Supplemental compensation to owner after retirement

[katieinny]

One of the owners is retiring.  The company has decided to pay him $50,000 per year over the next 10 years.  It's not deferred comp because he's not delaying any of his compensation.  He'll just continue to receive compensation for 10 more years, but won't be going to work.  If he dies during the 10 year period, the payments would continue to his spouse for the remaining time.  The accountant says it will be taxable income, but not subject to FICA or FUTA.  I did some reading on Supplemental Executive Retirement Plans, but one article said that SERP income is subject to employment taxes.  That doesn't make sense to me, but I suppose it could be true.  So, if it's not a SERP, what is it?  I assume there would have to be a written agreement to this arrangement.  

[jpod]

It may be disguised purchase price rather than compensation, but that's really the Company's tax risk, not the owner's, although by characterizing the payments as compensation he may be cheating himself out of LTCG treatment. Assuming it is compensation, it is deferred compensation subject to 409A, but it may not be deferred compensation subject to the 3121(v) rules.  Whether or not it is subject to 3121(v) it is most definitely subject to FICA and FUTA and Medicare taxes; you just have a timing question as to when it is subject to those taxes.  It also would be an ERISA pension plan, but presumably a top-hat plan. 

[katieinny]

Thank you, jpod.  I've continued to read this afternoon and now I'm thinking that the arrangement I described might be best called a salary continuation plan.  I'm struggling with the "deferred compensation" label because there was no prior agreement to get paid less so that he could continue to get paid later.  I'll keep reading...  I think you're right about the income being subject to employment taxes, so I'll have to find out where the accountant is coming from in that regard.

[jpod]

Just curious to know what your role is here.  I think the biggest issue for the owner is whether he can do better economically by selling his ownership interest for $500,000 paid over 10 years and paying tax at LTCG rates on the portion of each payment not deemed to be interest and having no FICA and Medicare tax liability.  On the other hand, maybe all of this has already been analyzed and negotiated.   

[CuseFan]

those payments are most definitely subject to payroll taxes. even bona fide deferred comp is subject to payroll taxes at some point in time. if this is a structured installment payment buyout then maybe it's not earned income.

[Mike Preston]

As I understand it, the goal is to have the value of the payments subject to payroll taxes in a year where there is significant other income so that, in effect, the employee has already reached with Wage Base and therefore the effective tax rate is greatly diminished.

[jpod]

Mike, that is impossible under 3121(v) if the plan is adopted close in time to retirement.  

[Mike Preston]

Even if so, taxing $500,000 in one year is far less than taxing $50,000 each year for 10 years, right?

[XTitan]

The FICA special timing rule on a defined benefit (non-account balance) arrangement (and $50k per year for 10 years sure sounds a defined benefit to me) would be to subject the lump sum equivalent to FICA up front, so I'd argue you may even get to discount the $500k lump sum.  Salary continuation sure seems to create a legally binding right today for compensation to be paid in the future, hence 409A comes in, with all it's required written documentation and such.  An employment contract with commitments to future compensation may still need to comply with 409A.

 

 

[jpod]

What I was saying to you is that if this plan is adopted on the eve of retirement the normal 3121(v) rule does not apply and the $50,000 will be subject to FICA/Medicare each year it is received.

[CuseFan]

Agreed - i believe you must enter into the agreement at least one year prior to retirement or you do not get the advantages of 3121, so I think you're stuck with pay as go full FICA and Medicare. I agree with X that 409A is also in play, which could impact the ability to modify payments, if desired.