Year-end tax planning often involves balancing two sets of tactics: deciding what can be earned or paid for this year, and what can be postponed or deferred until next year. Typically, taxpayers wanting to optimize their tax situation are inclined to defer any additional income, such as bonuses, until the following year in an effort to keep this year's taxes at a desirable level. For the year 2012, just the opposite tactic might produce a lesser tax bill. Here's why.
There are two sets of tax rate changes in store for 2013. The employee-portion Social security taxes are scheduled to revert back to the normal 6.2% rate from the 4.2% rate that has been in effect for 2011 and 2012. This two percentage point reduction in the Social Security tax rate probably will not be renewed for 2013, reports the New York Times.
Also, tax rates for 2013 are scheduled to revert to their pre-2001 levels, up from the tax rates in effect for 2012. The Tax Foundation has a very in-depth comparison of what tax rates for 2013 could be under different legislative scenarios.
Earning additional salary income in 2012 thus has a double effect on taxes: employees will save on their Social Security taxes, and could potentially save on federal income taxes.
The tax savings could be in more pronounced if salary will exceed the Social Security wage base of $110,100 for 2012. Salary earnings over this wage base aren't subject to the Social Security tax.
Here's a quick example of how these tax savings work. Let's say that Rick is single and has a base salary of $50,000. Under the 2012 tax rates, he falls within the 25% federal tax bracket. Suppose Rick can get a bonus paid out either this year or next year of $5,000. He'll still be within the 25% tax bracket for 2012. The federal taxes on this bonus pay out would amount to 4.2% for Social Security and 25% for federal income tax. (Rick will also pay Medicare tax and possibly state taxes, but we're just analyzing the two federal taxes that are changing, so we'll leave those out of our analysis.) Now, what if Rick's bonus is paid out in 2013 instead? The Social Security tax will be 6.2% and Rick will be in the 28% tax bracket. (Assuming that Congress allows all the tax rates to revert to their pre-2001 levels, which corresponds to Table 1 in the Tax Foundation's analysis of potential 2013 tax rates.) On the same amount of income, Rick's combined federal income tax and Social Security tax rates will be five percentage point higher, translating to an extra $250 in federal income tax and Social Security tax simply by deferring the salary into 2013.