The Social Security Administration (SSA) announced on October 16 that the Monthly Social Security and Supplemental Security Income (SSI) benefits will rise 1.7% in 2013. In addition, based on an increase in average wages, the maximum amount of earnings subject to the Social Security tax will rise to $113,700 in 2013, up from $110,100 in 2012. The SSA has published FAQs about these changes.
Social Security And Medicare Taxes: The Basics
Collectively known as FICA taxes (also employment taxes or payroll taxes), Social Security and Medicare taxes are withheld by your company, which pays them to the IRS. When nonqualified stock options and stock appreciation rights are exercised, and when restricted stock and restricted stock units vest, FICA taxes are owed alongside ordinary income taxes. Similarly, when you defer compensation, whether through a 401(k) plan or nonqualified deferred compensation plan, you owe FICA taxes at the time of deferral (even though income tax is delayed until the deferred money is later paid out).
Social Security tax is normally withheld at 6.2%, but a rate cut for 2011 and 2012 has temporarily brought Social Security withholding down to 4.2%. The combination of the current Social Security wage base ($110,100 for 2012) and the 4.2% rate results in maximum Social Security withholding of $4,624.20 during 2012. The New York Times has reported that the Social Security rate is likely to return to 6.2% after 2012, as there is little political support for extending the payroll-tax cut. In 2013, with the higher income ceiling and the return to the 6.2% rate, the maximum yearly withholding will jump to $7,049.40 (a 52.4% increase).
One year-end planning strategy for equity compensation relates to all of this. If your compensation for the year has already surpassed the taxable maximum for Social Security and you want to exercise nonqualified stock options, you can do so without paying Social Security tax on the income recognized at exercise. Alternatively, if your income for the year is under the taxable maximum, then exercising NQSOs before the end of 2012 will let you benefit from the current 2% rate cut before the rate almost certainly goes back up to 6.2% in 2013.
Meanwhile, unlike Social Security, the amount of compensation subject to the Medicare tax (1.45%) is uncapped. In 2013, this Medicare tax rate will rise to 2.35% for single taxpayers with annual income of more than $200,000 and for married joint filers whose combined annual income exceeds $250,000. For these taxpayers, an NQSO exercise before the end of 2012 would avoid that extra 0.9% Medicare tax on the exercise spread.
For details about tax withholding and the related reporting on your Form W-2, see the Tax Center at myStockOptions.com (for equity comp) or the FAQs on tax reporting at myNQDC.com (for nonqualified deferred comp).