Last week, I wrote about the American Taxpayer Relief Act more commonly referred to as the Fiscal Cliff deal. While it avoided reversion to the pre-Bush era marginal tax rates for most Americans, it certainly included a lot of tax increases. Here we will focus on nonqualified deferred compensation (NQDC). Does it make more sens to defer or less sense to defer?
First, the withholding rate on supplemental wages in excess of $1 million in the aggregate increased to 39.6%. For supplemental wages up to $1 million, the withholding rate remains at 25%, What are supplemental wages? Generally, they are pay to an employee that is not part of a regular wage. They include overtime, bonuses, and distribution of nonqualified deferred compensation among other things. Ultimately, the taxes that a taxpayer pays are determined based on a number of factors, but the amount that they will see in a check for supplemental wages will decrease for particularly high recipients of supplemental wages.
Second, the OASDI portion of Social Security tax returned to 6.2% after being at 4.2% for a few years. This is the percentage of your paycheck that goes to Social Security on earnings not in excess of the Social Security Wage Base ($113,700 for 2013). The employer portion of OASDI remains at 6.2% of pay. For participants on NQDC plans, this is may be important because Social Security taxes are paid on NQDC generally in the year that such compensation is both vested and reasonably ascertainable. For most plans, that is the date when vested. For certain more complex plans such as DB SERPs, the amount may not be reasonably ascertainable until the participant terminates employment.
Third, the Medicare or HI portion of Social Security taxes has increased largely to pay for the ACA or ObamaCare if you prefer. For single filers with wages in excess of $200,000 or those filing jointly with income in excess of $250,000, the amounts above those thresholds will see an increase in HI tax from 1.45% of excess wages to 2.35% of excess wages. Additionally, there is a new 3.8% surtax on investment income such as capital gains from the sale of stock.
So, how do you know whether to defer or not to defer? It's a difficult question and the math is not as easy as we might like. Generally, the higher the marginal tax rate that you are paying, the more useful tax deferral is. Of course, there are many other factors that may influence your decision including your view of future tax rates, your need for the money in the short term, the investment return you can achieve and other factors that may be particularly germane to you as an individual.
Best of all will likely be compensation deferred in qualified plans such as 401(k), other defined contribution, and defined benefit if you are fortunate enough to have those opportunities.
In any case, for high earners, the new tax rates are more confiscatory than were the old ones, but your guess is as good as mine with respect to where they will be in the future.