Federal income tax and Social Security tax rates would increase for employees in 2013 if Congress and President Obama fail to reach a compromise to extend some or all of the provisions at the current rates. Employers will need to adjust for the new rates and requirements if they take effect for 2013. As Congress heads into its summer break, conflicting proposals from the Democratic and Republican parties have been introduced to extend all or some of the existing rates.

Other payroll-related provisions scheduled to expire in 2013 include the exclusion of up to $5,250 a year for employer-provided educational assistance and increased tax-free amounts used for adoption assistance.

Pair of Competing Tax Proposals

The proposal by Sen. Harry Reid (D-Nev.), S. 3412, which was passed July 25 in the Senate by a 51-48 vote, would extend tax cuts established under President George W. Bush for single filers with income less than $200,000, head-of-household filers with income less than $225,000, and joint filers with income less than $250,000. Reid's proposal contrasts with a plan offered in the House by Rep. Dave Camp (R-Mich), H.R. 8, which would extend the tax cuts for all taxpayers.

Obama's press secretary said July 25 that the administration is to evaluate by the end of 2012 whether extending the lowered 4.2 percent Social Security tax rate for employees should be pursued for 2013. Last year, action to extend the lowered Social Security tax rate for 2012 occurred in the last two weeks of 2011 and in the first few months of 2012. Obama signed the Temporary Payroll Tax Cut Continuation Act of 2011 (Pub. L. 112-78) on Dec. 23, 2011, to extend the Social Security tax cut for the first two months of 2012. On Feb. 22, 2012, Obama signed the Middle Class Tax Relief and Job Creation Act of 2012 (Pub. L. 112-96) to apply the reduced rate for the rest of 2012.

End to Bush Tax Cuts Would Shift Tax Brackets

If Congress does not pass any income tax cut extensions, the four highest-percentage federal income tax brackets automatically would shift Jan. 1, 2013, to 39.6 percent, 36 percent, 31 percent, and 28 percent from 35 percent, 33 percent, 28 percent, and 25 percent.

Part of the tax bracket of 15 percent for 2012 would remain unchanged for 2013, while about the top 20 percent of the wages that would be in that bracket if the tax cuts were extended would instead be taxed at 28 percent if the cuts expire.

The income tax bracket of 10 percent would be merged into the 15 percent tax bracket for 2013.

Social Security Tax Would Increase by 2 Percent

If legislation is not approved to extend the Social Security tax cut, the rate for employees would revert to 6.2 percent from 4.2 percent. The Social Security tax rate for employees had been 6.2 percent from 1990 to 2010.

The employer portion of the Social Security tax, which was 6.2 percent in 2011 and 2012, would not change. Because the employee and employer Social Security tax rates would again be the same, employers would need to make system adjustments to account for the change in the employee rate.

The increased Social Security tax rate is likely to be implemented in conjunction with an increased Social Security taxable wage base for 2013, from $110,100 in 2012. The 2013 Social Security wage base could rise to $114,900, according to Social Security Administration actuarial estimates.

The Internal Revenue Service would need to again modify Form 941, Employer's Quarterly Federal Tax Return, for 2013 if the Social Security tax rate for employees increases. The lines for taxable Social Security wages and taxable Social Security tips would need to be updated to reflect a combined employer-employee rate of 12.4 percent instead of 10.4 percent. This rate modification also would need to be made for Form 943, Employer's Annual Federal Tax Return for Agricultural Employees, and Form 944, Employer's Annual Federal Tax Return.

Other Expiring Provisions

Neither competing proposal to extend the income tax rates into 2013 addresses the expiration of Internal Revenue Code Section 127, the tax exclusion for up to $5,250 in employer-provided educational assistance.

In addition, tax-free adoption assistance benefits would be affected. If Congress does nothing, starting in 2013, the exclusion amount will revert to $5,000 (from $12,650 in 2012) and the income phaseout threshold amount will revert to $75,000 (from $189,710 in 2012). These amounts would no longer be adjusted for inflation.

Medicare Tax Increase

If the Social Security employee tax rate increase occurs, it would not be the only Federal Insurance Contributions Act payroll tax increase to take place for 2013. Employers also would have to adjust FICA processing to include the Additional Medicare Tax rate of 0.9 percent on high earners that is to be implemented starting with 2013. The increase was affirmed by the Supreme Court's 5-4 decision that upheld the majority of the Patient Protection and Affordable Care Act (Pub. L. 111-148).

The withholding tax applies to wages exceeding $200,000.

A $2,500 tax-free limit on health flexible spending account amounts also takes effect Jan. 1, 2013.

Information for this blog article comes from the Bloomberg BNA Payroll Administration Guide Newsletter published on August 1, 2012, Volume 23 Number 16 and was written by Howard Perlman.