Are You Handling Your FICA Taxes on Deferred Compensation Properly?

FICA taxes on nonqualified deferred compensation (NQDC) were never a big deal. Chances were that if you had NQDC that your pay was well over the Social Security Wage Base. So, while there were situations where that was not the case, the IRS largely ignored the issue. There just weren't enough situations where it applied and there wasn't enough tax revenue in it to worry about enforcement.

Then came the uncapping of Medicare wages. That is, employees and employers were required to pay HI (Medicare) taxes on all wages, not just those up to the wage base. Suddenly, large amounts of NQDC were subject to this tax and it mattered.

For the last few years, there was a court case in Michigan related to payment of FICA taxes. I had largely forgotten about Davidson v. Henkel, but another blog reminded me of it (thanks Mike Melbinger). In the case, Henkel failed to pay FICA taxes on behalf of Plaintiff Davidson and others in the class leaving that class with a significant (to them) tax liability including penalties.

Why do we care? Why am I taking the time to write about this?

Most NQDC plans are drafted by or reviewed by attorneys (as they should be). While this is not always the case, in the typical situations, the plans are somewhat boilerplate in nature. In my personal experience, counsel often does not ask the client all of the details about how the plan will actually be administered. Frankly, even when they do ask, the client may not know. After all, the client may not be administering the plan on its own.

The plan document is a legal document. When that document says that the company shall remit FICA tax, it must. When the document instructs how or when FICA taxes will be calculated, that is what must happen.

In many plans, this is really a non-issue. There may only be one way to calculate these amounts and taxes will be due annually. In defined benefit (DB) SERPs and Restoration Plans however, there are multiple ways of handling the FICA situation. Most prominently, the sponsor may calculate (and remit) FICA taxes when they are reasonably ascertainable (a technical term from the regulations, but for many, this means at the employee's date of termination from the company) or by early inclusion which essentially means that FICA is calculated and paid annually. Early inclusion is sometimes more beneficial than waiting until retirement, but it is also more administratively complex.

Some plan documents leave the option of payment entirely to the discretion of the sponsor or administrator. Others specify that there will or will not be early inclusion.

What does yours say? Do you know?

Suppose your plan specifies early inclusion and you've not been doing that, do you have a problem? You might.

In fact, in my experience, more companies than not are not particularly on top of the administration of their NQDC plans. They've never particularly focused on compliance with these FICA rules or, even worse, Code Section 409A.

Oftentimes, it will be a good investment to have someone assist you in making sure the processes in this regard are being handled properly.