SERP Reporting / FICA / Vesting

[JProehl]

I am have been tasked with setting up a NQDC plan for a few key executives at our small company and it has my head spinning a bit.

Basically the owners of the company want to set aside an annual discretionary amount for a few key employees.  The contribution would be tied to employee and company performance.  The amount is intended to be a SERP (no employee deferrals)  and become available after the employee retires. Most of the target employees are 10-15 years away from retirement.

We are looking at the standard clauses providing for acceleration in the event of death, disability, change in control.  Also provision regarding non payment for termination for cause or going to work for a competitor.

I will admit I am getting somewhat confused  regarding the difference between vesting and triggering event.  I have talked with a couple of folks who state that it is normal for employees to vest over a 5-10 year period.  For example can 50 year old employee have a 5 year vesting schedule at 20% per year but the plan specify that payment is not made until they reach normal retirment age?

My lack of clarity of over the vesting / triggering question leads me down the path of the what is the correct reporting and payment regarding payroll / FICA.   I have some done some research and want to make sure we handle any issues regarding the special timing rule for FICA correctly.

What the owners have in mind is to make these annual discretionary contributions, perhaps tie a return rate on the contributions to the S&P500, and pay the employee out either in a lump sum or in 3 years after retirement.  The funds would be available at the later of age 65 or a separation from service (some employees may work until 67).

What I think I know so far:

- This would be a defined contribution SERP plan.

- It would be a non account balance plan.

- Distributions from the plan should be reported on a W2 and are subject to income tax when paid

- If FICA is not paid according to the special timing rule, then FICA would would also be owed at the time of distribution under the general timing rule.  FICA would be paid by both the employee and employer.

What I am confused about and seeking guidance

- The difference between vesting and triggering 

- When would the FICA tax be due? Does the special timing rule apply?

- If the special timing rule applies, how is the amount determined?

- What am I not thinking about that I should be?

[EBECatty]

I would strongly recommend getting in touch with a vendor, lawyer, CPA, or consultant with experience in setting up these types of plans. All of what you describe is more or less standard, but it will be challenging to coordinate, draft, and implement without professional advice. 

Broadly, "what you know so far" is right, except that I would label this an account balance plan (fixed amounts go in; there is investment gain or loss; the employee gets paid the amount in the account). 

For "what you're confused about," triggering, in my experience, can refer to either an event triggering vesting or an event triggering payment. There is not an independent concept of triggering. Vesting and payment do not have to occur at the same time. Generally, once money becomes vested, even if not yet paid out, FICA is due under the special timing rule. For an account balance plan, generally FICA is the amount of money in the plan that becomes vested on a given date. 

But, again, someone with experience in the process is your best bet.

[JProehl]

Thanks for the clarification on account balance vs non-account balance.  I have actually contacted several attorneys working in this space, however they are not the ones that would have to handle the actual payroll reporting, and I want to make sure we get it right.

So hypothetically if the employer sets aside $10,000 per year and credits it at a 5% rate of earnings with a cliff edge vesting of 5 years, in 5 years the account plus credited earnings is worth $58,019.  When the employee vests, I would add 58,019 to their Social Security and Medicare wages.  Each year subsequently I would add the annual contribution plus any earnings credited for the year.  

When the employee retires in 10 years, I would send them a W2 showing Box 1 Wages, and reporting Box 11 Nonqualifed distributions, but nothing in Box 3 and Box 5.

[CuseFan]

On 1/11/2023 at 4:49 PM, JProehl said:

Each year subsequently I would add the annual contribution plus any earnings credited for the year.  

Once the vested balance is subjected to FICA/Medicare, only subsequent vested contributions are further subject to such, but not future earnings. 

[JProehl]

Thanks Kenneth.

A little additional clarification on the W2  Reporting.

In the year of vesting I would report the vested amount in Form W‐2: boxes 3, 4, 5, and 6 - would I also report this vested amount in Box 11?

In the year of distribution I would report the distribution in Box 1 along with Box 11.

[JProehl]

Quote

Once the vested balance is subjected to FICA/Medicare, only subsequent vested contributions are further subject to such, but not future earnings. 

Using my example above in 5 years the account plus credited earnings is worth $58,019 - that is reported on the W2.  

In year 6 another $10,000 contribution vests.   Also in year 6 the total account earns $3,400 - $500 of which is related to the current year vesting and $2900 of which is related to the prior vested and earnings.   

Am I thinking correctly that the earnings have to be allocated between the prior reported and the current vesting? 

[XTitan]

You are correct.  Earnings attributable to balances that have vested are not included in box 3 & 5; just the portion attributable to the newly vested piece would be included in Box 3&5.