In Davidson v. Henkel Corporation, a former employee who was receiving distributions from the company’s non-qualified deferred compensation plan sued the company (and the plan) when the company began withholding required FICA tax payments from his distributions – including for payments it had failed to previously withhold. While we sympathize with Mr. Davidson, there was no allegation that the company was not required by law to withhold FICA taxes, only that the company should have withheld them sooner. Specifically, the plaintiff alleged that because the company failed to properly withhold taxes when he retired pursuant to the code’s special timing rule, he lost the benefit of the Code’s non-duplication rule and thus had a much greater tax burden. In denying the company’s motion to dismiss the lawsuit for the failure to state a claim, the court stated:

Plaintiff has alleged that the Plan Administrator discussed and provided Plaintiff with calculations of his benefits and tax liabilities at the time he was deciding whether to retire.  .  .  .  He further alleges that Defendants were aware or should have been aware of the devastating tax consequences if Plaintiff’s FICA taxes were not withheld pursuant to the special timing rule and that Plaintiff relied to his detriment upon Defendants’ erroneous representations. Lastly, Plaintiff has alleged special circumstances warranting the application of estoppel by setting forth facts detailing Defendantsgrossly negligent management of the Plan, negotiated resolution with the IRS without prior notice to Plaintiff and subsequent reduction to Plaintiff’s benefits. Accordingly, the Court concludes that Plaintiff has stated claims in Count I and III of his Complaint and these claims are not subject to dismissal. [emphasis added]

Some commentators are saying that this case is the template for future lawsuits against employers by executives hit with 409A penalties. Maybe. However, keep in mind that this is not a final decision following trial. It is only a refusal to dismiss the plaintiff’s claims without a hearing. Further, the court’s decision was based on three highly questionable premises:

  • The defendant company was grossly negligent in its failure to comply with the complicated special timing rule for withholding FICA tax on non-qualified plans benefits.
  • The company should have given notice to plaintiff of its attempt to negotiate a resolution of a federal tax compliance matter – involving penalties to the company for failure to make required withholding – with the IRS.
  • Plaintiff relied to his detriment upon defendants’ erroneous representations.

I doubt that many courts would agree with the first two premises. Additionally, numerous federal court have held that employees or former employees do not have a claim against employers providing incorrect information as to accrued benefits.

Stay tuned for further developments and double check the tax withholding procedures under your non-qualified plans.