Implications for Employers Who Delay Deferred Compensation FICA Taxation

Healthcare

Implications for Employers Who Delay Deferred Compensation FICA Taxation

Share on LinkedIn
Share on Facebook
Tweet Me
Subscribe to Withum News
Under the Federal Insurance Contributions Act (“FICA”), both for-profit and not-for-profit employers are required to withhold and remit from an employee’s compensation and remit an employer’s contribution for Social Security and Medicare taxes. As a retention tool, employers often offer employees the opportunity to take part in a deferred compensation plan.

Under Treasury Regulation §31.3121(v)(2)-(a)(2)(ii)-1(e), deferred compensation is subject to FICA taxation in the year the compensation (1) is earned; (2) becomes “vested”; and (3) is reasonably ascertainable. Employers may overlook the complex FICA rules and fail to properly report and withhold FICA taxes under the deferred compensation special timing rule. The Internal Revenue Service (“IRS”) previously allowed employers to correct this error after the expiration of the statutory correction period. Early in 2017, the IRS released Chief Counsel Memorandum 2017-001 which no longer allows employers to correct the omission of FICA taxes on deferred compensation after the statutory correction period.

Background

Under FICA, employers are required to withhold the following three separate taxes from employee wages:

  • Social Security tax of 6.2% of wages up to a wage base limit ($127,200 for 2017);
  • Medicare tax of 1.45% of wages on an unlimited wage base; and
  • Medicare surtax of 0.9% of wages in excess of wages above $250,000 for married taxpayers filing jointly; $125,000 if married filing separately; and $200,000 for all other filers.

Employers are subject to the remittance, to the IRS, of the Social Security tax of 6.2% of an employees’ wages up to the applicable wage base limit and Medicare tax of 1.45% of an employees’ wages on an unlimited wage base.

 

Special Timing Rule and Deferred Compensation

Employers often offer employees nonqualified deferred compensation (“NQDC”) plans in order to retain talented employees. A NQDC plan is an elective or non-elective plan, agreement, method, or arrangement between an employer and an employee to pay the employee compensation in the future. Compensation deferred under a NQDC plan may be subject to FICA tax under the special timing rule when the employee has become vested and has a right to the compensation. Under the special timing rule, once the deferred compensation has been subject to FICA tax withholding, the additional earnings and compensation will not be subject to any additional FICA tax when actually paid to the employee.

Employers and employees both benefit from the special timing rule due to the fact that the employee most likely is still employed and has earned wages in excess of the wage base limit for calculating the Social Security tax. Due to this fact, the employee and employer may not need to remit any Social Security tax due to the fact the employee has already reached the Social Security wage base.

FICA tax is imposed on deferred compensation when the compensation is paid if the employer does not apply the special timing rule. This mistake by the employer could cause adverse tax consequences for the employer.

Employer does not utilize Special Timing Rule

If an employer fails to withhold the applicable FICA taxes on deferred compensation, under the special timing rule, the employer may correct the mistake and remit the applicable FICA taxes if corrected within the statutory period of three years.

Often times, the employer does not discover the error until years after the deferred compensation has been vested and the statute of limitations has passed. In the past, the IRS would allow the employer to take advantage of the special timing rule if the employer entered into a Closing Agreement with the IRS and remitted the additional FICA taxes, plus interest, on the deferred compensation. With the IRS’ issuance of Chief Counsel Memorandum 2017-001, employers are no longer permitted to enter into a Closing Agreement with the IRS and take advantage of the special timing rule.

If an employer discovers an omission of FICA withholding on an employees deferred compensation after the statute of limitations has passed, the employer must follow the general timing rule and the deferred compensation will be subject to FICA tax when paid. Due to this error on the part of the employer, the employer and employee could be subject to higher FICA taxes, since they were unable to take advantage of the special timing rule.

Conclusion

For-profit and not-for-profit employers who offer NQDC plans to their employees should review their deferred compensation plans and payroll practices to ensure they are taking advantage of the special timing rule with respect to remitting FICA taxes. The special timing rule can help reduce the employer’s and employees’ FICA tax liability with respect to deferred compensation. Failure by the employer to take advantage of the special timing rule could have an adverse effect on the employer and employee and require the employer and employee to remit additional FICA taxes which can be avoided.

A copy of the IRS Chief Counsel Memorandum 2017-001 may be accessed at the healthcare services section of our Firm’s website.

For more information, fill out the form below and a member of our Healthcare Services team will respond.

Ask Our Experts

Previous Post

Next Post