What Will Happen to the ‘Annual Income Ceiling’(Threshold)? A Review of Tax Reforms Effective from 2025
Introduction
This article provides an overview of the amendments to the Income Tax Act and other laws enacted in April 2025. It explains the new system and its specific impacts in detail.
Overview of the Proposed Revision to the Annual Income Threshold
The government has revised the tax system with the aim of addressing labor shortages and promoting diverse working styles, focusing on the income threshold that had been a major factor in adjusting working hours for part-time and casual workers. Below, we summarize the key points and changes that will take effect from 2025 due to the 2025 tax reforms.
There are two types of income thresholds: tax-related and social insurance-related. For the sake of simplicity, this article will focus mainly on tax-related (income tax) thresholds. First, we will examine the thresholds prior to the revisions. These were in effect until the 2024 fiscal year.
1. Tax Thresholds (Income Tax)
• 1.03 million yen ‘ceiling' threshold
Once this ‘ceiling’ is exceeded, income tax begins to apply to the individual, and dependents (such as parents or spouses) can no longer claim the spouse deduction or dependent deduction.
• 1.5 million yen threshold
If the spouse's income exceeds this amount, the special deduction for a spouse begins to decrease in stages, increasing the tax burden on the taxpayer.
2. Social Insurance-related Annual Income ‘Ceiling’ Thresholds
1.06 million yen threshold / 1.3 million yen threshold
• 1.06 million yen: Equivalent to 88,000 yen per month. If five criteria, including working hours, are met, enrollment in the Employees' Pension Insurance and Health Insurance programs becomes mandatory.
• 1.3 million yen: The upper limit for dependent status. Exceeding this amount results in the individual becoming liable for their own insurance premiums.
These tax thresholds were the focus of the recent revisions.
Three Revisions to the "Tax Thresholds"
Under the 2025 tax reforms, the following three revisions have been implemented:
1. Individual taxpayer threshold: Current 1.03 million yen → "1.6 million yen"
Due to its complexity, details are omitted here; however, the taxable income threshold has been raised to 1.6 million yen. This may allow more people to work without worrying about income tax.
2. Dependent's income ceiling: Current threshold of 1.03 million yen → Proposed revision to “1.23 million yen”
The annual income limit for dependents (such as part-time working spouses or children working part-time) who qualify for the "spouse deduction" or "dependent deduction" has been raised to 1.23 million yen. This will help mitigate sudden increases in household tax burdens by raising the threshold at which dependents are no longer eligible for these deductions.
3. Special provision for college students: Proposed revision to “1.5 million yen”
A new "Special Dependent Relative Deduction" has been introduced for households with college students (ages 19–22) who have significant education expenses. Under this deduction, parents can continue to receive the same tax benefits (Specific Dependent Deductions of 630,000 yen per child) even if their children’s annual income exceeds 1.23 million yen per child, provided it does not exceed 1.5 million yen each.
Summary
While the previous ‘ceiling’ thresholds were the same for both individual taxpayers and dependents (1.03 million yen), the individual threshold has been raised to 1.6 million yen, the dependent threshold to 1.23 million yen in principle, and the threshold for dependents who are college-age children to 1.5 million yen under a special provision. Although the amounts have been increased, the number of thresholds has increased, making the system more complex. Please note that all the above amounts are based on salary income. Since it is difficult to accurately ascertain all the thresholds, taxpayers with college-age children should first inform their children to keep their annual income below 1.5 million yen. This will prevent the young earners incurring income tax liability, and allow the taxpayer parent(s) to continue receiving the same tax deductions for their children as under the previous specific dependent deduction system.
Can Wages and Compensation (Outsourcing Fees) Coexist in a Company?
Introduction
As social insurance rates continue to rise annually, many business owners are seeking ways to reduce their social insurance burdens. This article addresses this question. Additionally, we explain the legal and tax principles to keep in mind when considering outsourcing, as well as common misunderstandings in practice.
Transitioning From Employing Workers to Outsourcing
We have received many inquiries about whether the following options are available as social insurance costs increase:
- Converting part of the workforce from direct employment to outsourcing, and switching wages to compensation-based (outsourcing);
- Switching a portion of an employee's work to outsourcing, and converting part of their salary to compensation (outsourcing fees).
Is such a transition feasible? Note that labor-related laws such as the Employees' Pension Insurance Act and the Labor Standards Act prioritize actual circumstances over contractual names, so legal risks cannot be eliminated solely through mere contractual name changes.
Similarly, tax audits prioritize actual circumstances, so there is a high risk that such payments may be deemed wages rather than compensation (outsourcing fees), and the hurdles to overcome are significant. The following factors are comprehensively considered as criteria for determining actual circumstances:
① The existence of a command and control relationship in the performance of duties, ② The presence or absence of constraints on time and location, ③ Substitutability (freedom to delegate or subcontract), ④ The basis for calculating compensation, ⑤ The allocation of profit and loss risks
If wages are identified as such during a tax audit, issues arise regarding both consumption tax and withholding income tax. The input tax credit claimed for outsourcing expenses may be disallowed, and unpaid withholding income tax may be identified, leading to significant additional tax liabilities.
However, There Have Been Recognized Cases
In a ruling involving a snack bar, payments to all the hostesses except one were recognized as wages. The only hostess whose payments were recognized as compensation met the following conditions: ① no time constraints, ② no minimum guarantee in remuneration, which was a fully commission-based system linked to sales, ③ if customers failed to pay outstanding invoices, the hostess had to bear the costs, ④ the hostess bore part of the store-related expenses. Considering these circumstances comprehensively, the payments were judged to be compensation.
In theory, it is possible for "salaried employees" and "compensated employees" to coexist within the same company or store if all the above conditions are met. However, in practice, this is highly challenging.
If coexistence is to be permitted, employment rules, business outsourcing contracts, and non-disclosure agreements must be mutually consistent, and distinctions must be clearly recorded in business management systems and 勤怠ツールattendance tracking tools.
If the amount desired by the employer to be treated as outsourcing expenses is simply partially switched, there is a high likelihood that it will be deemed to be “wages” in practice. Especially if the wages of existing employees are reduced by a certain percentage under the guise of outsourcing expenses, this may constitute an unfavorable change in working conditions, potentially leading to labor disputes.
If you wish to treat payments for certain tasks or certain individuals as compensation (outsourcing expenses), it is important that the outsourced tasks are not subject to time constraints, and that the individuals receiving the outsourcing work assume a significant level of risk as part of their business operations.
At the very least, from a tax perspective, do not assume that simple contract formalities can resolve the issue.
Essential Knowledge for the "9-Year Rule" Regarding iDeCo and the Planned Receipt of Executive Retirement Benefits
Introduction
Under the tax reforms for the fiscal year 2025, the calculation rules for the "retirement income deduction" when receiving retirement benefits in two or more installments have been revised. The deduction amount is calculated by excluding the portion where the years of service overlap, which is a revision that is likely to be disadvantageous for general taxpayers. Let’s examine the details.
Period Affected by the Revision
- The starting point is the payment of old-age lump-sum benefits (such as through an iDeCo {individual-type Defined Contribution pension plan} or corporate-type DC plan) on or after January 1, 2026.
- If an employee then receives retirement benefits, etc., from their employer within nine years of the initial payment, the deduction available for the subsequent retirement benefits will be reduced.
※Previously, there were two patterns: the "4-year rule (between retirement benefits)" and the "19-year rule (from retirement benefits to defined contribution pensions)." The new "9-year rule (from defined contribution pensions to retirement benefits)" has been added. In this revision, the Income Tax Act Enforcement Order (所得税法施行令), which establishes adjustment provisions, has been revised, and the scope of its application has been expanded.
The purpose of the amendment is to include cases where the recipient received an old-age lump-sum payment within the nine years prior to the year in which they receive retirement benefits, taking into account cases where the recipient's retirement age is 65 or older.
The revision applies to lump-sum old-age benefits received on or after January 1, 2026. For example, in the case of an iDeCo (individual-type Defined Contribution pension plan), where contributions and investments have already been made, if a lump-sum old-age benefit is received at age 60 on or after January 1, 2026, and retirement benefits are received from an employer at age 65, the overlap period between the iDeCo membership period and the employment period must be excluded when calculating the retirement income deduction amount.
The retirement income deduction is an amount that can be deducted for tax calculation purposes from the retirement benefits received. The larger the deduction, the lower the tax liability, which is advantageous for taxpayers.
Tax Benefits from the Termination of Small-Scale Mutual Aid Plans are Still Available
As mentioned earlier, this revision applies to cases where the lump-sum old-age pension was received within the nine years prior to the year in which the retirement allowance or similar payment is received. Therefore, a "termination allowance under the Small and Medium-sized Enterprise Mutual Aid Scheme administered by the Independent Administrative Institution for Small and Medium-sized Enterprise Development” 「独立行政法人中小企業基盤整備機構の小規模企業共済に係る解約手当金等」, which is one of the lump-sum payments deemed to be retirement allowances, is not subject to adjustment unless it was received within the four years prior to the year in which the other retirement allowance or similar payment is received.
For example, in a case where an individual receives an old-age lump-sum payment at age 60, then a small business mutual aid termination allowance, etc., at age 70, and retirement benefits, etc., from an employer at age 75, the overlapping period between the membership period and the years of service need not be excluded in the calculation of the retirement income deduction amount (this is advantageous for the taxpayer). On the other hand, from January 1, 2026, if an individual receives an old-age lump-sum payment at age 60, then a termination allowance under the Small and Medium-Sized Enterprise Mutual Aid System at age 65, and retirement benefits from an employer at age 70, the termination allowance under the Small and Medium-Sized Enterprise Mutual Aid System will be subject to adjustment, because the old-age lump-sum payment was received within the nine years prior to the year of payment, thereby falling under the scope of the revision.
Important Considerations for Retirement Benefit Plans
Unlike salaried employees, owners of small businesses can to some extent control the timing of their retirement as executives, and their receipt of retirement benefits. It is important to understand the type of retirement benefit plan you are enrolled in and simulate the payment schedule to avoid unfavorable tax treatment.
