Help staff pay tuition via a deferred-pay plan
Parents on your staff face a big-time dilemma if they’ve got kids approaching the college years: How are they going to pay the ever-increasing tuition bills?
Advice: Set up a deferred-compensation plan to help them pay college costs. If you already have a plan in place, amend it to allow early withdrawals.
That type of plan can retain valuable workers and attract new talent. You could take advantage of this unique benefit yourself!
Best of all, the deferred-comp plan won’t cost your company one penny more than it’s paying now.
Put bonus in deferred college fund
Example: Say your company pays Sheila, a top young employee, a competitive salary for your industry. Also, you offer her the option of taking a $10,000 bonus at year-end or deferring the bonus.
By deferring the bonus, Sheila can’t access the money until she leaves the company. Assuming she defers the bonus for 10 years while her child grows, Sheila accumulates $100,000 in the bonus account.
Since the plan is considered "unfunded" —meaning the bonus is tracked as a bookkeeping entry, not actual money—Sheila doesn’t pay any income tax on the deferred amounts. (But federal payroll taxes apply to each year’s deferred bonus.)
In comparison, if the plan is "funded," the bonus would be treated as if she received the deferred amount each year, so she would owe tax on each $10,000 bonus at the time it was declared.
Now, let’s say your company amends the plan to let employees make withdrawals to pay for college expenses. In effect, there’s no tax change for Sheila.
Reason: She doesn’t owe any tax on the deferred-comp payouts until she actually receives the money. As an added incentive, your company can tack on an annual adjustment to reflect tuition increases.
What happens if Sheila’s child doesn’t go to college? No big deal. Your plan can include a provision that pays the deferred amount upon termination or resignation.
How does this affect your company’s write-offs? Your company deducts the deferred compensation at the time it makes payments to employees. Not a problem, since you don’t need to come up with the money before then.
Defer funds using ‘rabbi trust’
Here’s one hitch to an "unfunded" plan: The employee faces a risk of forfeiting the money. Naturally, most employees aren’t comfortable with that arrangement.
How can you overcome that hurdle? Use a "rabbi trust" as the vehicle for deferring the bonuses. That way, employees keep a vested right to future payment, but the money isn’t taxable each year because it’s technically subject to the company’s creditors. Ask your accountant how to set up such a trust.
Boost itemized deductions with year-end moves
The 2003 tax law raised the standard deduction for joint filers from $7,950 to $9,500, meaning more married couples will take it next year. But if you carry a sizable mortgage and lots of miscellaneous deductions, it’s wiser to itemize your deduction on Schedule A.
You’ll do even better on your Schedule A with some smart planning now. We discussed medical and charitable expenses in our Oct. 20 issue. Here’s advice on taxes and miscellaneous items:
Decide whether to prepay taxes. Typically, you want to prepay estimated state and local income taxes that are due in January 2004. Pay those taxes by Dec. 31, and you can take the deduction in 2003 instead of in 2004. The same reasoning holds true for your property taxes if you pay them directly.
But those tax payments aren’t deductible if you’re subject to the alternative minimum tax (AMT). Work with your tax adviser to discover how much in (if any) taxes you should prepay in 2003.
Move miscellaneous expenses into best year. You can deduct miscellaneous costs (tax prep, investment expenses, employee business expenses, etc.) only once they exceed 2 percent of your adjusted gross income (AGI).
So if your AGI is $100,000, you’d need more than $2,000 worth of miscellaneous expenses to deduct anything. If you’re over the 2 percent mark, subscribe to investment publications, pay for a session with your tax adviser, etc. before Jan. 1. Your outlays are fully deductible.
But if you’re below the 2 percent mark this year, defer paying those costs until 2004. (That way, you at least have a chance to deduct them next year.)
Again, if your tax pro says you’ll pay the AMT this year, you’ll reap no tax benefit from spending extra dollars on miscellaneous costs.