Download PDF

Insights
from Human Resource Services
Employers may be liable to
employees for failing to collect FICA
taxes on deferred compensation on a
timely basis
January 28, 2015
In brief
A federal district court has ruled that an employer violated ERISA by failing to follow the terms of its
nonqualified deferred compensation plan when it did not withhold Social Security and Medicare (FICA)
taxes when the plan benefits became vested. The court concluded that the participants were harmed
because they now had to pay FICA taxes on each payment that was made under the plan.
In detail
Background
Generally, FICA taxes are
withheld from wages at the time
the payments are actually made.
However, nonqualified deferred
compensation (NQDC) is
subject to a ‘special timing rule’
for FICA tax purposes. The
special timing rule provides that
NQDC be taken into account for
FICA purposes at the later of:
(1) the date on which the
services creating the right to
such amount are performed; or
(2) the date on which the right
to the deferred amount is no
longer subject to a substantial
risk of forfeiture (i.e., at the time
of vesting). For account balance
plans, such as salary and bonus
deferral arrangements, this
means that FICA taxes are
withheld at the time the deferral
is made, or upon vesting, if
later. For supplemental
executive retirement plans
(SERPs) that are structured as
defined benefit-type plans, the
special timing rule generally
applies at the resolution date
when the benefit is reasonably
ascertainable; this is often at
retirement when the
participant’s total years of
service, final compensation and
commencement date are known.
Employers can also estimate the
present value of the SERP each
year as it accrues, withhold
FICA on that estimated value,
and true up at retirement.
Under the special timing rule,
once an amount deferred under
a NQDC plan is taken into
account (i.e., included in
computing the amount of
taxable wages) for FICA
purposes, then neither the
amount taken into account nor
the income attributable to the
amount taken into account is
treated as wages for FICA tax
purposes at any time thereafter.
This is also known as the ‘nonduplication rule’ and it means
that future payments of the
benefit are not subject to FICA
taxes again. For account balance
plans that provide for earnings
on deferrals, the nonduplication rule eliminates FICA
taxes on earnings credited after
vesting.
If FICA taxes are not withheld
under the special timing rule,
they are due as each payment of
deferred compensation is made.
www.pwc.com
Insights
Davidson v. Henkel Corporation
A recent federal district court has
ruled that a company failed to follow
the terms of its NQDC plan by failing
to withhold FICA taxes on the
deferred compensation, which
resulted in a reduced benefit to a
group of plan participants. In this
case, Henkel Corporation (Henkel)
sponsored a deferred compensation
plan for a select group of management
employees. Participants were allowed
to defer a portion of their
compensation and received a
matching contribution from Henkel.
Davidson was a participant in the
plan.
Henkel did not withhold FICA taxes
on plan contributions at any time
prior to Davidson’s retirement and
initially did not withhold FICA taxes
from the payments. Several years after
Davidson had retired and begun
receiving benefits, the company paid
the FICA taxes due to date on behalf
of the participants, and reduced future
benefit payments to reflect this
amount. The employer then began to
withhold FICA taxes from each new
payment.
Davidson sued Henkel under ERISA
charging that the employer failed to
follow the plan terms that provided
that for each year in which a deferral
or match was credited to the
participant’s account, the company
would withhold all applicable Federal,
state or local taxes. The court found
that the company’s failure to withhold
FICA taxes violated the plan’s terms.
This violation caused the retirees to
lose the advantage of the nonduplication rule, one of the key
benefits of the plan, and had the effect
of lowering their vested benefits in
violation of ERISA.
Observation
Employees who voluntarily defer the
receipt of salary and bonus amounts
2
under a nonqualified plan do so with
the expectation that future taxes will
be less than the taxes due if they were
paid the compensation when it was
earned. Many nonqualified plan
participants have wages that exceed
the Social Security wage base with
normal salary and bonus payments.
Thus, annual deferrals and matching
contributions may only be subject to
the Medicare portion of the FICA tax
for that year. Failing to withhold
FICA taxes on a timely basis subjects
these amounts to Social Security
taxes when the benefits are paid to
the participant, when the participant
may not have other wages up to the
Social Security wage base and so
must pay both Medicare and OASDI
taxes on the payment. As a result,
employees’ benefits are less than they
would have been had the taxes been
withheld under the special timing
rule.
Accurate administration of
benefit plans
This case highlights the need for
employers to pay close attention to
plan terms and administer plans
according to such terms. Although
nonqualified plans are generally
excluded from many ERISA
requirements, participants can still
sue for damages under ERISA.
Employers should also review
processes for employment tax
withholding for deferred
compensation, and make sure these
taxes are calculated properly and
withheld on time, in accordance with
the terms of the plan. Employers may
be held responsible for excess taxes
that must be paid on deferrals and
earnings if FICA taxes were not
properly withheld under the special
timing rule.
Observation
For defined benefit-type plans,
applying FICA taxes to the accruals
each year and truing up the FICA due
at the final resolution date may also
reduce the amount of the SERP that is
subject to Social Security tax, even if
it does not reduce the amount of
Medicare tax. If an employer chooses
not apply FICA taxes prior to the
resolution date, it should review the
plan document to ensure that this
conforms to the terms of the plan.
Practical Considerations
Most employers choose to withhold
FICA tax due by means of an
employee’s normal salary. However,
there is a possibility the individual
lacks sufficient salary to cover the tax
due in the payroll period that it is due.
There is also the added administrative
complexity of coordination with
payroll. Companies may collect the tax
amounts due from an individual by
requesting a personal check or cash
wire, although this is not an ideal
solution as it can become
administratively burdensome when
dealing with a large population.
Retirement eligibility events under
SERPs also pose a compliance
challenge for many employers.
Generally, individuals will not receive
an actual cash payment at the time of
retirement or retirement eligibility
when FICA taxes are due.
Employers may take advantage of the
rule of administrative convenience to
postpone the date that FICA taxes
must be remitted during the year
when they are due. This rule allows an
employer to treat an amount deferred
as required to be taken into account
for FICA tax purposes on any date that
is later than, but within the same
calendar year as, the actual date on
which the amount deferred is
otherwise required to be taken into
account. For example, if an
individual’s right to the NQDC vested
on July 1, 2014, the employer may
choose to take the amount deferred
into account on December 31, 2014
instead of on the actual vesting date
pwc
Insights
(i.e., July 1, 2014). This rule may help
with some of the cash flow issues
identified above.
Observation
Generally, the burden falls on
stakeholders in Payroll and/or
Human Resources to ensure FICA
taxes are paid on time. Early
coordination with plan participants
is essential.
The takeaway
Plan sponsors should review plan
terms and to make sure their
nonqualified plans are being
administered in accordance with their
terms. Liability under ERISA for
failure to follow plan terms can
represent significant cost to an
employer. In addition, payment of
FICA taxes on nonqualified deferred
compensation plan benefits is
complex, particularly for defined
benefit SERPs; employers should
review their employment tax policies
and procedures to be certain they are
following the legal requirements and
taking advantage of the rules that
minimize tax payments. Finally, it is
important to confirm some type of
tracking mechanism is in place to
ensure FICA withholding is not
duplicated when amounts are
ultimately paid to participants.
Let’s talk
For more information, please contact our authors:
Kerri McKenna, Philadelphia
(267) 330-1723
[email protected]
Susan Lennon, Washington, DC
(202) 414-4625
[email protected]
Anne Waidmann, Washington, DC
(202) 414-1858
[email protected]
or your regional Human Resource Services professional:
US Practice Leader
Scott Olsen, New York
(646) 471-0651
[email protected]
Charlie Yovino, Atlanta
(678) 419-1330
[email protected]
Craig O'Donnell, Boston
(617) 530-5400
[email protected]
Pat Meyer, Chicago
(312) 298-6229
[email protected]
Terry Richardson, Dallas
(214) 999-2549
[email protected]
Todd Hoffman, Houston
(713) 356-8440
[email protected]
Carrie Duarte, Los Angeles
(213) 356-6396
[email protected]
Ed Donovan, New York Metro
(646) 471-8855
[email protected]
Bruce Clouser, Philadelphia
(267) 330-3194
[email protected]
Jim Dell, San Francisco
(415) 498-6090
[email protected],com
Scott Pollak, San Jose
(408) 817-7446
[email protected]
Nik Shah, Washington Metro
(703) 918-1208
[email protected]
© 2015 PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers (a Delaware limited liability partnership),
which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.
SOLICITATION
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
3
pwc