Employers seeking to attract and retain key employees may consider including nonqualified deferred compensation components in their compensation packages. When income is deferred, though, employers may be confused about how taxes are paid on deferred compensation, including Federal Insurance Contract Act (FICA) taxes.
The General Timing Rule
Employers usually pay the FICA taxes on employee income when that income is actually or constructively paid. However, nonqualified deferred compensation plans pose a special problem for employers when it comes to paying FICA taxes. The general timing rule states that FICA taxed should be reported when wages are paid or constructively received.
However, some employers forget that nonqualified deferred compensation plans operate under a different rule. Since the Internal Revenue Service will not forget this, it’s crucial for employers to know and understand when to pay FICA taxes on such compensation.
Special Timing Rule
Under the special timing rule, employers report FICA wages at the latter of:
- The time the services are rendered, or
- When compensation is safe from substantial risk of forfeiture
The second point is the one that may trip up employers. It means that the income could be subject to FICA taxes when the deferred compensation becomes fully vested. In other words, FICA taxes could be due long before the employee actually receives the compensation.
The employer may fail to pay the FICA taxes at the time of vesting. If so, and if the deadline for corrections has passed, the employer must use the general timing rule for future distributions and earnings.
Is Your Company Meeting its FICA Tax Obligations?
Nonqualified deferred compensation plans have a lot of moving parts. They are complex and covered by a myriad of federal laws. If your company offers this type of compensation, call us today to discuss meeting your obligations or making timely corrections.