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The Impact of the Fiscal Cliff Legislation

January 4, 2013 - UPDATED January 23, 2013

On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (the "Act"), commonly known as the "fiscal cliff" legislation.  The Act has generated extensive public interest and media commentary, which have largely focused on the provisions relating to marginal tax rates, the alternative minimum tax, and the phase-outs of personal exemptions and itemized deductions for high-income taxpayers.  This Client Alert supplements the existing commentary by focusing on the provisions of the Act affecting employer-sponsored benefit plans.

Specific Provisions

        a. Extension of Education Assistance Programs 

        Under Internal Revenue Code ("Code") section 127, the gross income of an employee does not include amounts paid or expenses incurred by the employer for educational assistance to the employee if the assistance qualifies as an "educational assistance program" and does not exceed $5,250 per employee during a calendar year.

        As part of the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (commonly known as the "Bush-era tax cuts"), the availability of this benefit was scheduled to expire on December 31, 2012.  By striking the sunset provisions of the 2001 legislation, the Act has extended indefinitely the exclusion from gross income for amounts received pursuant to educational assistance programs.

        b. Extension of Higher Spousal Deemed Income Amounts under Dependent Care Assistance Programs

        Under Code section 129, the gross income of an employee does not include amounts paid or incurred by the employer for dependent care assistance through a program provided to the employee (a "DCAP").  In the case of married employees, the exclusion cannot exceed the lesser of $5,000 or the lower of the employee's earned income or that of his/her spouse. If the employee's spouse is a student or is physically or mentally incapable of caring for him/herself, the spouse is deemed to have a specified amount of monthly income under the rules of Code section 21(d)(2). There are two deemed income amounts, one for employees with one dependent and the other for employees with more than one dependent.

        These deemed income amounts were scheduled to fall on January 1, 2013 from $250 and $500 per month to $200 and $400 per month respectively as part of the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (as amended by the Job Creation and Worker Assistance Act of 2002). By striking the sunset provisions of the 2001 legislation, the Act has extended indefinitely the higher spousal deemed income amounts for purposes of determining the exclusion from gross income for amounts paid pursuant to a DCAP. Therefore, affected employees may be able to exclude from their gross income more dependent care expenses paid pursuant to a DCAP than they could have absent the Act.   

        c. Extension of Parity of Mass Transit Benefits 

        Prior to January 1, 2012, a parity rule for nontaxable fringe benefits under Code section 132(f) set the combined monthly limit for qualified transit pass and vanpooling benefits at the same level as the monthly limit for qualified parking expenses. When this parity rule expired on January 1, 2012, the combined monthly transit limit fell to $125 while the monthly parking expenses limit remained at $240. The Act restores the parity rule for 2013, when the limit will be $245 each per month for qualified mass transit and parking expenses.

        The Act also restores the parity rule for 2012. As a result, the qualified mass transit limit for 2012 has been retroactively increased to $240 per month. In Notice 2013-8, the IRS has explained how employers who provided for and included in their employees' gross income mass transit benefits in excess of $125 per month in 2012 may now exclude from such employees' gross income for 2012 any excess transit benefits up to $240 per month.

        d. Extension of Qualified Adoption Assistance Programs

        Under Code section 137, the gross income of an employee does not include amounts paid or expenses incurred by the employer for qualified adoption expenses in connection with the adoption of a child by an employee if such amounts are furnished pursuant to an adoption assistance program and do not exceed $12,650.

        As with the education assistance programs discussed above, the availability of this benefit was scheduled to expire on December 31, 2012 as part of the sunset provisions of the Bush-era tax cuts.   By striking the sunset provisions of the 2001 legislation, the Act has extended indefinitely the exclusion from gross income for amounts received pursuant to qualified adoption assistance programs.

        e. Expiration of Social Security Payroll Tax Cut

        Pursuant to the "payroll tax holiday" enacted for calendar year 2011 and extended through the end of calendar year 2012, the employee's share of Social Security tax under Code section 3101 was reduced from 6.2% to 4.2% of income up to the Social Security wage base ($110,100 for 2012).  Because the Act did not further extend the payroll tax holiday, withholding of the employee's share of Social Security tax returned as of January 1, 2013 to 6.2% of income up to the 2013 Social Security wage base of $113,700.

        f. Expanded Availability of In-Plan Roth Rollovers

        Prior to the Act, employees who were participants in employer-sponsored retirement plans such as 401(k), 403(b), and 457(b) plans that offered a Roth (i.e., after-tax) contribution option were permitted to roll over pre-tax account balances to Roth accounts under the employer plan prior to their separation from service with the employer only upon the occurrence of a specified in-service distribution event such as attainment of age 59-1/2 (or, the case of 457(b) plans, attainment of age 70-1/2).  Pursuant to the Act, Code section 402A(c) has been amended to permit plans to allow such "in-plan Roth rollovers" regardless of whether an in-service distribution event has otherwise occurred.  Retirement plans are not required to offer this option and must affirmatively adopt it if they wish to do so.  Employees considering an in-plan Roth rollover should first consult their tax advisor in order to understand the tax implications specific to their situation.

For More Information

        As noted above, this Client Alert has focused on the employee benefits provisions of the Act.  For more information on these or other related provisions of the Act, please contact Joanne C. Youn at jyoun@capdale.com or at 202.862.7855.  

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