The BNA Tax and Accounting Center is the only planning resource to offer expert analysis and practice tools from the world's leading tax and accounting authorities along with the rest of the tax...
John E. Schembari and William C. McCartney
Kutak Rock LLP, Omaha, NE
A recent case out of a federal court in Michigan (Davidson v. Henkel Corp., No. 12-cv-14103, 2015 BL 1384 (E.D. Mich. Jan. 6, 2015) highlights the need for employers to properly withhold FICA taxes on nonqualified deferred compensation benefits. In the Michigan case, the employer failed to properly withhold FICA taxes and an executive successfully sued the employer for the delinquent FICA taxes. This case is a good reminder for employers to review their nonqualified plan documents and procedures to ensure the proper handling of FICA and income tax withholding.
Normally, wages are subject to FICA tax when they are actually paid to the employee. Under a special rule for nonqualified plans, deferred compensation is taken into account when the amount is no longer subject to a substantial risk of forfeiture. If FICA taxes are withheld under this special rule, there is no FICA tax withholding when the deferred compensation is later paid to the employee. Most employers and employees avail themselves of this rule, as many executives hit the maximum taxable wage base for FICA purposes sooner while they are working and deferring compensation as opposed to when they are retired and generally drawing down on their deferred compensation benefit. Note that if an employer does not follow this special rule, the deferred compensation will be subject to FICA taxes when the amount is paid.
Facts of the Case
Henkel Corporation maintained a nonqualified deferred compensation plan to provide supplemental retirement benefits to a select group of management and highly compensated employees. The plan permitted certain Henkel employees to defer compensation (and taxation thereon) until they retired.
One highly compensated employee, John Davidson, participated in the plan for several years before retiring in 2003, at which point he began receiving his monthly benefit under the plan. In 2011, Henkel sent a letter to Davidson informing Davidson that FICA taxes associated with his plan benefits had not been withheld. The letter further provided that FICA taxes were payable on the present value of all future plan payments as well as individually on each previous payment dating back to 2008 (the earliest tax year still considered open for retroactive payment purposes). Finally, the letter provided that Henkel had paid the FICA tax owed to the IRS and would reduce future plan benefits to reimburse itself.
Davidson sued Henkel, arguing he and other similarly situated participants suffered a reduction in their benefits under the plan due to Henkel's failure to withhold FICA taxes as required under the special rule for nonqualified plans.
The Court's Decision
The court held that Henkel did not have a mandatory obligation to withhold FICA taxes under the special rule since the regulations provide that if the special timing rule is not followed, FICA should be withheld as the benefits are paid. However, the court did find that the plan itself required Henkel to properly withhold taxes when assessable or due. Further, Henkel had previously conceded that FICA taxes had not been properly withheld.
As a result, the court found that Henkel was liable for failing to withhold FICA taxes under the special rule and Henkel was required to cover the costs of its failure.
If your company maintains a nonqualified deferred compensation plan or arrangement, you should review the terms of the plan and your procedures for withholding FICA taxes. If you are not taking advantage of the special FICA tax rule, you should determine whether this creates any risk for the organization and whether utilizing the special rule may make more sense for your executives and the company.
For more information, in the Tax Management Portfolios, see Brisendine, Drigotas and Pevarnik, 385 T.M., Deferred Compensation Arrangements, and in Tax Practice Series, see ¶5440, Employment Tax Withholding Requirements, ¶5710, Deferred Compensation Tax Concepts and Structures.
©Kutak Rock LLP 2015. All Rights Reserved
Copyright©2015 by The Bureau of National Affairs, Inc.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)