Compensating Executives in a "Challenging" World

The rationale has always gone something like this: if you don't compensate your executives at least equal to their peers and if you don't reward their performance, you will never have a top tier executive group and your company will not succeed.

Is that statement true? Is part of it true?

We're getting much closer to finding out. The big news this proxy season is from shareholder proposals on executive compensation. That's right -- since Say-on-Pay votes are non-binding, shareholder groups are looking to force companies to put components of executive compensation to a binding shareholder vote.

Before getting into a few details, let's understand how most companies are reacting. It's not surprising, but as a group, large corporations do not think their shareholders understand executive compensation. They are seeking to keep these votes off of their proxies. As a precursor to doing so, they request what is known as a "no-action letter" from the Securities and Exchange Commission (SEC). In brief, when a government agency issues a no-action letter, it assures the requestor that it will not take action on a given issue. So, when a company seeks such a letter from the SEC, the company is asking the SEC to confirm that it will not take action, for example, for a failure to place a particular item in its definitive proxy.

One of the most ardent submitters of executive compensation proposals is the largest American labor union, the AFL-CIO. In a statement, the AFL-CIO said, "We opposed compensation plans that provide windfalls to executives that are unrelated to their performance."

On its surface, that seems very prudent. But, it may be a bit trickier in practice.

What makes compensation related to performance? How does one define performance? Is compensation as expressed in the Summary Compensation Table? Is it cash only? Does it include equity? Does it include the (proxy-includable) value of deferred compensation?

Here is how it would strike me.

• Base pay is not related to performance. But, generally, to the extent that such pay is deductible to the employer under Section 162(m) ($1 million pay cap), some observers will not consider it to be egregious. On the other hand, in today's world of pay ratios and calls for increases in rank and file wages, other observers will ask that it be capped at some multiple of either the median pay for the entire company or even that of the lowest-paid employees of the company.
• Bonuses are theoretically related to performance. To the extent that the criteria used to evaluate executive performance and by extension, executive bonuses, are appropriate, so should those bonuses be. To play devil's advocate, however, if an executive knows how her bonus will be calculated, she may take inappropriate risks (for the company) in order to maximize the expected value of her bonus. Similarly, she may find ways to accelerate certain items into the fiscal year in question while deferring others until the next year. 
• Long-term incentives are [nearly] always performance based. In today's world, it is expected that those incentive payouts will be based on the achievement of a set of goals related to metrics deemed appropriate for that executive. Often, there are circuit breakers (elements that if the executive fails to meet a pre-established minimum level of performance, he will not receive a payout or that part of a payout at all). But, long-term incentives are often paid in company equity. This means that compensation will, to a large extent, be tied to share price. As we know, however, share price is not always tied to corporate performance. On any given day, share price may be influenced by such as the state of peace or war in the Middle East, a speech given by the President of the United States, or the rise or fall of housing starts during the last month. 
• What about deferred compensation (here I am referring to traditional deferred compensation plans, either defined benefit or defined contribution)? It's rarely performance based. Theoretically, the company is paying an executive less today for a promise to give them some of that pay in the future. What sorts of plans should be challenged? If an executive voluntarily defers some of their compensation and it grows at a rate tied to some broadly investable index, is that okay? Suppose she has a DB SERP that looks just like the broad-based plan (qualified plan), but without limitations applicable to qualified plans. Institutional Shareholder Services (ISS) is generally fine with this, but major labor unions may not be. And, if that SERP looks very different from qualified plans, even if there is a good reason for it, this may be a situation where no institutional shareholders are satisfied.

What should Boards of Directors and their Compensation Committees do about all of this? ConocoPhillips shareholders are asking that the Compensation Committee develop a program to determine which portions of a bonus should be paid immediately, which portions should be deferred, and what adjustments should be made to those deferrals based on performance.

Perhaps this has some merit. If it does, however, it's a bit of a nightmare for people who need to figure out how to make such a plan 409A-compliant and for those who need to administer FICA tax payments.

On the other hand, if adjustments are to be made based on performance, can't the same executive who is able to manipulate performance metrics in the LTI scenario described above also find a way to manipulate them here? Where there are objective formulas, there are smart people who can figure out how to game the system. Where there are subjective evaluations, Boards will be accused of pandering to the executives of the companies.

More than ever, the Compensation Discussion and Analysis (CD&A) will be very key. Explaining why the mix of objective and subjective factors was chosen can go a long way to appeasing large shareholders. Explaining how levels of compensation were chosen is a must. And, for the first time, we may see companies rationalizing their levels of executive pay as compared to rank and file pay.

With all of these challenges to executive compensation, these are challenging times for Compensation Committees.

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.

Is IRS Stepping Up Nonqualified Audits?

Two weeks ago, the IRS released nonqualified deferred compensation audit techniques guide. While no one can be certain, this would seem to signal that the Service is showing more interest in auditing these plans, available almost exclusively to the highest paid of employees.

For years, many have thought that nonqualified (NQDC or NQ) plans to be a significant area of tax abuse and a potential source of tax revenue for the federal government. And, whether this is simply a much needed update or the beginning of a push, the language in the guide would seem to suggest where the IRS thinks there are problems.

Let's look at the paragraph headers in the guide as a means of determining where the focus is likely to be:

1. Examining Constructive Receipt and Economic Benefit Issues
2. Audit Techniques
3. Examining the Employer's Deduction
4. Employment Taxes
5. Important Note [related to 401(k) plans]
6. The American Jobs Creation Act of 2004 [the law that brought us Code Section 409A]

Constructive Receipt and Economic Benefit Issues

Here, the guide instructs auditors to look for assets set aside free from creditors for the benefit of employees. It also instructs these auditors to look to see how executives can use the benefits in these nonqualified plans. For example, if a SERP might be pledged as collateral, then the employee has enough control to have constructively received the benefit and is subject to current taxation, or was when the benefit was first constructively received. 

For employers with any knowledge of NQDC plans or those who use counsel who work at all in this area, getting this right falls under the heading of basic blocking and tackling. So, while the IRS might be able to find some defects here, it would not seem to be a source of significant revenue.

Audit Techniques

In this section, frankly, I think that the IRS is grasping at straws. It asks auditors to interview personnel most knowledgeable about the plans. Further, the auditors are encouraged to review Forms 10-K and to learn whether the company uses a consulting firm to assist with its NQDC plans. 

There seems to be little glue holding this section together. Instead, what I am seeing is that their may be a needle in a haystack and a fortunate auditor might find that needle. Other sections of the guide may prove more fruitful.

Examining the Employer's Deduction

Generally, the amount and timing of the employer's deduction must match the amount and timing of the executive's inclusion in income. Looking from the outside in, this would seem to be simple. But, corporate tax returns, especially for large corporations are quite complex. Similarly, a corporate executive is fairly likely to have a complex tax return. It's not unlikely that treatment of income from NQDC plans is nowhere near the top of the priority list for either the corporate tax department or for the executive's accountant. 

In fact, in my experience, some corporate tax departments do not have significant familiarity with this type of plan (some have exceptional knowledge). Similarly, and perhaps more glaring, many personal accountants, again in my experience, just don't know much about nonqualified plans. 

The Internal Revenue Code is a complex instrument. The instructions to government forms, especially if you include the various Publications that they reference, are quite confusing. If an accountant deals with particularly few NQDC plans, it would not be shocking to find that accountant confused by their tax treatment. Certainly, I would not expect them to confirm that the amount and timing of inclusion in income coincides with the corporate tax deduction.

Employment Taxes

This is the section that deals with FICA and FUTA taxes. Until the cap was removed from Medicare wages, this section would have been ignored. The reason is that although nonqualified deferred compensation is subject to these taxes when it is both vested and reasonably ascertainable (a technical term meaning that a knowledgeable person can figure out about how much it is worth), virtually all NQDC participants earned far more than the Social Security Wage Base each year. But, when the cap at the Wage Base was removed for Medicare taxes, new NQDC was necessarily subject to that tax. 

The regulations on this topic are, in a word, confusing. Specifically for what are known as non-account balance plans (generally defined benefit SERPs), the guidance on how to perform calculations was likely written by someone who did not know what they were prescribing and the guidance on the actuarial assumptions to be used in those calculations is virtually nonexistent.

However, in my experience with this topic, the IRS does have strong opinion on what the Treasury Regulations mean and intend. That said, when the regulations under Section 3121(v) were issued, I co-authored a research memo on the calculation of the amount of FICA wages from NQDC plans (the focus was on non-account balance plans). To say that the authors went back and forth many times before agreeing on the intended methodology is an understatement. To think that similar authors at other actuarial consulting firms would reach exactly the same conclusion is no plausible. Add to that the various accounting and tax firms who might have their own opinions and you would certainly have a lack of consistency. About 15 years ago, however, one IRS examiner that I spoke with off the record said that there was just one consistent method available under the regulations.

Said differently, while I don't know how much revenue is potentially available, the calculation of employment taxes with respect to NQDC plans, and specifically non-account balance plans would not all meet with the approval of that particular examiner.

Important Note [related to 401(k) plans]

The coordination of qualified 401(k) plans and NQDC plans that provide for deferrals in excess of those allowed in the qualified plan seems like it should be simple. It's not. In particular, it's not if the two plans (qualified and nonqualified) are administered by different providers (or if one is administered externally and the other internally). Generally, these plans allow participants to defer amounts where IRS limits would otherwise preclude such deferrals. In the simple situations where the 401(k) plan passes nondiscrimination testing, this is pretty easy. But, when the plan is forced to refund deferrals due to test failure or when deferrals are restricted in hopes of making the testing work, things can go horribly wrong. Do the two separate administrators communicate with each other? It's doubtful.

There is likely not a lot of revenue for the government to find here, but there are probably a large number of very small problems.

The American Jobs Creation Act of 2004 [the law that added Section 409A to the Internal Revenue Code]

I've written about 409A here many times. If you are interested, go the little search box at the top of the page and type 409A. I'd be surprised if you get fewer than 25 hits in this blog, but I've not counted. 

As is often said about relationships, it's complicated. 

The regulations are long and were written in a fashion similar to the regulations under Section 3121(v). Frankly, I don't think the people who worked on the project did a bad job writing the regulations. They're not perfect, but they wouldn't have been perfect if you or I had written them either, so we must be careful with our criticism.

But, certain parts of the regulations that have lots of calculational elements where the calculations almost necessarily must be performed by actuaries were written by attorneys. I know some of those attorneys. They're smart people. And, they spent lots of time understanding the statute and developing regulations to enforce that statute. They could have done far worse.

The people that I know, however, who worked on the project are not actuaries. While they have some familiarity with actuarial calculations, they don't actually do them and I think they would tell you if you asked candidly that they have only a minimal understanding of them. Yet, for certain types of plans (mostly non-account balance plans), there is much in the way of actuarial calculations that determines potential tax liabilities. 

Frankly, we don't know what was intended. We tend to reference the FICA regulations, but even there as I noted above, the regulations are not prescriptive.

Section 409A is a mess. I don't think anyone intends to violate it, but there are lots of people who don't get it right. Finding the violations is difficult, but if examiners do find violations, with those violations will come some fairly meaningful tax revenue.

*           *          *          *          *           *             *              *             *            *            *           *          *

So, that's my take on where the IRS is headed and what value it has to them. Time will tell if I got it right for a change or not.

Higher FICA Taxes on the Horizon

Health care reform in the guise of the Patient Protection and Affordable Care Act (PPACA) came to us with many new benefits. In order to pay for those benefits, the government had two options -- cut costs or raise revenue (spelled T-A-X). Here we talk about one of those new taxes.

Beginning January 1, 2013, high earners will be required to pay additional HI (Medicare) taxes under the FICA program. The additional tax is 0.9% of compensation in excess of $200,000 for individual filers or $250,000 for couples filing jointly. The employer portion of FICA will not increase.

First, this is going to need to be administered differently from traditional FICA taxes which generally are paid through payroll deduction. Here, your employer has no obligation to know how you file (in fact, you don't need to decide until you actually file), and your employer has neither the obligation nor the right to know your spouse's income. So, presumably, higher earners will simply have an additional tax tacked on to their Form 1040.

Think about this. What are FICA wages. Generally, they are compensation first vested and reasonably ascertainable in a year. For most deferred compensation plans, the amount of compensation that has been deferred is reasonably ascertainable. However, for plans such as defined benefit SERPs or for certain stock plans, this may not be the case. Regulations under Code Section 3121(v) allow taxpayers to early include such deferred compensation. In the case of individuals with significant SERP benefits in particular, they may want to discuss the possibility of early inclusion with their employers. While the tax hit for 2012 could be meaningful, it may lessen the long-term blow.

On the other hand, we don't yet know the outcome of the 2012 presidential election. Mitt Romney has pledged to repeal PPACA if elected. Its repeal would eliminate this tax.

Planning isn't as easy as it used to be.

The Social Security Tax Cut May Not Apply to You

Congress has reached a new level of confusing the American public. We have the new 2-month Social Security tax cut. And, it applies to all working Americans (except those like Senators and Representatives whose wages as elected officials I think are exempted from Social Security). So, for the months of January and February, we all get a decrease of 2% in our Social Security taxes. Fantastic!

Now, for some explanation. Generally, a person pays into the Social Security system at the rate of 7.65% of pay up to the Social Security Wage Base (I believe that is $110,100 for 2012). Above that level of wages, a person pays in at the rate of 1.45% of pay. And, for each dollar that a person pays in, their employer pays in an equal amount. If you are self-employed, you are both the employer and the employee, so you pay both parts.

Now, that sounds unfair, doesn't it, that you stop paying in the Old-Age, Survivor and Disability Insurance part (the first 6.2%) after your pay reaches the wage base? Well, you do need to consider that any pay that you receive that is above the wage base is not used in computing your eventual Social Security benefit. For those who are still with me, the other 1.45% is used for Health Insurance, i.e., Medicare.

Here is the good and fair news -- we all get that that cut in our OASDI (the 6.2% piece) during the months of January and February 2012 from 6.2% to 4.2%. But, some of us are deemed to apparently have no need for the extra 2%, so we have the honor of getting to pay a recapture tax, an increase to your federal income tax.

Yeehaw, gotta love it, a recapture tax. I know, what in the world is a recapture tax. Read on, poor reader.

Start by dividing $110,100 (the wage base) by 12 (to get a monthly rate) and you get $9,175. Double that to get a two-month rate and you are up to $18,350.

Now, suppose your Social Security wages for January and February are more than $18,350. [For those who aren't sure, Social Security wages look a lot like your gross pay before taxes are taken out. If you pay for certain welfare benefits on a pre-tax basis, they get taken out. And, if you defer compensation to a 401(k) or similar plan or even to a nonqualified deferred compensation plan to the extent that the amount is vested, those get included.]

If you are fortunate enough to still have your Social Security wages for that two-month period exceed $18,350, then you have the honor of paying a recapture tax calculated as follows:

1. Subtract $18,350 from your Social Security wages for the months of January and February combined. If the answer is 0 or less, then this doesn't apply to you. If the answer is greater than $18,350, then call it $18,350.
2. Take the result from step 1 and multiply it by 2%
3. This is the additional income tax that you will owe for 2012 and it is called a recapture tax.

Think of the scenarios. Lots of companies pay bonuses for your performance during the previous year (2011, in this case) during January or February. For people with base pay less than $110,100, your bonus could put you into recapture territory. Maybe you are fortunate enough to be entitled to a really big bonus for 2011 paid during January or February 2012. It might run through recapture territory into I-Don't-Owe-Recapture-Taxes-On-This Territory. And, then, there are the people whose bonuses will get paid during the first half of March. They get the old-fashioned treatment.

Got it? Good!

Now, think about your paycheck. If you are like lots of Americans, the payroll of your company gets handled by an outside provider. And, miraculously, once a week, once every two weeks, once or twice every month, the right amount of pay gets deposited electronically into your checking (or savings) account. Hmm, do you think that will happen now?

The IRS thinks that it may not. In fact, they have already published rules for companies and individuals that mess this up. Doesn't that just build up your confidence?

So, why do we have this nonsense? In my opinion, it's all because our government no longer chooses to govern. Instead, the two major parties wage a constant battle to see which can find a way to embarrass the other. Does it matter if a law is a good law? Of course not. Does it matter if the law can be administered? Of  course not. Does it matter if the law says what it is purported to say? Of course not.

The Democrats appear to have won this game of shame. It's not their first win. But, Republican lovers shouldn't feel left out. They have won the shame game about the same number of times.

So, now we have a middle-class tax cut ... unless your bonus gets paid at the wrong time, or unless you make too much overtime during January and February, or unless ...

Everything You Should Know About the American Jobs Act

Ever needy for material to blog about, I eagerly awaited President Obama's address to a Joint Session of Congress where he would introduce his American Jobs Act (AJA). I listened carefully.

I did hear about cuts in FICA taxes. I did hear about small business tax credits. I really didn't hear much, though, that is relevant to what we discuss here.

So, I searched the internet. Google couldn't find text of AJA. Bing couldn't find AJA. Yahoo couldn't find AJA. Only Steely Dan could find AJA (if you get that one, you must either be old like me or old at heart).

We are supposed to learn in a week and a half how it is that the President plans to pay for this stimulus (my word, not his). Here are some things to look for (and everything on this list is 100% speculation on my part):

• Reduction in the defined contribution 415 limit to $20,000. That is, workers who can afford to make large 401(k) deferrals will not be able to get much in the way of company contributions.
• Limits on corporate tax deductions for so-called Cadillac health plans for non-union workers. That is, if your employer gives you "too" rich a health benefit, they can't get a tax deduction for all of it.
• Further erosion of the $1 million limit on deductible compensation under Code Section 162(m). As the President seems to believe that "CEOs and CFOs" make too much money, and he can't stop companies from paying that much money, he will seek to limit the tax deductions that they get. My feeling is that if you limit the deduction much more, most companies will just ignore the deductibility issue and pay their executives however they like.
• Means testing of Social Security (and perhaps Medicare) benefits so that those who are better financially prepared for retirement will not receive the full benefits to which they thought they were entitled.
• Some sort of restriction on the tax deductibility of equity compensation.

Ultimately, if the first bullet [above] becomes reality, it may result in joblock. That is, employees currently in the workforce will have difficulty being able to retire and thus will not open up jobs to those not in the workforce. Of course, it's possible that all of my thoughts are incorrect and misguided.

Perhaps Donald Fagan and Walter Becker know.

Executive Compensation and the Tax Code -- the Knot that Won't Untie

Do you remember when a company could pay an executive what it wanted to? Do you remember when the market decided how much a company would pay its executives? It wasn't that long ago. There weren't a lot of rules.

So, what happened? Things got out of hand. You can place the blame where you like. You can put it with executive compensation consultants, and surely, there is a group of them (not all of them) that deserve a lot of the blame, as everyone in the industry knew that a key to getting a new engagement was promising a company's management that you could get them more. You can blame it on Compensation Committees, as they didn't seem to care how much their company's executives got so long as a consultant could support it. You could even choose to blame it on me, although that would be misguided.

And, then what happened? Congress found a new whipping boy so to speak. The first key change was when they decided that deferred compensation should be subject to FICA tax. In a vacuum, this is probably the correct thing to do within the context of public policy. Your wages should be subject to a payroll tax (taking the broad leap of faith here that a payroll tax is appropriate) in the year that you earn them to some reasonable degree of certainty. What was the problem with that? I don't think that Congress actually knew what they intended. Did they really mean to FICA tax company-provided nonqualified plans? I bet they didn't know. In 1983, it probably didn't matter. The Social Security Wage Base applied equally to the OASDI (old age, survivor, and disability) portion of FICA and to the HI (Medicare) portion. It wasn't until much later that they pay cap on HI taxes was removed.

Then came Code Section 162(m). Congress decided that no disqualified individual (that's a fancy term for the people they are targeting) should earn more than $1 million in a year. But, wait, suppose an executive performed really well. That might merit more pay. So, performance-based compensation was exempted from Section 162(m), so long as whoever crafted the plan got the design just right. Companies found ways to skirt this one pretty easily.

And, then came the nightmare before Christmas, Code Section 409A. I've written about it here many times before. The worst thing is that it was part of a jobs bill, the American Jobs Creation Act of 2004. If you don't work in this area or if you have been living under a rock, I'll give you the brief summary of how Section 409A creates jobs.

Ready?

It places additional 20% income taxes on nonqualified deferred compensation that doesn't meet some of the most convoluted rules that even the Treasury Department has ever come up with. And, what is worse, the more time that passes, the more problems that are uncovered with respect to plans subject to 409A ... all in the name of creating jobs.

Well, I have done a detailed statistical analysis (remember, I'm an actuary and I have training in this area), and I have determined with a particularly high confidence level exactly how many jobs were created (outside of government jobs to regulate and enforce this mess and attorneys to find ways around it) by Section 409A.

Zero. Zilch. Nada.

But, it has taken some perfectly innocent plan designs and made them seem like they were created by scoundrels the likes of which even Gordon Gekko has never seen. Imagine this: suppose that an employer provides its CEO with restricted stock units (RSUs). And, further, suppose that the restrictions lapse (the units vest) after 10 years, or after bona fide retirement on or after age 65. Lots of critics think that this is a desirable design of an executive compensation program. It ties executive compensation both to company stock performance and to the executive staying with the company.

Oops, the fact that the RSUs could vest upon retirement (seems innocent enough to me) makes the plan subject to Section 409A, and as often as not, nobody worked this out in advance, so the plan fails to comply with Section 409A and there are draconian tax penalties on the executive ... all because the company thought it was fair that he or she should have access to his or her earnings upon retirement from the company. The nerve of the CEO!

Excuse me, the nerve of Congress.

IRS Still Auditing Executive Compensation

Over a year ago, the IRS announced that it was stepping up its audit program with respect to executive compensation. Frankly, any activity at all would have been a step up. For the majority of the time since we have had an income tax (and therefore an Internal Revenue Code) in the US, audits of executive compensation have been virtually nonexistent. Why? The biggest reason is that there have not been a whole lot of rules. Number two on the list is that the IRS has not chosen to place its resources there.

For many who are fortunate enough to be the beneficiaries of executive [levels] of compensation, the good news is that most are still not getting audited. However, with the interplay of Code Sections 83 (constructive receipt and the economic benefit doctrine plus some other related stuff), 162(m) (the million dollar pay cap), 409A (taxing people to death when they mess up their deferred compensation programs), and 3121(v) (FICA tax on deferred compensation), the IRS has plenty of things to audit. Surprisingly, at least to this writer, we're finding that they are catching people on some fairly tricky applications of the law.

Notably, I've seen or heard of multiple people getting dinged on these infractions:

• Stock awards that vest at a retirement date, causing constructive receipt under Section 83
• Linked retirement plans where the offset from the qualified plan is not well enough specified, causing a 409A violation
• Failure to pay FICA tax on deferred compensation that employers didn't realize technically was deferred compensation
• Improperly constructed performance pay plans that run afoul of 162(m) by not qualifying as performance pay
• Severance pay plans that did not have a 6-month payment delay for specified employees because they looked like broad-based plans. The fact that the compensation considered exceeded the pay cap (401(a)(17)) caused the problem.
• A 409A plan having a plan document that specifies for one set of administrative procedures, but the plan being administered the way it always was before someone wrote a document without bothering to check to see how it was being administered.

There are more, plenty more. There are a few ways that you can handle this.

• Do nothing and play audit roulette.
• Have your documents reviewed by someone other than the person who wrote them (the person who wrote them will read what they intended even if nobody else reads it that way).
• Have your administrative processes reviewed by someone who is not your administrator, but has experience with the administration of nonqualified deferred compensation plans.
• If you find problems, take corrective action. The IRS has been nice enough to give us corrective methods that lessen or eliminate the additional tax burden, but only if you fix them before the IRS catches you.

The 1-Year FICA Cut and 401(k) Plans

Every working American subject to FICA taxes will see a pay increase in 2011 of 2% of pay up to a maximum savings of $2,136. For those who have not been saving enough in their 401(k), I am going to suggest that they increase their rate of deferral to that plan. It doesn't matter from a FICA standpoint whether you put that money in as pre-tax, Roth, or after-tax, as money put into a 401(k) plan by an employee is FICA taxable.

Suppose employees choose to contribute more. Then, employer matching contributions will increase. Are companies budgeting for this? Are they even thinking about it?

This all goes back to risk management. Is this a risk that has been considered? Where will the money come from?

GOP-Obama Compromise Would Lower 2011 Employee Portion of FICA Taxes

Have you been hiding under a rock? If you are reading this, I'm guessing not. In that case, you know that (surprise, surprise) the President and Congressional Republicans reached a compromise yesterday.

The well-publicized items were that:

• The so-called Bush tax cuts (enacted through EGTRRA in 2001) will become permanent for incomes less than $200,000 (for singles) and $250,000 (for married)
• For higher earners, those cuts will delay their scheduled sunset until the end of 2012 presumably setting up more Congressional warfare after the 2012 elections
• Renew jobless benefits for the long-term unemployed

Not publicized, but perhaps more important to many were these:

• A 2% of pay reduction in the employee-provided portion of FICA (Social Security) taxes for 2011 only. What this means is that workers will get an effective pay increase for 2011 of 2% on the first $106,800 of pay. This may not seem like much, but more US workers than not pay more in FICA taxes than they do in federal income taxes
• Estates would be taxed at a 35% rate for amounts in excess of $5 million

Beware! This is not law yet. House Democrats will need to support this in order to pass it in December. And, whether an associated bill comes to the Senate floor during the lame-duck session of this Congress or during the next Congress, a meaningful number of Senate Democrats would have to support passage in order to make it law.

We'll continue to cover this here.