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FICA Taxes on Nonqualifed Deferred Compensation Plans

When is the appropriate time to withhold FICA (social security and Medicare) tax on amounts deferred under a Nonqualified Deferred Compensation Plan ("NQDC Plan")? The following briefly summarizes the primary two withholding rules (the special timing rule and general timing rule) that apply to amounts credited to a NQDC Plan.

Special Timing Rule for FICA Tax on Deferred Compensation

Wages are generally subject to FICA tax when they are paid, whether actually or constructively, to the employee. However, under the special timing rule for FICA tax withholding, amounts deferred under a NQDC Plan are subject to FICA tax upon the later of (1) when the services are performed to which the deferred amounts relate or (2) when there is no substantial risk of forfeiture for such amount (i.e. upon full vesting). Therefore, immediately vested amounts (e.g., salary deferrals) are subject to FICA tax at the time these amounts are withheld from pay. If an amount remains subject to a substantial risk of forfeiture, the amount (plus any earnings accruing prior to the date the amounts vest) will be subject to FICA tax at the time it is no longer subject to a substantial risk of forfeiture or vested. Any future earnings accruing on amounts that have been subjected to FICA withholding will not be subject to future FICA taxes.

If the NQDC Plan uses a deferral benefit type formula to determine a participant's benefit, FICA tax is not withheld on the amount until it is both vested and "reasonably ascertainable".

In addition to the potential FICA tax savings on future earnings, withholding FICA tax from deferred amounts under a NQDC Plan under the special timing rule may be favorable to the participant depending on their wages for the year of deferral (or, in the case of amounts that vest on a later date, the vesting date). The social security portion of FICA tax is only imposed on compensation amounts up to the social security taxable wage base. Therefore, if a participant has other, substantial compensation while still employed during the year of deferral or the year of vesting, some or all of the social security portion of the FICA tax on the deferred amount under the NQDC Plan may be eliminated.

General Timing Rule for FICA Tax on Deferred Compensation

If an employer does not withhold FICA tax on deferred amounts in accordance with the special timing rule, FICA tax will need to be withheld in accordance with the general timing rule. Under the general timing rule, FICA tax is withheld in the year of payment of the NQDC Plan benefits to the participant on all deferred amounts and any earnings that have accrued through the date of payment.

Correction of Missed Application of Special Timing Rule

If an employer fails to initially withhold FICA tax from deferred amounts under a NQDC Plan in accordance with the special timing rule, the employer generally may take steps to correct within 3 years by amending prior tax returns and paying any additional FICA tax plus interest resulting from application of the special timing rule.

In situations where the three-year period had passed, employers used to have the opportunity to enter into a closing agreement with the IRS to retroactively pay the additional FICA tax, according to the special timing rule, plus interest. Unfortunately, the IRS has stated it will no longer be entering into closing agreements with employers who request to fix the FICA tax error after the three-year period to amend their FICA tax reporting has passed.

Because of the potential tax savings, it is generally recommended that employers take advantage of the special timing rule.

© 2007-2020 Hill Ward Henderson, All Rights ReservedNational Law Review, Volume IX, Number 262


About this Author

Al Ward Executive Compensation Hill Ward Henderson

Al is Co-Chair of the firm's Executive Compensation & Employee Benefits practice. Al is recognized throughout the professional community for his depth of experience and knowledge in the employee benefits area. Prior to entering the practice of law, Al was an actuarial and employee benefits consultant for over eight years.

Al has focused for over four decades on executive compensation, employee benefits, trusts and taxation. He represents many clients including publicly traded and privately held, taxable or tax-...

Kirsten Vignec Employee Benefits Attorney HIll Ward Henderson

Kirsten is a Shareholder in the firm's Corporate & Tax Group and practice co-chair of the Executive Compensation & Employee Benefits Group. Kirsten’s practice involves employee benefit matters associated with the design and ongoing administration of executive deferred compensation plans, welfare benefit plans, Section 401(k) plans, profit sharing plans, and pension plans. Kirsten represents tax-exempt entities, for-profit, private, and publicly-traded companies.

Kirsten represents clients before the IRS, DOL, and the PBGC with respect to employee benefits matters.

She is a member of the Tax Sections of The Florida Bar and the American Bar Association, as well as the State Bar of California and the District of Columbia Bar.

Away from the office, Kirsten enjoys travel, reading, and spending time with her husband and children.

Melanie Hancock Brown Employee Benefits lawyer Hill Ward Henderson

Melanie is a Shareholder in the firm’s Executive Compensation & Employee Benefits Group. She practices in the area of ERISA, employee benefits and executive compensation. Melanie counsels a diverse clientele of for-profit,  nonprofit and governmental entities of all sizes regarding their qualified and nonqualified employee benefit plans, including 401(k) and profit sharing plans, 457 and 403(b) plans, defined benefit plans, ESOPs and other stock based benefits, and health, welfare and other fringe benefit plans. She drafts qualified and nonqualified plans, and provides...

Bret Hamlin employee benefit lawyer Hill Ward Henderson

Bret is a Shareholder in the firm’s Executive Compensation & Employee Benefits Group. He practices primarily in the areas of employee benefits, deferred compensation and trusts. Prior to entering the private practice of law, he provided plan design and consulting, third-party administration and investment, as well as retirement plan education services for clients. 

Bret represents large, medium and small employers with respect to many employee benefit matters, including both single employer and multiple employer qualified retirement plans, deferred...

Timothy P Zehnder employee lawyer Hill Ward Henderson

Tim is an Associate in the firm’s Executive Compensation & Employee Benefits Group. His practice focuses primarily on advising client employers (private and public, tax-exempt and for-profit) on a wide variety of compensation and benefits matters, including plan design, administration and termination, compliance with applicable laws (including the Internal Revenue Code, ERISA, HIPAA, and the Affordable Care Act), and resolution of compliance issues with the Internal Revenue Service, Department of Labor and Pension Benefit Guaranty Corporation.  Tim has experience assisting...

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