What every accountant should know about Social Security tax and Medicare developments.

The Social Security Administration announced cost-of-living changes for 2005 affecting working Americans, businesses and retirees (SSA Release, Oct. 19, 2004, www.ssa.gov/pressoffice/pr/2005cola-pr.htm). The wage base for workers and employers paying into the Social Security system is increased, while certain Social Security recipients can earn more without causing a reduction in their benefits. Retirement benefits increased by 2.7 percent compared with last year's increase of 2.1 percent.

Wage Base for Social Security Taxes

For 2005, the Social Security portion of FICA and self-employment taxes will apply to the first $90,000 of wages and/or net earnings from self-employment (up from $87,900 in 2002). The Medicare portion will apply to all wages and net earnings from self-employment, without limitation. The tax rate on employees and employers remains unchanged at 6.2 percent for the Social Security portion and 1.45 percent for the Medicare portion (totals 7.65 percent). The tax rate on self-employed individuals is 12.4 percent for the Social Security portion and 2.9 percent for the Medicare portion (totals 15.3 percent). Self-employed individuals can deduct one-half of their tax as an adjustment to gross income.

The increased wage base means that working individuals earning the maximum amount will pay an additional $130.20 in Social Security tax ($260.40 for self-employed individuals). Companies paying the employer share of FICA also will pay an additional $130.20 for each employee earning $90,000 or more in 2005.

Higher Benefits for Retirees

Due to the 1.4 percent cost-of-living adjustment, the average monthly benefit for retirees will increase to $955 (up $15 over the 2004 average benefit amount). The maximum benefit payable to someone retiring at the full retirement age rises to $1,939 (up $114 over the 2004 maximum benefit amount).

Note: The full retirement age continues to increase for those born after 1937. The full retirement age for those born in 1939 is 65 years and four months; for those born in 1940, the full retirement age is 65 years and six months. So, individuals who were born in 1940 or earlier, who want to commence benefits in 2005, should check the extent of reduction in benefits that early claims produce.

Higher Earnings Limit for Retirees

Retirees under the age of full retirement age (65 years, four months for those born in 1939 and 65 years, six months for those born in 1940) can lose some or all of their Social Security benefits if they continue to work. However, the earnings limit increased for 2005 allowing individuals to earn more each month without reduction of benefits.

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Retirees under the full retirement age can earn up to $12,000, or $360 per month (up from $11,640 in 2004). For every two dollars of earnings over this limit, retirees in this age category lose one dollar of benefits. If an individual attains full retirement age in 2005, an earnings limit of $2,650 per month applies for each month that benefits commence before the full retirement age. For every three dollars of earnings over this limit, retirees in this age category lose one dollar of benefits.

Retirees who are at least the full retirement age can earn any amount without causing any reduction in benefits. However, retirees--regardless of age--who continue to work must still pay Social Security and Medicare taxes as described above.

Deferred Compensation

For amounts deferred in tax years beginning after Dec. 31, 2004, new rules apply. The American Jobs Creation Act of 2004, signed into law on Oct. 22, 2004, provides penalties for certain early distributions and delayed payouts.

The new law does not change the employment tax treatment of deferred compensation. Deferred amounts are subject to Social Security and Medicare taxes (FICA) and federal unemployment taxes (FUTA) in the year in which they are earned, not the year in which they are received.

Medicare

The monthly premium in 2005 for Medicare Part B increases to $78.20 per month (up $11.60 over the $66.60 premium in 2004). Medicare Part B covers physician services, outpatient hospital services, certain home health services, durable medical equipment and other items. The premium increase cannot exceed the benefits increase in Social Security checks. While most retirees will see a greater increase in benefits than in cost of premiums, some will continue to collect the same amount of benefits and be treated as having made full premium payments.

The Medicare Part B deductible increases in 2005 to $110 (up from $100 in 2004). Medicare Part A deductibles also increase as follows:

* deductible for the first 60 days of in-patient, skilled nursing facility and home health care: $912 (up from $876 in 2004);

* deductible for days 61 through 90: $228 (up from $219 in 2004); and

* deductible for hospital stays beyond 90 days: $456 (up from $438 in 2004).

Sidney Kess, CPA, JD, LLM, is a former partner at KPMG Peat Marwick and former national director of taxes at KPMG Main Hurdman. Contact him at sidkess@verizon.net.