The NASPP Blog

Trivia question: Which major US Supreme Court decision this summer is going to impact tax withholding procedures for your stock plans next year?

If you guessed the decision on the Patient Protection and Affordable Care Act (President Obama’s healthcare reform package), you are a winner! 10 points to you!

What the Heck?

The reason is that the healthcare reform package increases Medicare taxes beginning next year (see my blog “One for You, Nineteen for Me–US Style,” July 20, 2010), which changes the rate at which Medicare needs to be withheld for stock compensation. With the Supreme Courts’ ruling, the new tax rates will now go into effect as planned. Even if Mitt Romney wins the presidency and does manage to repeal the entire healthcare package, he’s won’t take office in time to prevent the new Medicare tax rate from going into effect for at least part of 2013.

Another Tax Threshold to Track

Under the Act, Medicare will increase to 2.35%, but only for compensation in excess of $200,000 ($250,000 for married taxpayers that file jointly, $125,000 for married taxpayers that file separately).

If you are counting, this makes three separate wage thresholds that we need to track to properly withhold taxes on stock compensation:

• Social Security: Applies only to wages under a specified maximum, currently $110,100, but this could increase for next year (but it is unlikely to increase to $200,000). All wages, both regular and supplemental, count towards this threshold.
• Flat Supplemental Rate: When an individual has received $1 million in supplemental payments, tax on any additional supplemental payments must be withheld at the maximum individual tax rate (currently 35%, but this could increase to 39.6% next year–stay tuned on this one). Only supplemental payments, not regular wages, count towards this threshold.
• Medicare: When an individual has received more than $200,000 in wages, the Medicare tax rate increases to 2.35%. All wages, both regular and supplemental, count towards this threshold.

Withholding Mechanics

Because you don’t know participants’ filing statuses (or their spouses’ incomes), you’ll withhold at the higher rate for any employees that have earned more than $200,000, even though they may not yet be liable for the additional tax. Any excess Medicare payments will be sorted out when they file their tax return.

Unlike the supplemental income tax rate, where you can apply the higher rate to an entire payment that straddles the threshold, the higher Medicare rate should only be applied to the portion of the payment that exceeds the threshold. For example, let’s say an employee that has received wages of $190,000 exercises an NQSO at a gain of $40,000.  The first $10,000 of gain on the exercise is subject to the standard Medicare rate of 1.45%; only $30,000 of the gain is subject to the 2.35% rate.  Then, from that point forward until the end of the year, any further NQSO exercises and award payouts are subject to 2.35% (as well as any other wages paid to the employee).

And, just in case that wasn’t confusing enough, the company’s matching payment remains at 1.45%; the additional tax applies to the employee only.

Next Steps and More Information

If you haven’t started talking to your payroll group about this, now might be a good time to take them lunch. It also might be a good time to ask your administrative provider about how they’ll handle the new rate in their system.

Also, tune in next week, when I’ll discuss planning considerations for employees.

For more information on the new rate, see the IRS’s “Questions and Answers for the Additional Medicare Tax.”  And don’t miss the session “The IRS and Treasury Speak” at the 20th Annual NASPP Conference, where this topic is certain to be discussed.

– Barbara