3576 / Are contributions to, and postretirement payments from, a deferred compensation account balance or nonaccount balance plan subject to FICA and FUTA taxes?

There are two timing rules for the treatment of deferred compensation amounts under the Federal Insurance Contributions Act (“FICA”) and the Federal Unemployment Tax Act (“FUTA”): (1) the “general timing rule,” and (2) the “special timing rule.”

The general timing rule provides that amounts taxable as wages generally are taxed when paid or “constructively received” ( Q 3541).

The special timing rule applies to amounts deferred by an employee under any deferred compensation plan of an employer covered by FICA. The special timing rule applies to voluntary salary, commission and bonus reduction plans, employer-paid supplemental plans, funded and unfunded plans, private plans, and eligible or ineligible Section 457 plans. It does not apply to excess (golden) parachute payments.

In a 2016 case, the 11th Circuit affirmed this application of FICA taxation to an employer-paid SERP in a case where the taxpayer sought to argue that the subject plan was not a supplementary deferred compensation plan that constituted FICA taxable “wages.”¹

Section 409A has not changed the application or calculation of employment taxes. Under these rules, vested nonqualified plan contributions (and the earnings on them) generally are taxable for employment tax purposes (compared with income tax purposes) when they are contributed (as in the case of most voluntary salary/bonus deferral plans) or when they are vested (as in the case of an employer-paid supplemental plan with risks of forfeiture on the benefits).

General Timing Rule

Under the general timing rule, an employee’s “amount deferred” is considered to be “wages” for FICA purposes at the later of the date when the services are performed or the employee’s rights to such amount are no longer subject to a Section 3121 “substantial risk of forfeiture” governing the timing of the imposition of FICA taxes on compensation.² This definition of substantial risk of forfeiture or limitation should not be confused with the seven others discussed in Q 3538 and Q 3541; it is similar but not the same as the others and should be reviewed separately for FICA inclusion questions.

Similar rules apply for FUTA (federal unemployment tax) purposes, although the taxable wage base for FUTA purposes is substantially smaller ($7,000).³

Where an amount deferred cannot be readily calculated by the last day of the year, employers may choose between two alternative methods: the estimated method and the lag method.

Under the estimated method, the employer treats a reasonably estimated amount as wages paid on the last day of the calendar year. If the employer underestimates, it may treat the shortfall as wages in the first year (or in the first quarter of the second year). If the employer overestimates, it may claim a refund or credit.

Under the lag method, the employer may calculate the end-of-year amount deferred on any date in the first quarter of the next calendar year. The amount deferred will be treated as wages paid and received on that date, and the amount deferred that otherwise would have been taken into account on the last day of the year must be increased by income through the date on which the amount is taken into account.⁴

Special Timing (Nonduplication) Rule

The “special timing” (nonduplication) rule is designed to prevent double taxation once an amount is treated as wages. Under this rule, any amount (and any income attributable to it) will not again be treated as wages for FICA or FUTA purposes in any later year.⁵ A deferred amount is treated as taken into account for FICA and FUTA purposes when it is included in computing the amount of wages, but only to the extent that any additional tax for the year resulting from the inclusion actually is paid before the expiration of the period of limitation for the year. A failure to take a deferred amount into account subjects it (and any income attributable thereto) to inclusion when actually or constructively paid.⁶

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Planning Point: In an important case development, in 2016 a Federal District Court (affirmed on appeal by the 11th circuit) held that an employer was responsible under the plan provisions for some FICA taxes paid by its plan participants on plan benefits because of its failure to withhold FICA taxes in connection with a SERP during the active working life of those plan participants rather than at the time the benefits were paid.⁷

The participants argued that the employer was obligated to pay those taxes under the plan and by failing to withhold during the working period they incurred FICA taxes on their benefits that would not have been due otherwise. Because of annual caps on total FICA contributions, the FICA taxes were often muted or avoided entirely for deferred compensation plan participants, except for the Medicare portion. Under the application of the FICA rules to the plan, by failing to withhold on FICA during the working period, their benefits were thereby subjected to FICA taxation as paid contrary to the plan provisions.

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