A federal district court in Davidson v. Henkel Corp. (E.D. Mich, July 24, 2013) recently denied an employer’s motion to dismiss an ERISA claim by a nonqualified deferred compensation plan participant, holding that employers could be liable to plan participants for failing to withhold FICA taxes properly.

Under the general FICA tax withholding rule, employers are required to withhold FICA taxes from an employee’s wages when those wages are actually or constructively paid.  However, under the special timing rules for nonqualified deferred compensation plans, FICA taxation does not occur at the time of payment (or constructive payment), but rather amounts accrued under account balance plans are generally subject to FICA tax withholding when the amount becomes vested.  Amounts under non-account balance plans are generally subject to FICA tax withholding when the amount payable is reasonably ascertainable, which is usually at retirement (even if actual payments will be in installments over a number of years).  A non-duplication rule applies to prevent previously taxed amounts (including any earnings) from becoming subject to additional FICA tax withholding in the future. 

The plaintiff in Davidson v. Henkel Corp. was a former employee and participant in the employer’s supplemental executive retirement plan (SERP), which was a top-hat plan subject to ERISA.  The participant retired in 2003 and began to receive periodic payments under the SERP.  Following a compliance review of the SERP in 2011, the employer discovered FICA taxes should have been withheld when the plaintiff retired in 2003 but were not.  The employer then contacted the plaintiff and other affected participants and informed them that FICA taxes were not properly withheld and that their future SERP periodic payments would be reduced to take into account FICA tax withholdings. 

The plaintiff filed suit against his former employer claiming that the value of his SERP benefits was reduced due to the employer’s gross negligence and recklessness to properly withhold FICA taxes.  The plaintiff claims that if the employer withheld FICA taxes in 2003 when he retired as required under the special timing rules, his FICA tax liability would have been much less than the amount he was now being required to pay.  Under the special timing rules, a one-time FICA tax withholding would have been applied to the present value of his SERP benefits in 2003 instead of the actual value of each periodic payment (including earnings) that he actually will receive.  As further damage, since the plaintiff had other FICA taxable wages in 2003, the annual wage limit for the social security portion (6.2%) of the FICA tax in 2003 would have limited the amount of the plaintiff’s SERP benefits subject to FICA tax.  Now, with no other FICA-taxable wages, the plaintiff could not take advantage of the annual wage limit for the social security portion of the FICA tax.

While it is unknown whether the plaintiff will succeed, employers that sponsor nonqualified deferred compensation plans should review their plan administration to ensure that FICA taxes are being properly withheld in accordance with the special timing rules.  Given the size of some nonqualified benefits, the potential liability to plan participants could be significant.