FICA Special Timing Lag Method Interest Calculation and Reporting

Thanks to all in this forum for their help as I bumble through our NQDC plan.

We are approaching the first vesting cliff at the end of this year.   The vesting occurs basically at 12/31/2025.

Since the value of the plan is based on underlying investments and not a fixed interest rate and could move quite a bit by year end, I plan on using the Lag Method to report the FICA earnings.  I anticipate this will be run through payroll around the end of January or more likely the end of first week of February.

I know that for the Lag Method, I have to report not only on the vested balance but also add interst to the vested amount.  From what I have read the amount must be increased by interest through the date on which the wages are treated as paid, at a rate that is not less than the January Mid-Term AFR .   

ILLUSTRATION

For purposes of illustration, assume that an original award of $50,000 several years ago is valued at $62,000 as of 12/31 based on credited earnings.

Vesting will be credit on paydate 2/7/2026.  

Mid Term January AFR rate is 3.8%

Calculation 

Vested Amount at 12/31 - 62,000

Multiplied by AFR Rate -  3.80%

Equal Annual Interst - $2,356

Multiplied by Days until Reported  / 365 days in year -  38/365 = .1041 - 31 days in January plus 7 days in February until paydate

Equals Interest to be added to Vested Amount - $245.28

Vested Amount ($62,000) plus Interest ($245.28) = $62,248.28 = Total Amount subject to FICA 

1) Is my understanding of the Lag Method correct?

2) Does my method of calculating interest make sense?

Thank you as always for any guidance and feedback.

I haven’t looked at this in ages but here is my concern.  I believe you need to make sure that the $12,000 you are crediting as earnings as of 12/31/2025 ($62k-$50k) is no less than the amount of earnings you would credit if you used the applicable AFR for the period from the date of the original deferral to the vesting date.  Your stub year calc methodology looks reasonable.  I looked at a document I have on this and, at least at the time we looked at it, there was not a ton of authorities out there to review (I didn't look to update this).  I pasted authorities from that document down below.  In each of the authorities listed, it appears that the operative term under each is the “amount deferred”.  So our interpretation was that if you use the lag method and pay on the later within-3-months’ date, earnings are calculated from the date the original amount was deferred through the date of payment, compounding annually using the AFR for each January during this period.  The parenthetical under Ex. 4 seems to support this interpretation also. 

Not advice, just my thoughts….

Treas. Reg. §313121)v)(2)-1(f)(3) states:

Lag Method.  Under the alternative method provided in this paragraph (f)(3), an amount deferred, plus interest, may be treated as wages paid by the employer and received by the employee, for purposes of withholding and depositing FICA tax, on any date that is no later than three months after the date the amount is required to be taken into account in accordance with paragraph (e) of this section. For purposes of this paragraph (f)(3), the amount deferred must be increased by interest through the date on which the wages are treated as paid, at a rate that is not less than AFR. If the employer withholds and deposits FICA tax in accordance with this paragraph (f)(3), the employer will be treated as having taken into account the amount deferred plus income to the date on which the wages are treated as paid.

Treas. Reg. §313121)v)(2)-1(f)(4) Examples:

Example (1).  (i) Employer M maintains a nonqualified deferred compensation plan that is an account balance plan. The plan provides for annual bonuses based on current year profits to be deferred until termination of employment. Employer M's profits for 2003, and thus the amount deferred, is reasonably ascertainable, but Employer M calculates the amount deferred on March 3, 2004, when the relevant data is available.

. . . .

Example (4). 

(i) The facts are the same as in Example 1, except that an amount is also deferred for Employee B which is required to be taken into account on October 15, 2003, and Employer M chooses to use the lag method in paragraph (f)(3) of this section in order to provide time to calculate the amount deferred.

(ii) Employer M may use any date not later than January 15, 2004, to take the amount deferred into account (provided that the amount deferred includes interest, at AFR for January 1, 2003, through December 31, 2003, and at AFR for January 1, 2004, through January 15, 2004).

Preamble to the Final Treas. Regs. Under 3121(v)(2) (TD 8814)

At page 18, states:

Further, the final regulations provide that, under the second alternative method, the lag method, an employer may treat the amount deferred on any date as wages paid on any date that is no later than three months following the date the amount deferred is required to be taken into account. In addition, in response to comments, the final regulations simplify use of the lag method by permitting the FICA tax due to be calculated using a fixed rate of interest, not less than AFR, rather than on the basis of income under the plan.

Text accompanying footnote 2 states:

Alternatively, FICA tax payment can be postponed by treating the entire amount deferred as if it were deferred on a date that is within three months of the date the amount is otherwise required to be taken into account, provided that the amount deferred is increased by interest at the applicable federal rate (AFR) until it is included in wages.