Some Wall Street investment houses and top industrial companies are offering to pay year-end bonuses a bit early, seeking to help highly paid employees cope with President-elect Bill Clinton's promise to raise taxes for the wealthy.
But deciding whether to take those bonuses now or wait--thus deferring the tax liability by a year but risking higher tax rates under Clinton--is going to be tough.
Of investment houses, Bear Stearns Cos. recently announced that it will distribute "bonus shares" to about 130 top executives. Morgan Stanley said all employees eligible for bonuses can get as much as 50% of the payment now instead of next year. Merrill Lynch will pay up to 75% of an employee's bonus before year's end. And First Boston is reportedly offering early payments but says employees will have to pay interest on the money they receive early.
About 7% of the nation's top industrial companies are accelerating bonus payments and another 6% are considering such moves, according to a survey by William M. Mercer Inc., a New York-based benefits consulting firm. Other benefit consultants peg the number higher--estimating that about 15% of the nation's big companies will push bonus payments forward a few days.
"Virtually every Wall Street firm will pay bonuses early," added Roger Brossy, principal at Sibson & Co. in Los Angeles. And many other companies that have highly paid workers and substantial bonuses are also expected to make the money available before the end of the year to workers who ask, he said.
The point of this year-end bonus bonanza is tax planning. In normal years, workers prefer to get their bonuses after the first of the year so they can delay paying tax on it for an extra 12 months.
But this is no ordinary year.
Clinton, who will be inaugurated in January, has promised to hike taxes on America's wealthiest families, as well as on corporations that pay their executives "excessive" amounts in 1993.
Specifically, Clinton has pledged to raise the top federal tax rate to 36% from 31% for families earning more than $200,000. And he wants to make companies pay tax on salaries that exceed $1 million. (Wages are now considered an ordinary business expense and are subtracted from a corporation's taxable earnings. But some proposals would force companies to add back individual wages exceeding $1 million for tax purposes.)
That's caused companies and individuals to rethink their tax planning strategies.
Companies generally are leaving it up to their workers to decide whether they want their bonuses now or later. So, which is better: getting the money and paying the tax at 1992 rates or waiting and possibly paying a higher rate next year?
There is no clear answer. It depends on individual circumstances and how certain you are that Clinton's tax plans will become reality, said Eric C. Scoones, principal at William M. Mercer in New York.
If you earn more than $200,000 and expect the tax proposals to pass as envisioned, it makes sense to take the money now, tax advisers say. There is an "opportunity" cost involved in paying tax a year early and not having that money available for other uses, but it's outweighed by the higher tax rate.
But if the tax hikes don't go into effect in 1993, or are less substantial than expected, it's best to delay the bonus.
To illustrate, consider an individual who will receive a $50,000 bonus. His company will either pay the bonus Dec. 31 or Jan. 1, at the employee's option.
If the bonus is paid Dec. 31, this executive pays $15,500 in tax by April, 1993. He'll probably also be hit with an underpayment penalty that affects only high-income individuals who earned $40,000 more in 1992 than they did in 1991. In this case, the penalty amounts to about $270. Uncle Sam gets $15,770. However, we'll assume this executive could have invested that $15,770 for an extra year and earned 5% on his money, so his "opportunity cost" was $788. Total cost: $16,558.
What happens if he opts to get the payment Jan. 1? If the Clinton tax proposals go into effect as promised, he'll pay $18,000 in tax the following April. He's $1,442 poorer than if he had taken the bonus early.
"There is certainly some risk involved" in taking bonuses early, Scoones said. "We don't know for sure that the increase will be passed and will take effect next year. You could end up getting burned."