Paying for Performance and 2014 Raises: What Others are Planning

Job performance matters. But at your organization, does it matter enough when the time comes to hand out raises? The latest General Industry Salary Budget Survey of 910 employers from Towers Watson Data Services indicates employees whose performance ratings are below average can look forward to raises next year in the 1.3 percent range, which is slightly below the projected national inflation rate (based on the Consumer Price Index).  

This 1.3 percent figure for below average performance is the same across categories, from non-exempt employees to managers and executives. This suggests one of two things.

1. Respondents to the survey have confidence their under-performing employees and managers have the potential to improve their performance and will improve in the future, or


2. Respondents simply don't have the stomach to "punish" under-performers by giving them no raise at all.

Yet taking this more hard-nosed no raise approach, particularly in a low-inflation, relatively high unemployment environment, would convey a stronger message that under-performance is not taken lightly, without being unduly harsh.

How Average is Average? 

In addition, as the table below indicates, employers are rating fairly high numbers of employees either as top performers or above-average performers (combining those two categories). The proportion of employees receiving "below average" ratings is much smaller. This pattern is reminiscent of Lake Wobegone of Prairie Home Companion radio show fame, where everybody is above average. 

Employee Performance Rating Distributions by Job Category
Performance rating	Management and Executives	Exempt Non-Management	Non-Exempt Salaried*	Non-Exempt Hourly
Highest possible	14%	11%	10%	10%
Above average	31%	28%	26%	24%
Average	51%	56%	57%	60%
Below average	4%	5%	6%	6%

* Total equals 99% due to rounding error.
Source: 2013 Towers Watson General Industry Salary Budget Survey

Also noteworthy in the table above is the relative similarity of the performance distributions by job function. The one exception is the management/executive category, which has a significantly higher distribution of combined above-average and highest possible performance ratings.

Modest Raises for Top Performers

Projected 2014 raises for employees by job performance rating, as shown in the table below, also reveals a general consistency in the planned percentage-of-salary level of raises for each of the four basic job categories. The numbers are remarkably similar to raises granted this year and in 2012.

Projected 2014 Employee Raises by Job Category
Performance rating	Management and Executives	Exempt Non-Management	Non-Exempt Salaried	Non-Exempt Hourly
Highest possible	4.50%	4.60%	4.50%	4.30%
Above average	3.50%	3.60%	3.50%	3.40%
Average	2.60%	2.60%	2.60%	2.50%
Below average	1.30%	1.30%	1.30%	1.40%

Source: 2013 Towers Watson General Industry Salary Budget Survey

According to the table above, projected raises for top performers are not even double those of average employees, at these companies. This approach may be a mistake. At the Fortune "Most Admired" companies, top performers received raises triple those of average performers. Where the "raise gap" is narrower, incentives to work harder and smarter are narrowed as well. Also top performers -- assuming they are rated honestly -- are the ones you can least afford to lose. Not only does their performance matter in and of itself, but top performers set the bar higher for everyone else, by their example. 

Raises not Only Factor in Retention

Giving out large raises to those who perform well is not the only thing you need to do to retain them, of course. You can have high turnover rates regardless of the competitiveness of your salary and raise levels if you have deficient supervisors. In fact employees often quit because of workplace environment issues rather than pay -- although a low pay raise may be the last straw for top performers who are unhappy with their jobs for other reasons.

Additional highlights from the Towers Watson Survey:

• Budgeted 2014 pay raises are remarkably similar by job level; the average is 3 percent, with the highest average (3.1 percent) for executives and the lowest (2.9 percent) for non-exempt hourly workers.


• The average company is projecting the additional cost to their salary budgets in 2014 due to employee promotions will be 1.4 percent of their entire salary budget.


• Projected discretionary bonuses to be awarded next year will average 18 percent of salary for executives, 9 percent for non-executive managers, 6 percent for exempt non-managers, 5 percent for non-exempt salaried employees and the same level for non-exempt hourly workers.

If you are scratching your head trying to fairly divvy up a small budget for raises, it might be time to consider not just what you feel you have to do to keep employees happy, but consider what you are trying to accomplish, what performance you are hoping to reward and encourage, and proceed from there.

What Does the Federal Government Shutdown Mean for Taxes?

Due to the current federal government shutdown, IRS operations are limited. However, the tax agency issued a release stating "the underlying tax law remains in effect, and all taxpayers should continue to meet their tax obligations as normal."

Here are some basic questions for taxpayers about what they should do during the shutdown, along with answers from the IRS.

How Does the Shutdown Affect Me?

• You should continue to file and pay taxes as normal.
• All other tax deadlines remain in effect, including those covering individuals, corporations, partnerships and employers. The regular payroll tax deadlines remain in effect as well.
• You can file your tax return electronically or on paper --- although the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them.
• Tax refunds will not be issued until normal government operations resume.
• Tax software companies, tax practitioners and Free File will remain available to assist with taxes.

What IRS Services Will Be Available?

• For taxpayers seeking assistance, only the automated applications on the regular 800-829-1040 telephone line will remain open.
• The IRS website (IRS.gov) will remain available, although some interactive features may not be working.
• The IRS Free File partners will continue to accept and file tax returns.
• Tax software companies will continue to accept and file tax returns.

Is the October 15 Due Date Still in Effect and Should People Still File by Then?
Taxpayers should continue to file and pay taxes during a lapse in appropriations as they would under normal government operations. Individuals who requested an extension of time to file should file their returns by October 15, 2013. Taxpayers can file their tax returns electronically or on paper. However, the processing of paper returns will be delayed until full government operations resume.
Payments accompanying paper tax returns will still be accepted as the IRS receives them. Tax refunds will not be issued until normal government operations resume. Tax software companies, tax practitioners and Free File will remain available to assist with taxes.
All other tax deadlines remain in effect, including those covering individuals, corporations, partnerships and employers. The regular payroll tax deadlines remain in effect as well. Penalties and interest still apply for all late filings not received by the regular deadlines.

Will Electronically Filed Returns Be Processed? 
Individuals and businesses should keep filing their tax returns and making deposits with the IRS, as they are required to do so by law. Taxpayers are urged to file electronically, because most of these returns will be processed automatically. Payments accompanying electronic tax returns will be accepted as the IRS receives them, although the IRS will be unable to issue refunds during this time.

Will Paper Tax Returns Be Processed?
Individuals and businesses should keep filing their tax returns and making deposits with the IRS as they are required to do so by law. However, the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them, though the IRS will be unable to issue refunds during this time.

Will Paper Tax Returns Be Considered to Be Filed on Time Even though the IRS is Not Processing Paper Returns?
Yes. the U.S. Postal Service is operating during the shutdown, and it will postmark and deliver mail to the IRS. Any return postmarked by the due date will be considered timely filed by the IRS even though processing of the return may not occur until after the return due date depending on the length of the lapse in appropriations.

Can I Obtain a Tax Transcript during the Shutdown?
Yes. This is an automated process. Taxpayers can still use automated tools, including IRS.gov, to request that a transcript of their personal tax records be sent to their address of record; the taxpayer will typically receive transcripts in the mail within five to 10 calendar days.

Can a Third Party Obtain a Tax Transcript during the Shutdown?

No. Transcript requests from third parties require actions by IRS employees, who are not available due to the current lapse in government appropriations. During this period, transcript requests by third parties, such as financial institutions, cannot be processed through the IRS Return and Income Verification Services and Income Verification Express Service. These processes are not automated. However, individuals requesting their own transcripts can still use the automated process.

For more information, contact your tax adviser or visit the IRS.gov website.

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IRS Debuts Final Repair Regs

Business owners have lots of questions when it comes to deciding whether to expense costs or capitalize fixed assets, such as:

• Can I expense a laptop computer I purchased for $699 in the current year?
• What qualifies as standby emergency spare parts, and can I capitalize them for tax purposes?
• Can I use the same accounting capitalization policy for book and tax purposes?
• I replaced the roof on my factory -- but haven't yet finished depreciating the original roof -- how should I handle the disposition of the old roof?

In the past, tax preparers and business owners criticized the IRS capitalization guidelines for being ambiguous, complex and subjective. There were few quantitative brightline rules. Instead, the appropriate tax treatment was governed by qualitative "betterment" tests and Tax Court cases. The IRS released temporary guidelines in 2011 to clarify how to apply Internal Revenue Code Sections 162 and 263.

Two Tax Treatments The IRS final capitalization regulations are sometimes known as the Repair Regs. But they cover far more than just repairs. They address money spent to acquire, produce or improve property, plant and equipment. When deciding how to handle tangible property costs, you generally have two options: Deduct now. Internal Revenue Code Section 162 allows you to deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business, including the costs of certain supplies, repairs and maintenance. Capitalize and depreciate later.Internal Revenue Code Section 263 requires you to capitalize amounts paid to acquire, produce or improve tangible property. Capitalized costs are generally not deducted in the current tax year; they are depreciated over their economic useful lives. In general, taxpayers prefer to deduct as many tangible property costs as possible to lower their taxable income in the current period. But the decision to expense or capitalize an item is just a matter of timing. You will pay the same taxes over the life of the asset, regardless of how you classify the costs, as long as tax rates and laws remain consistent. If you expect higher tax rates or more restrictive tax laws in the future, you might prefer to capitalize costs to reduce taxable income in future periods. Some items are easily classified as a deductible business expense (such as a box of staples) or a capital expenditure (such as a new forklift). Others fall in the gray area between Sections 162 and 263. The final capitalization rules attempt to refine and clarify those gray areas, as well as provide new safe harbors that might make filing your federal tax return less burdensome.

On September 13, 2013, the final regulations (IRS T.D. 9636) debuted, revealing some significant changes from the 2011 temporary version. Here is an overview of the major changes that will affect your privately held firm.

Materials and Supplies
The new regulations generally allow you to deduct materials and supplies that cost $200 or less to acquire or produce under Section 162.

The final regs also permit an optional election to capitalize rotable, temporary or standby emergency spare parts that have been acquired to maintain, repair or improve your property. Most taxpayers would prefer to expense them in the current period, however.

Repairs versus Improvements
When it comes to repairs, the final regulations retain most of the guidance issued under the 2011 temporary regulations. Under Section 162, incidental repairs are expensed.
Under Section 263, however, you must generally capitalize improvements that:

1. Add to the value, or substantially prolong the useful life, of your property or
2. Adapt the property to a new or different use.

Betterment test. The final regs use a modified "betterment" test to determine whether to capitalize costs as improvements. An improvement makes the property better if it materially adds to the asset, restores a major condition or defect, or increases its productivity, efficiency, strength, quality, or output.

An improvement also must be capitalized if it restores the asset by replacing a major component or substantial structural part of the asset, including buildings. The final regs no longer require you to consider how the expenditure is treated on your financial statements when applying the betterment test.

Routine maintenance safe harbor. The final regs also allow routine maintenance on fixed assets -- including routine building maintenance -- to be deducted for tax purposes. Routine maintenance costs are those recurring activities you expect to perform to keep the property in its ordinarily efficient operating condition. Examples include inspection, cleaning, testing and replacing parts.

To qualify as "routine," you must expect, at the time the property was placed in service, to perform the activity more than once during its economic useful life. For building improvements to qualify under the routine maintenance safe harbor, you must expect to perform the activity more than once in 10 years.

De Minimis Safe Harbor for Acquisitions
For simplicity's sake, many business owners prefer to use the same capitalization methods for book and tax purposes. The final regs permit certain taxpayers to deduct tangible property they acquire or produce, if the total cost per item (or invoice) is $5,000 or less. To qualify for this safe harbor, you must:

• Prepare an "applicable financial statement." That is, a certified audited financial statement or a financial statement filed with a state or local government.
• Possess a written accounting procedure at the beginning of the tax year for expensing property under a specified dollar amount.
• Expense the cost on your applicable financial statement, not just your tax return.

The de minimis safe harbor also applies to property with an economic useful life of 12 months or less as long as the item does not cost more than $5,000 per item (or per invoice).

Many private businesses do not prepare "applicable financial statements." You might prepare financial statements in-house or have them compiled by a CPA, for example. Taxpayers without applicable financial statements are subject to a $500 capitalization threshold. Even to qualify for the lesser amount, you must have accounting procedures in place at the beginning of the tax year for expensing property below the threshold, however.

If you elect to use this safe harbor on your tax return, you must use the de minimis safe harbor for all amounts paid in the taxable year for tangible property -- including materials and supplies -- that meet the requirements. You can only revoke an election to use the de minimis safe harbor by filing an application for change in accounting method.

If you do not currently have a written policy for expensing property under a specified dollar amount, consider drafting one before year end, if you plan to elect the de minimis safe harbor in 2014.

Small Business Safe Harbor
The final regs offer a break to small businesses with gross receipts of $10 million (or less) when it comes to building improvements. For buildings that initially cost $1 million or less, qualifying small taxpayers may elect to deduct the lesser of $10,000 or 2 percent of the adjusted basis of the property for repairs, maintenance, improvements and similar activities each year.

You may elect annually to use the safe harbor for buildings on a building-by-building basis by including a statement on your federal tax return. Amounts to which you correctly apply this safe harbor are not treated as capitalizable building improvements under Section 263; instead, they are expensed under Section 162.

Effective Date
The final regulations generally apply to taxable years beginning on or after January 1, 2014. However, certain provisions of the final regs only apply to amounts paid or incurred in taxable years beginning on or after January 1, 2014.

You may apply the new regulations to tax years beginning on or after January 1, 2012. Compliance may require you to change your current capitalization procedures and file an IRS form.

The Next Step
The Repair Regs have been a work-in-progress for many years. The final framework provides much-needed clarity and guidance. But, at more than 200 pages, the final regs are hardly clear and concise. This brief article just scratches the surface of the complex capitalization rules. There are many nuances, exceptions and safe harbors. The IRS expects to publish additional industry-specific guidelines on capitalizing or expensing tangible property for cable networks, natural gas firms and retailers in 2014.

If your business owns or leases fixed assets, consult with your tax adviser to determine how these rules affect your accounting practices -- and whether they will result in tax savings or unexpected costs.

P.S. Don't Forget Expanded Section 179 and Bonus Depreciation Deductions If you are contemplating purchasing or improving a fixed asset in the coming months, you might want to act sooner, rather than later. The American Taxpayer Relief Act (ATRA) provides increased Section 179 and bonus depreciation deductions for qualifying improvements and acquisitions through the end of 2013. Items that can be capitalized under the final regs can be partially or entirely deducted now if you act before year-end. Section 179 allows you to write off up to $500,000 of qualified capital expenditures in 2013, subject to a dollar-for-dollar phaseout once these expenditures exceed $2 million. These amounts are scheduled to go down significantly next year if Congress does not act to retain them. If the phaseout provision limits your Section 179 deduction, you may still be eligible for 50 percent bonus depreciation on qualifying new asset purchases above the $2 million cap. Contact your tax adviser to determine whether Section 179 and/or bonus depreciation make sense for your business.