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5 Tax Rules for Year-End Bonuses
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5 Tax Rules for Year-End Bonuses
If 2013 has been a profitable year for your business, you may want to share your good fortune with your staff. Typically this is done by giving year-end bonuses. Before you cut a check, understand what these bonuses mean to your business and your employees as well as some alternatives to cash bonuses. The following points apply if December 31 is the end of your business year.
Timing of payments
Your company can pay bonuses before the end of the year and deduct them in 2013. If your business is on the accrual basis, you can declare the bonuses this year, pay them next year, but get a deduction this year as long as the payment is made to an unrelated person (not an owner or someone in the owner’s immediate family). Make sure corporate minutes or other company records reflect the bonus declaration.
0.9% additional Medicare tax
Employees with substantial compensation should be apprised of the new 0.9% additional Medicare tax that applies to earned income (wages, commissions, tips, taxable fringe benefits, and other taxable compensation) over a threshold amount for their filing status ($200,000 for singles; $250,000 for joint filers). Thus, if a manager who is single has a salary of $180,000 and you want to pay a $50,000 year-end bonus, $30,000 of his earnings for the year will be subject to the additional Medicare tax.
Note: As an employer, you must start to withhold this 0.9% tax once earnings exceed $200,000, regardless of the employee’s filing status. Employees can request additional income tax withholding to be applied for this Medicare tax when they file their personal income tax returns.
FICA on deferred compensation
You and other high-earning employees may want to defer compensation to the future, presumably to be received in retirement when tax rates will be lower because income will be less. Strict rules apply to deferred compensation to prevent the earner from tapping the money at will.
For FICA tax purposes, deferred compensation usually is taxable in the year in which it is earned, not the year in which it is received. For example, deferring a 2013 year-end bonus means that bonus is subject to FICA tax this year and not in 2017 when the employee retires and receives the funds. This is advantageous because many high earners have already maxed out on the Social Security portion of FICA; the wage base limit for 2013 is $113,700, so earnings above this threshold are not subject to any additional Social Security tax. Of course, there is no cap on the Medicare portion of FICA.
Using qualified retirement plans
Instead of giving cash, you can use profits to fund a qualified retirement plan, such as a profit-sharing plan. The law restricts how much you can add each year and requires contributions to be nondiscriminatory (they can’t favor owners and managers).
- The good news: You have until the extended due date of the return to fund the plan, so if you obtain a filing extension, you have until October 15, 2014, to make 2013 contributions.
- The bad news: You must sign the paperwork to set up the plan by December 31, 2013, if you want a profit-sharing plan or certain other plans. If you miss this deadline, however, you can still use a SEP plan because this can be set up and funded by the extended due date of the return for the year.
Find details about qualified retirement plans in IRS Publication 560 (watch for an update to this publication for 2013).
Giving stock instead of cash
If you are willing to share a bit of ownership with your staff, you can give stock in your corporation. Without your giving them tax advice, you may want to tell them about a Sec. 83(b) election to report the stock as compensation now so that any future appreciation will be taxed to them at capital gains rates.
If your company is a C corporation that meets the definition of a qualified small business, you can issue the stock to employees as compensation. If they hold shares for more than five years, all of their gain will be tax free. Note that stock issued after 2013 will give owners only a 50% exclusion unless Congress extends the current 100% exclusion.
Make sure your year-end bonus plans factor in cash flow considerations. Discuss your options with your tax advisor now so you can take action before the end of the year. And tell employees to talk with their tax advisors as well.
About the Author:
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BarbaraWeltman.