myNQDC.com Alert (Sept. 19, 2012): Insights & Updates
Editor's Note: The alert below concerns our sister website myNQDC.com, a resource about nonqualified deferred compensation that is a separate publication from myStockOptions.com. The alert was sent by email to registered users of myNQDC.com on Sept. 19, 2012.
At myNQDC.com, we continue to enrich our content with crucial updates and practical new articles and FAQs about key NQDC topics, including the prospect of tax increases after 2012. Below we outline the major tax-planning issues ahead for people with nonqualified deferred compensation. In addition, we also provide selected additions and updates from the past few months.
Potential Tax Changes Ahead Will Affect Nonqualified Deferred Compensation
The current tax law is set to end at the close of 2012. Although the timeline for new tax legislation in Congress is not yet clear, the future tax environment for nonqualified deferred compensation will soon be determined amid a comprehensive flood of necessary new legislation affecting all areas of the tax system. Unless the current tax rates are extended beyond 2012, the following potential tax increases may apply to nonqualified deferred compensation in 2013.
- The flat federal rates for supplemental income withholding that apply to current and former employees at distribution may rise to 28% and 39.6%. These withholding rates, currently 25% (amounts under $1 million) and 35% (amounts over $1 million), are tied to specific tax brackets.
- At the time of your compensation deferral or the vesting of a company match or contribution, you pay Social Security tax. The Social Security rate may return to 6.2% from the current reduced rate of 4.2%.
- At deferral or vesting, you also pay Medicare tax. Under the Affordable Care Act, for high-income taxpayers the Medicare tax rate on compensation income will rise from 1.45% to 2.35%. It is unlikely that that new 3.8% Medicare surtax on net investment income will apply to distributions from nonqualified plans.
Generally, the likely rise in tax rates increases the attractiveness of deferring income into the future. Each person's situation is different, however, and you should make projections involving various factors:
- your calculation of current and future tax rates for both ordinary income and capital gains
- the investment return on the compensation you defer
- the growth of alternative investment(s) for the after-tax amount of the compensation without deferral
The calculator on myNQDC.com lets you model these different variables to help you make decisions about whether or not to defer income. For additional analysis about the effect of tax increases on whether to defer, and if so how much, see a pair of articles on myNQDC.com: The Growing Importance Of Nonqualified Deferred Compensation Amid Rising Tax Rates and Advantages To Deferring Income In An Uncertain Tax Environment.
As explained in an FAQ on myNQDC.com, even though you may want to accelerate income into the current year, when tax rates are lower, you cannot change your deferral election for this year's compensation and instead receive the money. Similarly, you cannot move a scheduled future income distribution into this year.
Medicare Tax Increases Make NQDC Plans More Attractive
When the Supreme Court upheld the constitutionality of the Affordable Care Act in June 2012, its decision also ensured the survival of two features in the new law that affect Medicare tax, starting in 2013. For high-income taxpayers, the Medicare rate on compensation income will increase from 1.45% to 2.35%, along with the new 3.8% Medicare surtax on net investment income. These will have an impact on anyone with nonqualified deferred compensation. In some ways, the tax change makes NQDC plans and income deferral more attractive than ever. For the details of the new tax law and its impact on NQDC planning, see our new FAQ on this topic.New Content On Other Topics
- Section 162 Bonus Plans: An Alternative Or Companion To NQDC Plans, by William L. MacDonald. The type of executive benefit plan called a Section 162 bonus plan has become very attractive to employers, since all contributions are currently tax-deductible. NQDC expert William MacDonald explains these plans, and their benefits, in detail.
- Is there a distribution-election strategy when I’m uncertain in the intermediate term about my own cash flow and the company’s finances? If you have concerns about the risks of NQDC and your need for cash, what is the best approach to NQDC distribution elections? This new FAQ presents planning ideas.
Reminder For Year-End Compliance
Employment and severance agreements that condition any payments upon a release of claims may need amendments by year-end to comply with IRC Section 409A, as the transition relief is expiring at the end of 2012. For more details, see helpful alerts from the law firms McGuireWoods, Cooley, and O’Melveny & Myers.
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