricted stock in December 2012 instead of in early 2013 so that employees may make a section 83(b) election and pay income and employment tax in 2012. (Vesting schedules can be adjusted to reflect what would have been the vesting schedule if the awards had been granted in 2013.)
- Stock Options and SARs.
- Accelerate vesting of nonqualified stock options or SARs, so that employees may exercise the options or SARs and pay income and employment tax in 2012. (There is no tax savings from the exercise of an incentive stock option in 2012, unless the exercise is followed immediately by a sale of the share in a disqualifying disposition.)
- Amend nonqualified stock options to allow for the “early exercise” of unvested options that the employee can exercise to receive restricted shares of stock. The employee can then make a section 83(b) election and pay income and employment tax in 2012 with respect to the restricted shares. (A section 83(b) election will not result in income tax savings with respect to a share received from the early exercise of an incentive stock option, but the section 83(b) election will apply to the extent the option gain is subject to alternative minimum tax.)
- Non-Account Balance Deferred Compensation. For defined benefit and other non-account balance deferred compensation plans, take amounts deferred into account for FICA purposes in 2012 under the “early inclusion” rule so that more income is subject to FICA in 2012. Employers can then use the true-up mechanism set forth in the FICA regulations at a later date when amounts are reasonably ascertainable.
Employers considering accelerating payments or vesting awards should be mindful of the following:
- Section 409A. Because section 409A generally prohibits acceleration of deferred compensation, it is easiest to accelerate payments such as those listed above that are exempt from section 409A (and its 20% additional income tax). However, even for nonqualified deferred compensation that is subject to section 409A, an employer could consider: (1) making a payment early as long as the payment is made no earlier than 30 days before the designated payment date and the employee is not permitted, directly or indirectly, to designate the taxable year of payment; and (2) accelerating payment from a nonqualified deferred compensation plan if acceleration is in connection with the termination of the plan, and all plans of the same type for all participants, within 30 days preceding or 12 months following a change in control.
- Section 162(m). Public companies should review the complicated rules under section 162(m) before accelerating any payment intended to constitute performance-based compensation to certain officers. For example, performance-based compensation may only be paid after the company’s compensation committee certifies that the pre-established, objective performance goals have been achieved.
- Constructive Receipt. If employees are given the choice to elect payment in 2012 or 2013, the IRS might consider the payment taxable to the employee in 2012 under the “constructive receipt” doctrine regardless of whether the employee elects to be paid in 2012. So, even if an employee elects to receive an amount in 2013, if he or she could have elected the payment in 2012, the IRS might view the amount as taxable in 2012.
- Corporate Governance and Disclosure. Public companies should carefully consider all applicable disclosure rules, and all employers should review any corporate governance issues related to accelerating payments and awards. For example, an acceleration of payment could constitute a material modification of a previously disclosed award, which would trigger an obligation to file a current report on Form 8-K. Further, acceleration of payments associated with performance-based awards, prior to a determination whether the relevant performance criteria have been achieved, could trigger close scrutiny by ISS and other proxy advisory firms.
- Employee Motivation. Employers should consider whether paying amounts in 2012 will affect employees’ motivation to remain with the employer and maintain high-performance through the end of the year and into 2013.
- General Business Considerations. Employers should consider other general business considerations, such as whether they have sufficient cash on hand to pay the awards early.
As the tax landscape for 2013 solidifies, we will keep you posted.