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January 7, 2013

Employee Benefit Taxation and the Fiscal Cliff Legislation

The new year will see changes in the taxation of many employer-provided benefits as  health care reform provisions of the Patient Protection and Affordable Care Act of 2010 (PPA) go into effect. Changes to Social Security (FICA) taxes and Medicare tax for 2013 were discussed in an earlier Client Alert (available at While Congress did act to save some employee benefit provisions discussed below that were scheduled to expire, the 2% FICA tax break that was in effect for all employees in 2011 and 2012 was not extended to 2013. 

Employer-provided benefits for educational assistance and adoption assistance were  saved by the last minute action of Congress to avoid the fiscal cliff.  The reduction to $2,500 on medical expenses that may be paid from a pre-tax flexible spending account (FSA) in 2013 however, remains in place as it was part of the health care reform provisions designed to help  pay for PPA. 

2% FICA Tax Increase for all Employees
In 2011 and 2012 all employees enjoyed a decrease in their FICA tax from 6.2% to 4.2% on wages up to $110,000.  The employer’s matching obligation with respect to FICA remained at 6.2%.  The FICA tax cut was a temporary measure and neither Congress nor the administration backed extending the FICA cut for 2013.  Accordingly, effective January 1, 2013 the employer’s withholding obligations will change to take into account the 2% increase in FICA tax for all employees. In addition to the 2% FICA increase, employers must also for the first time begin withholding the 0.9% increase in Medicare tax that will apply to employees earning over $200,000 annually.  

Educational Assistance

Section 127 of the Internal Revenue Code allows an employer to reimburse an employee on a tax-free basis up to $5,250 for certain educational expenses provided through a non-discriminatory educational assistance program, including reimbursements for graduate school and notwithstanding that the course of study is not job-related and/or may allow the employee to qualify for a new position. This type of employer-provided educational assistance program which has now been extended to 2013 by the fiscal cliff legislation, is to be distinguished from qualifying work-related education, i.e. education that is required by the employer or improves skills used in a current job, but does not qualify an employee for a new career.   

Adoption Assistance

Section 137 of the Internal Revenue Code provides that amounts paid by an employer under a qualified adoption assistance program up to $12,650 in 2012 are tax-free to the employee. Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging while away from home) and other expenses directly related to the legal adoption of an eligible child.  Section 137 was also set to expire on December 31, 2012.  However, Congress has now acted to extend adoption assistance to 2013.  

Flexible Spending Accounts

Under PPA, the amount of employee contributions that may be made for medical expense reimbursement from a flexible spending account under a cafeteria plan is limited to $2,500.  Prior to the enactment of PPA, there was no limitation in the Code on health care FSA contributions.  The $2,500 limit applies for plan years beginning in 2013.  For calendar year plans this will be January 1, 2013, but the restriction may start later for some non-calendar year plans.

Plan amendments are required to reflect this change by December 31, 2014, regardless of the plan year of the cafeteria plan.  This limit on medical care reimbursements was not changed by the fiscal cliff legislation.

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Please do not hesitate to contact us should you have any questions concerning these new tax rules.