NQDCP FICA Taxation - Independent Contractor

[Guest tompaul]

Independent contractor (insurance agent) participated in a non-qualified deferred compensation plan. In each year during which income was deferred, contractor's non-deferred income exceeded the maximum FICA wage base and contractor paid maximum FICA taxes during these years. Now, contractor has retired but has not yet received plan distributions. Company notifies employee that distributions will be reportable on 1099 misc. Question: Will contractor be required to pay FICA taxes on distributions? Or, is income exempt givent hat contractor paid the maximum FICA taxes in the years in which the income was deferred? Thank you.

[Guest Harry O]

Independent contractors don't pay FICA taxes, they pay self-employment SECA taxes (the equivalent of FICA for self-employed taxpayers). The special FICA rule in 3121(v) only applies to deferred compensation for employees. There is no equivalent rule for self-employeds, so they pay SECA tax as they are paid the deferred compensation.

[Guest Harry O]

P.S. Some insurance agents may be statutory employees. The answer will be different in that case.

[Guest tompaul]

If I understand correctly, SECA taxes are payable when distributions are made. In essence, contractor was successful in deferring income tax payments and reducing his average tax rate - but these benefits are largely offset by the fact that he will be paying additional SECA taxes. The only way around this is to qualify as an employee - which the company obviously denies.

[mbozek]

Def. comp that is income from self employment will be included for SECA tax on Schedule SE for the year paid. See PLR 9609011. The SECA tax is 15.3% of the first 90k of net earnings from SE, not 7.65% and employee deducts 1/2 of the SECA tax from taxable income.

[Guest tompaul]

Harsh reality. Remaining challenge will be to determine if there is an advantage (and ability) to receive distributions on an accelerated basis. Using round numbers, if the plan has $900,000 and this sum is distributed equally over ten years (i.e. $90,000 per year), the contractor will pay the maximum SECA tax in each of the ten years (oversimplified...). Possible alternative (if available) is to distribute $300,000 per year for three years, thus subjecting the income to higher average tax rates, but avoiding seven years of SEPA tax. The problem is even more vexing if one assumes that the social security wage base increases in future years.

[mbozek]

This is why IC should never enter into NQDC agreements unless the rate of return on the deferrals is greater than the SECA tax rate (15.3%)

[Guest Harry O]

mbozek -

Your calculator must be broken.

It makes no sense that the individual must at least earn the SECA rate!!!!

Please post an example.

My back of the envelope calculations show that deferred compensation makes sense if the individual can get a pre-tax return in the NQ plan of approximately 6.5% (assuming 28% federal rate, after-tax SECA rate of approximately 13%, a 10 year deferral period, a 5% rate of return outside the plan taxed only at the end of the 10 year period at a 15% LTCG rate, and, generously, no SECA payable in year compensation earned because other self-employment income exceeded wage base (even ignored medicare tax that would have been payable in that year)).

Your theory would indeed be revolutionary and make every outside director at public companies throughout the U.S. drop their deferred fee plans! I'm not aware of any such plans paying a greater than 15.3% return!

[GBurns]

Harry O

"Your theory would indeed be revolutionary and make every outside director at public companies throughout the U.S. drop their deferred fee plans! I'm not aware of any such plans paying a greater than 15.3% return!" makes no sense. mbozek referenced ICs, there should be no public companies having deferred comp for their ICs and there are no public companies that could drop their DC plan because of what ICs should have to earn to break even There is no relevance in this comment to what mbozek posted.

How come you picked on mbozek's rational follow up to tompaul's analysis but did not criticize that analysis which is the basis for his comment?

Aside from that your calculation is either questionable or badly illustrated, but I will leave that for now to see what others see.

[Guest tompaul]

I did not post an analysis per se - just a hypothetical illustration of what I perceive to be the tradeoffs between paying the maximum SEPA tax over an extended period of time versus the possibility of paying increased income taxes on an accelerated distribution. Thank you to those who have replied.

[Guest Harry O]

GBurns -

Public companies have outside directors that are considered independent contractors, or self-employed, for tax law purposes. Many such public companies have deferral plans established for their outside directors whereby they can elect to defer all or a portion of their director fees. This is essentially equivalent to a salary deferral plan for employees.

So . . . most public companies have deferred comp plans for their ICs. They are called director deferral plans.

You should read your proxy statements for more information . . .

[GBurns]

You are right I really should read proxy statements. I did not realize how many such plans there were including ones such as Nextel's which lumps employees and non-employee directors together in 1 plan.

However, I notice that an increasing number have frozen their plans in response to 409A. As the SEC site gets updated I expect to see many more doing so.

I wonder if it has ever been put to the test, by the IRS, as to whether or not the Corp can be the plan sponsor for a non-employee and whether an IC can have someone else sponsor the plan of the non-employee. I would love to have someone sponsor a plan for me.

By the way, Directors are not "considered independent contractors, or self-employed, for tax law purposes". They are considered so for ALL purposes whether it be Labor law, Workers Comp etc.

[Guest Harry O]

There is nothing for the IRS to "test" as far as sponsorship of these plans is concerned. These are not qualified plans that must meet the "exclusive benefit" test. They are nonqualified programs. There is no prohibition (other than constructive receipt) on a company agreeing to defer payment to an outside service provider for services rendered, whether it be an outside director or outside counsel.

[mbozek]

See RR 71-419 -Def comp for directors is agreement with corp to to defer fees.