Obama 2011 Budget - Potential Impacts for Employers and PEOs

Commentary from StaffMarket Services - February 2010

Obamas Budget Proposal for 2011 contains major items for employers and PEOs. If the 2011 budget gets approved as proposed, PEOs will need to expand their offering to assist business owners with significant changes to their employment and accounting practices. Employer related subjects will include the following areas.

Reforming and Expanding the Saver's Credit

Current Law
A nonrefundable tax credit is available for eligible individuals who make voluntary contributions to 401(k) plans and other retirement plans, including IRAs. The maximum annual contribution eligible for the credit is $2,000 for single taxpayers or married individuals filing separately. In the case of a married couple filing jointly, the maximum annual contribution eligible for the credit is $2,000 for each spouse (for a total of up to $4,000). The resulting maximum credits are $1,000 and $2,000, respectively. The credit rate is 10 percent, 20 percent or 50 percent, depending on the taxpayer’s adjusted gross income (AGI). The AGI thresholds for the credit are subject to adjustment each calendar year based on increases in the cost-of-living. In 2010, “eligible individuals” who may claim the credit are Married couples filing jointly with incomes up to $55,500,Heads of households with incomes up to $41,625, and Married individuals filing separately and single taxpayers with incomes up to $27,750, who are eighteen or older, other than individuals who are full-time students or claimed as a dependent on another taxpayer’s return. The credit is available with respect to an eligible individual's “qualified retirement savings contributions.” These include: (i) elective deferrals to a section 401(k) plan, section 403(b) plan, section 457 plan, SIMPLE, or simplified employee pension (SEP); (ii) contributions to a traditional or Roth IRA; and (iii) other voluntary employee contributions to a qualified retirement plan, including voluntary after-tax contributions and voluntary contributions to a defined benefit pension plan. The eligible individual may direct that the amount of any refund attributable to the credit be directly deposited by the IRS into an IRA or certain other accounts. The credit is nonrefundable and, therefore, only offsets regular tax liability or alternative minimum tax liability. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution.

Reasons for Change
The saver’s credit should be amended to more effectively encourage moderate- and lower-income individuals to save for retirement. Because it is currently nonrefundable, the saver's credit only offsets a taxpayer’s income tax liability and therefore offers no saving incentive to tens of millions of households without income tax liability. In addition, to provide a stronger incentive, the credit rate should be increased for most eligible households, the current three-tier credit rate structure should be simplified, and the number of eligible households should be increased by raising the income thresholds. Finally, making the saver’s credit more like a matching contribution would enhance the likelihood that the credit would be saved and would increase the salience of the incentive by framing it as a match similar to the familiar employer matching contributions to 401(k) plans.

Proposal
The proposal would offer a more meaningful saving incentive to tens of millions of additional households by making the saver’s credit fully refundable and raising the eligibility income threshold to cover millions of additional moderate-income taxpayers. The proposal also would raise the credit rate and simplify the current three-tier credit structure by prescribing a uniform 50 percent credit rate, and would allow the credit to be deposited automatically in the qualified retirement plan account or IRA to which the eligible individual contributed.

In place of the current 10-percent/20-percent/50-percent credit for up to $2,000 of qualified retirement savings contributions per individual, the proposal would provide a 50-percent refundable credit that effectively matches 50 percent of the first $500 of such contributions per individual (allowing a married couple filing a joint return to make up to $1,000 of such contributions) per year, indexed annually for inflation beginning in taxable year 2012). Accordingly, the maximum credit would be $250 for a single filer and $500 for a married couple filing a joint return.

The eligibility income threshold would be increased to $65,000 for married couples filing jointly, $48,750 for heads of households, and $32,500 for single taxpayers and married individuals filing separately, with the amount of contributions eligible for the credit phased out at a 5-percent rate for AGI exceeding those levels (so that some amount of credit would be available to joint filers with AGI between $65,000 and $85,000). The proposal would be effective for taxable years beginning after December 31, 2010.

Potential Impacts for Employers and PEOs
The impact of this change could make it easier for employers since the intention is to change the credit from non refundable to refundable. Currently the credit and it contribution is based on the overall tax liability of the filer, which is unknown to the employer. The proposal to make it refundable removes the challenge for employers to understand the filers overall tax situation when calculating payroll deductions and remitting funds to the government and other fiduciaries. Of course employers need to modify payroll systems to reflect the wage cutoff thresholds for credit eligibility. Since eligibility thresholds are based on the employees participation and filing status, some kind of documentation (as yet undefined) must be collected from the employee determining their election in the program.

Reference Links
http://www.irs.gov/pub/irs-pdf/n1036.pdf
http://www.irs.gov/newsroom/article/0,,id=204447,00.html
http://www.irs.gov/newsroom/article/0,,id=204521,00.html
 

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