California employees with annual wages more than $153,164 may soon be in for a surprise tax increase on a largely unnoticed employee-paid state payroll tax—state disability insurance (SDI). Beginning January 1, 2024, instead of paying an annual maximum SDI of $1,378.48 on an SDI taxable wage ceiling of $153,164 (the 2023 cap), employees who make more than the wage ceiling will pay an unlimited amount of SDI—permanently. Currently, employees pay SDI through wage withholding on every paycheck until they reach the wage ceiling of $153,164, and then the withholding stops. Withholding will never stop starting in 2024. Affected employees’ tax increase will pay for an expansion of paid family leave (PFL) benefits and SDI benefits starting in 2025.
SB 951 (Ch. 22-878), signed by Governor Newsom September 30, 2022, eliminated the SDI taxable wage cap, starting in 2024. Further, the SDI rate will jump from 0.9% in 2023 to 1.1% in 2024. SDI is financed solely by worker contributions and must have an adequate reserve rate, which is why the SDI rate is subject to change annually and can go up or down.
As an example of the tax increase, an individual earning $400,000 annually paid the SDI maximum of $1,378.48 in 2023 ($153,164 x 0.9%). Because the SDI wage cap has been eliminated, in 2024, the same employee will pay $4,400 of SDI or $3,021.52 more. This is a 219% tax increase. The higher rate will be applied in perpetuity. For highly compensated corporate officers, the tax increase will be significant. For example, an officer who earns $2 million annually paid the SDI maximum of $1,378.48 in 2023. The same officer will pay $22,000 of SDI in 2024 ($2 million x 1.1%), or $20,621.52 more. This is a 1,496% increase.
To mitigate the impact of the tax increase on affected employees, employers may want to consider switching from SDI to a voluntary plan (VP), a legal alternative to mandatory SDI. Both SDI and VP provide short-term wage replacement disability insurance and family leave benefits.
To offer a VP, employers must first apply and get approval from the California Employment Development Department (EDD). Employers may establish a VP with approval from a majority of their employees and must provide to the EDD proof of the approval. A VP must:
- Offer the same benefits to employees as SDI
- Provide at least one benefit that is better than SDI
- Not cost employees more than SDI
- Be updated to match any increase in benefits that SDI implements from legislation or approved regulation
Any contributions that are required from VP employees must be secured in a trust fund.
Besides switching to a VP to protect employees from the tax increase, there also may be a planning opportunity for an individual who is a corporation’s sole shareholder. Such individuals may elect out of SDI (and the withholding requirement) by filing California EDD Form DE 459, Sole Shareholder/Corporate Officer Exclusion Statement. The individual’s spouse also may elect out of SDI on the same form if the spouse is a shareholder/corporate officer. Payroll providers will need to be notified. Also, before electing out of SDI, such individuals may want to secure private short-term disability insurance to replace SDI.
This is a unique opportunity to protect many of your California employees from a substantial tax increase. To explore your options or if you have any questions, reach out to the Ryan experts listed below for assistance.
TECHNICAL INFORMATION CONTACTS:
Kevin Cappock
Principal
Ryan
813.879.5127
kevin.cappock@ryan.com
Gina Rodriquez
Principal
Ryan
916.414.0400
gina.rodriquez@ryan.com
The material presented in this communication is intended to provide general information only and should solely be seen as broad guidance and not directed to the particular facts or circumstances of any individual who may read this publication. No liability is accepted for acts or omissions taken in reliance upon the content of this piece. Before taking (or not taking) any action, readers should seek professional advice specific to their situation from Ryan, LLC or other tax professionals. For additional information about this topic, please contact us at info@ryan.com.