FICA Taxes on Employer Contributions

[HCE]

Can someone please confirm that employer contributions to a nonqualified plan are subject to FICA taxes at the time they vest?  

We recently found out our payroll isn't applying FICA taxes to our employer contributions to our NQDC Plan (in our plan employer contributions are always 100% vested).  They claim this is correct, so I'm second guessing myself.  My understanding is FICA taxes must be paid under the "special timing rule" when contributions to a NQDC Plan vest, even employer contributions.  If they aren't applying FICA upon contribution (or, if later, vesting) we'll have to apply FICA to the employer contribution part of the distribution later, correct?

[Peter Gulia]

For unfunded deferred compensation (other than a length-of-service award to a volunteer) with a nongovernmental employer, deferrals count in FICA and FUTA wages as of the later of (i) when the services creating the right are performed, or (ii) when there is no substantial risk of forfeiture (determined following Internal Revenue Code § 83) of the right to the amount.

FICA

I.R.C. (26 U.S.C.) § 3121(a)(5), 3121(v)(2) http://uscode.house.gov/view.xhtml?req=(title:26%20section:3121%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section3121)&f=treesort&edition=prelim&num=0&jumpTo=true;

26 C.F.R. § 31.3121(v)(2)-1(a)(2)(ii) https://www.ecfr.gov/current/title-26/part-31/section-31.3121(v)(2)-1#p-31.3121(v)(2)-1(a)(2)(ii);

IRS, Eligible Deferred Compensation Plans Under Section 457, Notice 2003–20, 2003-19 I.R.B. 894(May 12, 2003), at § VI, 896-897 (explaining FICA and FUTA taxes for unfunded deferred compensation with a nongovernmental tax-exempt organization).

FUTA

I.R.C. (26 U.S.C.) § 3306(b), 3306(r)(2) http://uscode.house.gov/view.xhtml?req=(title:26%20section:3306%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section3306)&f=treesort&edition=prelim&num=0&jumpTo=true;

26 C.F.R. § 31.3306(r)(2)-1(a) https://www.ecfr.gov/current/title-26/part-31/section-31.3306(r)(2)-1#p-31.3306(r)(2)-1(a).

This is not advice to anyone.

[david rigby]

As usual, @Peter Gulia is thorough.  The big picture way to think about this is (first link above), the beginning of IRC section 3121(a) says:

Quote

..."wages" means all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except ...

That is, the portion of the statute that follows is a list of exceptions or "carve-outs".  For example, subsection 5 includes the carve-outs of various retirement plans.  No non-qualified plan is in that list, so we must conclude that it is not excluded from "wages".

[CuseFan]

HCE, you are correct. You may want to explore, with legal counsel and accounting input, the possibility of correcting now by applying FICA and Medicare taxes to the existing employer-attributed account (contributions and earnings) as if it just became vested, and then do properly going forward. Another potential fix is applying retroactively and paying the interest and late payment penalties, if these don't go back ages. Hope that is not your case as you don't mention related issues for any current or prior distributions. Again, consult legal and accounting counsel.

The "penalty" for missing this, as you note, is that all payouts are then fully subject to FICA and Medicare, accumulated contributions and all investment earnings. Any investment earnings on contributions (and prior earnings, if applicable) already subjected to FICA and Medicare are not subjected thereto, which is why I would explore the prior years' fix and do properly going forward.

At worst, you could probably split employer-based accounts into wrong portion (subject to F&M on payout) and right portion (apply F&M as contributed/credited).

If your payroll is external, I'd review that contract/service agreement and look to seek some compensation or other recourse for the error.

Good luck

[Artie M]

Agree with all about the timing of the FICA.  As far as correcting this, if FICA has not been paid in accordance with 3121v2, withholding may be corrected only if there is still time to amend withholding returns.  In the IRS's view, only the last three years are open for correction, and earlier tax years cannot be opened to apply the special timing rule.  To correct for past quarters, Form 941-X for the specific quarter must be used to report the corrected FICA taxes and, for prior years, a Form W-2c must also be completed to correct the employees' previously filed W-2s. Generally, the IRS will not charge penalties or interest for timely corrections of inadvertent FICA errors; however, any additional Medicare tax (the 0.9% on amounts in excess of $200,000) for a prior year must be corrected by the employee.  (Usually do not have to worry about FUTA because of the administrative rule of convenience that amounts can be taken in on the last day of the year).  If not correctable, per the regulations, FICA will be due when payments are actually (or constructively) received and become taxable for income tax purposes (as said above, this will likely result in more FICA than if withheld earlier).  (I personally believe this is an unconstitutional tolling of the statute of limitations but I won't be the one litigating this.)  I have seen this on several occasions regarding employer contributions in part I think because, unless the employer will accelerate the payment of some of the otherwise nonvested employer contributions for payment of the FICA (which would be permitted under 409A), the "withholding" must come from other compensation of or by direct payment by the employee and the employers don't think about this.