Mary Basil is an engineer who works for Mining Corps. In October 2013 she was of

Question

Mary Basil is an engineer who works for Mining Corps. In October 2013 she was offered a new position with a competitor. As part of the incentive to encourage her to take up the offer and leave her existing job she was offered and accepted a “welcome aboard” offer of $30,000, an annual salary of $150,000 and a car of $40,000. She also received a relocation allowance of $10,000. At the end of the year each staff member was paid a productivity bonus of $5,000. Mary requested that this bonus be paid directly to offset her mortgage.

Required: Advise Mary on the tax consequences arising from each of these arrangements. Justify your answer with reference to relevant tax sections or tax cases.

Explanation / Answer

Tax consequences for signing bonus

The IRS specifies a flat “supplemental rate” of 25%, meaning that any supplemental wages (including bonuses) should be taxed in that amount. This is only federal tax . Other taxes -

Tax consequence on annual salary

Income taxes in the United States normally contain the following:

Federal Income Tax—this is a progressive income tax, which means the tax rate increases as your income grows. Currently, the federal income tax rate tops out at 39.6%.

State Income Tax—Seven states impose no income tax – Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In the states that do impose an income tax, the lowest maximum rate is 3.07%, in Pennsylvania. The highest maximum rate is 13.3%, in California. Most states have a progressive income tax.

Local/City/Municipal Income Tax—some cities impose local tax – such as New York City, Philadelphia, etc. The state and local taxes are normally deductible for federal income tax.

Payroll Tax—this refers to Social Security tax and Medicare tax. The Social Security tax rate is 12.4% up to an annual maximum ($117,000 for 2014, $118,500 for 2015, $118,500 for 2016). Based on the "American Taxpayer Relief Act of 2012", the Medicare tax rate is 2.9% up to $200,000 for singles and $250,000 if married and filed jointly. After that, the Medicare tax rate is 3.8% with no up limit. If you are self-employed, you are responsible for your full payroll taxes. If you are an employee, your payroll taxes are shared by you and your employer. Your Social Security tax rate is 6.2% (4.2% for 2011 and 2012) and your Medicare tax rate is 1.45% if your income is below $200,000 (single) or $250,000 (married and filed jointly). If your income is higher, your Medicare tax rate is 2.35% for the higher portion. Your employer will pay a 6.2% of Social Security tax up to the annual maximum and 1.45% of Medicare tax with no up limit for you.

Taxability of Relocation allowance

If the amounts are reported as taxable in the W-2, the employee can take a deduction on their U.S. federal individual income tax return for the qualified moving expenses.

Certain moving expenses, paid or reimbursed by the employer, are not taxable under the definition of U.S. wage income. To qualify as "non-taxable," the expenses generally must be accountable, substantiated and reasonable for the circumstances of the move. Expenses that can qualify as non-taxable include:

Productivity bonus

The following methods are applicable for taxation of bonus.

Percentage Method

If the bonus is a standalone payment and the employer uses the percentage method, this results in a flat 25 percent federal taxation rate. State law determines a second tax deduction. In California, the flat tax rate for bonus payment is 9.3 percent. When employers combine bonus payments with regularly scheduled wages, your payroll department may deduct taxes using a different approach. Adding the wage and bonus together then correlating the sum to the standard withholding amount published on the tax tables identifies the deduction. If you are aware in advance that you are getting a bonus and your annual income does not warrant taxation at that level, see your payroll department. Ask for a Form W-4 and increase your withholding allowances. It is best to check with a tax adviser before making any adjustments.

Aggregate Method

Another approach to taxing incentive compensation is the aggregate method. Only some states sanction this. Companies who use this calculation tax your bonus amount on your wages and current tax-withholding amount. This means state tax deducted from your bonus is at the same rate as your current paycheck. Federal taxation remains the same; however, the end result leaves you with a larger net amount.

Tax Filing

Regardless of the method used to tax your bonus earnings, when year-end rolls around and you file your tax return, a form of tax balancing occurs. If you have overpaid the Internal Revenue Service and the state you work in, you are obviously entitled to a refund. Employees who consistently receive annual bonuses have a better idea of how to plan their tax year. Consider the tax implications, and discuss the best withholding allowance approach with a tax adviser.

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