MARKET TREND: Financial and tax planning considerations have made the use of nonqualified deferred compensation vehicles increasingly popular. While these arrangements generally result in the deferral of income taxation until the time at which the deferred compensation is paid to the plan participant, special rules under the Internal Revenue Code ("Code") require that FICA taxes (i.e., Social Security and Medicare) be paid at an earlier time and emphasize the importance of proper plan administration.
SYNOPSIS: In Davidson v. Henkel, an employer maintained a supplemental retirement plan for the benefit of certain employees under which it promised benefits based on the amount that would be payable to a participant under the employer’s tax-qualified pension plan. The employer did not withhold and pay FICA taxes at the time they were due under the Code and, instead, paid these taxes at the time of each benefit payment. This approach resulted in the participant owing more in FICA taxes than he would have if the employer paid these taxes timely, thereby reducing the net benefit payable to the participant. The participant sued the employer for the lost benefit, and the employer filed a motion to dismiss the participant’s suit for failure to state a claim. The court found that the participant’s complaint did state a claim for benefits.
TAKE AWAY: Failure to properly administer a nonqualified plan, specifically with regard to the special rules governing the FICA taxation of these arrangements, may result in significant additional FICA tax liability to the participant and employer, as well as expose the employer to possible benefit claims. Advisors to employers sponsoring nonqualified deferred compensation plans can assist their clients in avoiding claims for benefits by ensuring that the employers are aware of, and have in place procedures that properly take into account, the rules for paying and withholding FICA taxes on amounts deferred under these plans.
MAJOR REFERENCES: Davidson v. Henkel (Case No. 12-cv-14103, filed July 24, 2013, United States District Court for the Eastern District of Michigan, Southern Division).
Click to download a printable pdf.
SYNOPSIS: In Davidson v. Henkel, an employer maintained a supplemental retirement plan for the benefit of certain employees under which it promised benefits based on the amount that would be payable to a participant under the employer’s tax-qualified pension plan. The employer did not withhold and pay FICA taxes at the time they were due under the Code and, instead, paid these taxes at the time of each benefit payment. This approach resulted in the participant owing more in FICA taxes than he would have if the employer paid these taxes timely, thereby reducing the net benefit payable to the participant. The participant sued the employer for the lost benefit, and the employer filed a motion to dismiss the participant’s suit for failure to state a claim. The court found that the participant’s complaint did state a claim for benefits.
TAKE AWAY: Failure to properly administer a nonqualified plan, specifically with regard to the special rules governing the FICA taxation of these arrangements, may result in significant additional FICA tax liability to the participant and employer, as well as expose the employer to possible benefit claims. Advisors to employers sponsoring nonqualified deferred compensation plans can assist their clients in avoiding claims for benefits by ensuring that the employers are aware of, and have in place procedures that properly take into account, the rules for paying and withholding FICA taxes on amounts deferred under these plans.
MAJOR REFERENCES: Davidson v. Henkel (Case No. 12-cv-14103, filed July 24, 2013, United States District Court for the Eastern District of Michigan, Southern Division).
Click to download a printable pdf.
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