last updated 1/30/2014
'While the typical U.S. employee may expect to earn a bit more in 2014, high earners will find that more of their salary is subject to Social Security payroll taxes. And since income thresholds are not inflation adjusted for the Additional Medicare Tax on high earners, more employees will pay this extra levy as well.
On Oct. 30, 2013, the Social Security Administration (SSA) announced that the maximum amount of earnings subject to the Social Security payroll tax will increase to $117,000 from $113,700, beginning Jan. 1, 2014. Of the estimated 165 million U.S. workers who will pay Social Security payroll taxes in 2014, about 10 million will pay a higher amount as a result of the inflation-based increase in wages subject to Social Security withholding.
Social Security and Medicare payroll withholding are collected together as the Federal Insurance Contributions Act (FICA) tax.
By Jan. 1, U.S. employers should have:
- Adjusted their payroll systems to account for the higher taxable maximum under the Social Security portion of FICA.
- Notified affected employees that more of their paychecks will be subject to FICA.
Withholding Rates Unchanged
The portion of the Social Security FICA tax that employees pay remains unchanged at the 6.2 percent withholding rate. Correspondingly, the portion of the tax that employers cover also remains at 6.2 percent of employee wages. This amounts to a total Social Security FICA tax of 12.4 percent.
These rates are set by statute and are not adjusted annually based on inflation. Except for a temporary 2 percent cut in the employee portion of the Social Security payroll-tax rate, which took effect in 2011 and ended in January 2013, they have been in place since 1990.
At the close of 2013, the IRS issued payroll withholding tables for 2014:
Additional withholding information will be available at www.IRS.gov.
In 2014, with the higher income ceiling, the maximum yearly Social Security tax withholding amount rises to $7,254 (6.2 percent withholding on earnings of up to $117,000), up from $7,049.40 (6.2 percent withholding on earnings of up to $113,700).
For most Americans, the Medicare portion of the FICA tax remains at 2.9 percent, of which half (1.45 percent) is paid by employees and half by employers. Unlike Society Security, there is no limit on the amount of wages subject to the Medicare portion of the tax. This results in a total FICA tax for most wage earners of 15.3 percent (Social Security plus Medicare), half of which is paid by employees and half by employers.
Self-employed individuals are responsible for the entire FICA tax rate of 15.3 percent (12.4 percent Social Security plus 2.9 percent Medicare).
Additional Medicare Tax
For high earners, Medicare takes a somewhat larger bite, under a provision of the Patient Protection and Affordable Care Act. Beginning in 2013, the employee-paid portion of the Medicare FICA tax became subject to the 0.9 percent Additional Medicare Tax. The threshold amounts are $250,000 for married taxpayers who file jointly, $125,000 for married taxpayers who file separately, and $200,000 for single and all other taxpayers. These wage thresholds are not inflation adjusted, and thus apply to more employees each year.
An employer must withhold the Additional Medicare Tax from the wages or compensation it pays to an employee in excess of $200,000 in a calendar year.
The Additional Medicare Tax raised the individual wage earner’s portion on compensation above the threshold amounts to 2.35 percent from 1.45 percent; the employer-paid portion of the Medicare tax on these amounts remained at 1.45 percent.
Additional Medicare Tax: Compliance
In late November 2013, the IRS issued final regulations and an updated version of its guidance and FAQs on the Additional Medicare Tax. The IRS also issued a draft Form 8959 that taxpayers can use to determine whether they owe the Additional Medicare Tax and whether their employer withheld the right amount of Additional Medicare Tax from their wages or compensation.
According to a December 2013 analysis by law firm McDermott Will & Emery:
If an employer underwithholds the Additional Medicare Tax from wages it pays to an employee and discovers the error in the same year it pays the wages, the employer may correct the error by making an interest-free adjustment on the appropriate corrected form (e.g., Form 941-X). Once the employer discovers the error, the employer should deduct the correct amount of Additional Medicare Tax from other wages or other remuneration, if any, it pays to the employee on or before the last day of the calendar year.
If the employer overwithholds, the employer should repay or reimburse the amount to the employee prior to the end of the year and make an interest-free adjustment on the appropriate corrected form (e.g., Form 941-X).
In contrast, if an employer underwithholds the Additional Medicare Tax from wages it pays to an employee and discovers the error after the year it pays the wages, the employer cannot correct the error by making an interest-free adjustment. The employer may be liable for the amount it failed to withhold; however, to the extent the employer can show that the employee paid the Additional Medicare Tax, the employer will not be liable for the underwithheld amount but may remain subject to applicable penalties, unless the failure has a reasonable cause and is not the result of willful neglect.
If the employer overwithholds, the employer should report the amount of withheld Additional Medicare Tax on the employee’s Form W-2 so that the employee may retain credit to be applied against the taxes shown on the employee’s individual tax return.
Net Investment Income Tax
Although it is not a payroll tax, HR professionals also should be aware of the net investment income tax (NIIT), sometimes referred to as the "Medicare surcharge," that high earners must also pay when they file their income tax returns. This is separate from the similarly named Additional Medicare Tax discussed above, and consists of a 3.8 percent surtax on investment income, including capital gains, to be paid by those with modified adjusted gross income above $200,000 (single filers) or $250,000 (joint filers).
Individuals that expect to be subject to the tax should adjust their income tax withholding or estimated payments to account for the tax increase in order to avoid underpayment penalties. The IRS also issued final regulations and an updated set of FAQs on the net investment income tax, and a draft Form 8960 for paying it.
Under IRS final regulations, qualified plans and executive pay programs are generally exempt from the 3.8 percent NIIT on high-income individuals, an analysis by Towers Watson points out. "Because most executive pay programs are not affected by the NIIT, employers might want to consider expanding deferral opportunities under these plans to enable executives to accrue earnings and receive income exempt from the tax," the consultancy advised. "Also, since inside buildup on restricted stock before vesting, restricted stock units (or performance shares) before payment and stock options before exercise also can accrue without exposure to the NIIT, these programs might be more attractive."
Social Security Benefits Adjust, Too
The SSA also announced that the annual cost-of-living adjustment (COLA) for monthly Social Security and Supplemental Security Income benefits paid to nearly 63 million Americans will increase 1.5 percent in 2014, slightly less than the 1.7 percent COLA that took effect in 2013.
Stephen Miller, CEBS, is an online editor/manager for SHRM.
2014 SHRM Benefit Change Articles:
- Pretax Limit on Transit Benefits Drops for 2014, SHRM Online Benefits, December 2013
- For 2014, IRS Issues 401(k) and Pension Plan Limits, SHRM Online Benefits, November 2013
- For 2014, Higher Limits for HSA Contributions, SHRM Online Benefits, May 2013
- FSA Use-It-or-Lose-It Rule Modified, SHRM Online Benefits, November 2013
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