IRS Releases New Cost of Living Adjustments for Social Security and other Popular Benefits Programs

The Internal Revenue Service (IRS) and Social Security Administration have released the cost-of-living (COLA) adjustments that apply to dollar limitations set forth in certain IRS Code Sections. The Consumer Price Index rose enough since the third quarter of last year to warrant an increase in indexed figures for 2012.

Social Security and Medicare Wage Base
For 2012, the Social Security wage base increases to $110,100 from $106,800 in 2011. Unless Congress acts to extend the current reduction in the tax rate for employee withholdings, they will increase to 7.65 percent in 2012 from the 5.65 percent withheld in 2011. The Social Security rate of 6.2 percent is applied to wages up to the maximum taxable amount for the year; the Medicare portion of 1.45 percent applies to all wages.

Indexed Compensation Levels
The indexed compensation levels for determining who is considered highly compensated or a key employee increases for 2012:

401(k) Plans
In 2012, the maximum for elective deferrals increases to $17,000. The catch-up contribution for those 50 or older remains at $5,500 for 2012 (no change from 2011). That means if you are age 50 or over during the 2012 taxable year, you may generally defer up to $22,500 into your 401(k) plan.

Adoption Credit
For 2012, unless Congress acts, this tax credit again becomes non-refundable and decreases from $13,360 to $12,650. The credit starts to phase out at $189,710 of modified adjusted gross income (AGI) levels, and is completely phased out when modified AGI reaches $229,710. 

The exclusion from income provided through an employer or a Section 125 cafeteria plan for adoption assistance also has a $12,650 limit for the 2012 taxable year. And remember, a participant may take the exclusion from income and the tax credit if enough expenses are incurred to support both programs separately. 

Health Savings Account (HSA)
Minimum deductible amounts for the qualifying High-Deductible Health Plan (HDHP) remain at $1,200 for self-only coverage and $2,400 for family coverage in 2012. Maximums for the HDHP out-of-pocket expenses increase to $6,050 for self-only coverage and $12,100 for family coverage.

Maximum contribution levels to an HSA also increased for 2012 to $3,100 for self-only coverage and $6,250 for family coverage. The catch-up contribution allowed for those 55 and over is set at $1,000 for 2012. Remember, qualifying HDHPs and no other impermissible coverage (such as coverage under another employer’s plan or from a health care flexible spending account that is not specifically compatible with an HSA) are required in order to fund an HSA.

Archer Medical Savings Account (MSA)
For a high-deductible insurance plan that provides single coverage, the deductible amount must be between $2,100 and $3,150 for 2012. Total out-of-pocket expenses under a plan that provides single coverage cannot exceed $4,200. The deductible amount must be between $4,200 and $6,300 for a plan that provides family coverage in 2012, with out-of-pocket expenses that do not exceed $7,650.

Although new MSAs are not allowed, , the maximum contribution to an existing MSA that is attributable to a single-coverage plan is 65% of the deductible amount. Maximum contributions for a family-coverage plan are limited to 75% of the deductible amount. MSA contributions must be coordinated with any HSA contributions for the taxable year and cannot exceed the HSA maximums.

Dependent and/or Child Daycare Expenses
Just a reminder that although the daycare expense limit associated with a cafeteria plan is not indexed, the credit available through a participant’s tax filing was raised in 2003. The daycare credit must be filed on Form 2441 and attached to the 1040 tax filing form.

The limits for the daycare credit expenses are $3,000 of expenses covering one child and $6,000 for families with two or more children. If one of the parents is going to school full time or is incapable of self-care, the non-working spouse would be "deemed" as earning $250 per month for one qualifying child and $500 for two or more qualifying children. This "deemed" earned income is used whether a person is using the employer’s cafeteria plan or taking the daycare credit.

The current child and dependent care tax credit limits are scheduled to sunset on December 31, 2012. Without Congressional action, the limits for the daycare credit will revert to $2,400 of expenses covering one child and $4,800 for families with two or more children on January 1, 2013.

The cafeteria plan daycare contribution limit is $5,000 for a married couple filing a joint return, or for a single parent filing as "Head of Household." For a married couple filing separate returns, the limit is $2,500 each.

The daycare credit is reduced dollar for dollar by contributions to or benefits received from an employer’s cafeteria plan. An employee may participate in their employer’s cafeteria plan and take a portion of the daycare expenses through the credit if they have sufficient expenses in excess of their cafeteria plan annual election, but within the tax credit limits.

Parking and Transit Accounts
For 2012, the monthly parking amount increases from $230 in 2011 to $240. And, unless Congress acts to extend the transit parity that currently exists, the 2012 monthly limit for transit drops from $230 in 2011 to $125 in 2012.

Long-Term Care
For a qualified long-term care insurance policy, the maximum non-taxable payment is now $310 per day for 2012.

Finally, by participating in a cafeteria plan, the participant will be lowering their income for the Earned Income Tax Credit (EITC). Check out the new limits in IRS Publication 596 "Earned Income Credit" and for more information about this tax credit.

The information contained in this memo is not intended to be legal, accounting, or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.