Reporting Distributions from Rabbi Trust

[EBECatty]

I know the general rabbi trust template (and many others based on it that I have seen from trust companies) says the trustee will make all distributions to participants and report/withhold. Others say (and in my experience this is what the sponsors often do, regardless of the trust terms) the sponsor may pay the benefits directly and request reimbursement from the trust. 

Sponsors paying directly and requesting reimbursement usually cite the inability for the payroll systems to accurately record a direct payment from the trustee for W-2 reporting.

In the former case, where the trust makes the payment directly, what exactly do they report to the IRS and how does that information get reconciled with the sponsor's payroll system?

Thanks in advance for any insight.

[Luke Bailey]

2 hours ago, EBECatty said:

says the trustee will make all distributions to participants and report/withhold

EBECatty, the IRS model trust agreement says the trustee "shall make provision" for reporting and withholding. That provision can be, and in my experience usually is, that the employer will do it.

 

2 hours ago, EBECatty said:

Others say (and in my experience this is what the sponsors often do, regardless of the trust terms) the sponsor may pay the benefits directly and request reimbursement from the trust. 

That is also in the IRS form. I think the main thing the IRS is concerned about is to make sure the trustee remains liable if it some how pays the entire benefit and there is no withholding by either employer or trustee. It would be practical for the bank to withhold the appropriate amount from the distribution, as determined by the employer, if the distribution is made from the trust, and remit that amount to the employer for its payroll tax deposit.

 

2 hours ago, EBECatty said:

In the former case, where the trust makes the payment directly, what exactly do they report to the IRS and how does that information get reconciled with the sponsor's payroll system?

I guess you could prepare a separate W-2. If the payee is a former employee, it could be practical since it would be the only payment the individual might receive. The bank would have to know what the employer did with FICA while the amount was accrued, and be confident it was correct.

[EBECatty]

Luke, thanks for your response. 

I may not have stated my question the right way. I see all of that flowing from a tax withholding standpoint, particularly under section 2(a), but generally when I have encountered this situation, the employer runs the entire gross benefit payment through their payroll, then requests reimbursement from the trust of entire gross amount. I don't see a provision in the model document allowing that (at least where the trust is irrevocable). Section 2(c) allows the employer to make payment directly by notifying the trustee before making the payment, but does not seem to contemplate the employer making the entire payment then requesting a distribution from the trust to reimburse the entire benefit payment.

In that situation, the reporting, withholding, etc. is all very easy (and usually why the employer does it that way). Perhaps it's easy but wrong. 

As a matter of practice, to your last point, if the trust makes the benefit payment net of withholding and remits the withheld amounts to the employer, does the reporting all take place on the W-2 issued by the employer? 

[Peter Gulia]

My experience is with the trustee accepting obligations to pay (when instructed) to the participant or beneficiary, tax-report, and withhold at least Federal and State income taxes from the deferred compensation.

 

This requires a service provider with systems to differentiate a plan that requires wage reporting and withholding from those with a pension regime.

 

That deferred compensation is paid in a year in which the employer also paid the same employee/participant regular wages does not always make impractical a trustee’s payment.

 

If paying deferred compensation is distinct from paying regular wages, a payor might apply optional flat-rate withholding to the deferred compensation payments.  26 C.F.R. § 31.3402(g)-1(a); Rev. Rul. 82-46, 1982-1 C.B. 158.

 

If I advise a nongovernmental tax-exempt organization’s executive, I might suggest not allowing the rabbi trustee a power to pay the employer merely because the employer instructed that it had paid a deferred compensation obligation.  Such a provision readily can be used to defeat whatever limited set-aside a rabbi trust can provide.

[Luke Bailey]

3 hours ago, EBECatty said:

I may not have stated my question the right way. I see all of that flowing from a tax withholding standpoint, particularly under section 2(a), but generally when I have encountered this situation, the employer runs the entire gross benefit payment through their payroll, then requests reimbursement from the trust of entire gross amount. I don't see a provision in the model document allowing that (at least where the trust is irrevocable). Section 2(c) allows the employer to make payment directly by notifying the trustee before making the payment, but does not seem to contemplate the employer making the entire payment then requesting a distribution from the trust to reimburse the entire benefit payment.

OK. I see what you mean, EBECatty. I have established many rabbi trusts, but never had to deal with this issue. It seems to me that the best way to do it would be for the trustee to receive from the employer instructions as to what the amount of withholding would be, and then withhold that amount. I would have to review the guidance on payroll agents to determine whether the employer could be the trustee's agent, or vice versa. Peter Gulia's suggesting that flat rate withholding could be applied seems correct, subject to the limitations of that method.

[Luke Bailey]

EBECatty, another thought. Suppose payment is due and the employer instructs trustee as to gross amount. Trustee transfers funds to employer as its agent, with instructions from trustee accepted by employer to pay the distribution to the employee, subject to withholding and reporting on employer's payroll system. Because the employer is acting as the bank's agent, the bank is paying the funds to the executive. If you vary the facts a little, such that the employer pays a day ahead of getting the funds from the bank, or two days, etc., should that really change the result? As long as the executive is paid, he or she has no complaint, and as long as the IRS gets paid, same.

[EBECatty]

Luke, that may be the more accurate technical description. I was able to find some examples with the reimbursement language--see, e.g., section 4.2(c) here:

https://www.sec.gov/Archives/edgar/data/859737/000119312506253369/dex1011.htm

There were others I was able to pull from EDGAR from several different employers and trust companies with similar language, so there seems to be at least some comfort level with the process generally.

Out of curiosity, and this is getting into the nuts and bolts, when the trust makes payment directly to the participant and remits withheld income taxes, does the trust(ee) file a 941 reporting the withholding? I assume all the wage reporting itself comes only from the employer's W-2. 

[Luke Bailey]

4 hours ago, EBECatty said:

Out of curiosity, and this is getting into the nuts and bolts, when the trust makes payment directly to the participant and remits withheld income taxes, does the trust(ee) file a 941 reporting the withholding? I assume all the wage reporting itself comes only from the employer's W-2.

EBECatty, thanks for the cite.

I don't know. I suspect the bank just let's the employer do everything. There is a legal issue having to do with who actually controls the payment of wages, which is typically the employer, e.g. in a staffing situation. There is an IRS process to appoint someone as a withholding agent, but while that is not complex, and while you could have the employee get 2 W-2's, there would be a lot of complexity, I think, with exchanging payroll data and filing 941's that would make having the bank deposit and report impractical.

[XTitan]

My experience is that the Rabbi Trust will provide the employer information for the employer to do the 941 filing but will provide a separate W-2 to the participant. That seems to be pretty consistent.  The trust I work with most will withhold and remit federal and state income taxes only and will leave it up to the employer to handle FICA and local taxation, as applicable.  

[EBECatty]

Interesting, thanks. In pulling documents from EDGAR and other sources, there seem to be a few other alternatives, including several that explicitly state that the trustee will deliver all withholdings back to the employer for remittance and reporting.

My overall reaction is that splitting up the reporting, remittance, local tax (if applicable), FICA, 941 info, and multiple W-2s is convoluted. It would seem easier to have the employer run payment through its payroll, show proof of payment to the trustee, and request reimbursement from the trust. The few examples I've found explicitly permitting that approach are from the early-to-mid 2000s so maybe preferences have changed?

Alternatively, this article ran in Spring 2020 and suggests the reimbursement approach should be acceptable, even if not explicitly addressed in the IRS model document:

https://www.thompsoncoburn.com/insights/publications/item/2020-04-27/rabbi-trusts-taxation-basics-and-drafting-beyond-the-model-language

Either way, it sounds like the ultimate answer is that there's not one clear answer. Appreciate your input and time. 

[XTitan]

Post-separation, many employers ultimately remove their folks from payroll if there only remaining benefit is nonqualified distributions.  Having the Rabbi Trust process distributions, withholding and W-2 (and possibly interacting with the individuals directly for W-4 info) can simplify the process.  All depends on the needs of the employer I suppose.

As for reimbursement, you are correct that adding that provision is a sight modification from the model trust guidance.  But conventional wisdom is the trust is in the same place whether the trust pays the participant or the trust pays the client who already paid the participant.  There are rare cases where the client rejected the reimbursement clause in the trust because they (their counsel) refused to deviate from the model trust.

[EBECatty]

Makes sense. Our clients are generally on the smaller end of the spectrum so that may be a factor as well.