Employment Taxes

[Guest PBJ]

I am new to the deferred compensation plan arena so I am hoping someone can help me. An executive has a deferred compensation plan that has a formula that includes an earnings component. For instance, the amount deferred each year is increased (or decreased) based on the rate of return of a fund stated in the plan document. The amount deferred does not actually earn the earnings so they are really hypothetical. So my question is this: what is the employment tax treatment with respect to the hypothetical earnings on the deferred compensation account?

Any help, or pointing in the right direction, would be greatly appreciated!!

Thank you.

[Steelerfan]

I am new to the deferred compensation plan arena so I am hoping someone can help me. An executive has a deferred compensation plan that has a formula that includes an earnings component. For instance, the amount deferred each year is increased (or decreased) based on the rate of return of a fund stated in the plan document. The amount deferred does not actually earn the earnings so they are really hypothetical. So my question is this: what is the employment tax treatment with respect to the hypothetical earnings on the deferred compensation account?

Any help, or pointing in the right direction, would be greatly appreciated!!

Thank you.

(assuming this in an elective deferral account balance plan)

The FICA regulations address this. There's a special timing rule and a non duplication rule. Under the special timing rule, if the deferrals are not subject to a substantial risk of forfeiture (elective deferrals would not be) they are subject to FICA/FUTA tax at the time of deferral, and under the non duplication rule, the subsequent earnings will not be FICA/FUTA taxed at any time including distribution. The rules are different for amounts subject to SRF or nonaccount balance plans.

I'm sure others can explain it better, I hope that helps.

[Guest Harry O]

Look at the Section 3121(v) regs. Assuming this is an account balance plan and you collected FICA when the initial award vested, there is no further FICA obligation as long as the credited earnings are reasonable. You don't have to actually have the deferred comp invested, you just need to make sure the earnings are reasonable. Generally, if the earnings are based on an investment that could actually be made, you will be ok.

[Steelerfan]

I forgot to mention about the earnings. There's not a whole lot of guidance, if you set the rate artificially high, the service would probably challenge, but as you say you will use a fund and that should be fine. As Harry O said, if the amounts are subject to SRF, there will be no further taxation of earnings after vesting, but earnings up until vesting are subject to FICA. If the amounts are immediately vested you can potentially have all earnings escape FICA tax--that is the beauty of the non duplication rule.