Complying with FICA’s Special Timing Rule

Taxes collected under Federal Insurance Contributions Act (FICA) are levied on wages paid by an employer to an employee regarding their employment. Collecting the tax on basic wages is fairly simple. However, nonqualified deferred compensation plans present special problems for compliance with the law, especially considering FICA’s special timing rule.
 

What Is the Special Timing Rule?

The Internal Revenue Service (IRS) states the following about nonqualified deferred compensation and the special timing rule:

“Under section 3121(v)(2)(A), any amount deferred under a nonqualified deferred compensation plan must be taken into account as wages for FICA tax purposes as of the later of (1) when the services are performed or (2) when there is no substantial risk of forfeiture of the rights to such amount. This special timing rule may result in imposition of FICA tax before the benefit payments under the plan begin.”

Under the special timing rule, FICA tax typically becomes due when amounts are credited to the employee or when they become vested.

Paying the tax now instead of when the employee actually receives the deferred income can save the employee a future tax burden. To avoid double taxation, once FICA has been paid on deferred compensation, it will not be taxed again under most circumstances.

How to Comply with FICA’s Special Timing Rule

Companies often offer nonqualified deferred compensation packages to their employees. The problem then becomes when the tax should be paid to the IRS. The withholding method chosen affects the amount of FICA tax that is due under the special timing rule.

  • Employers may use the “estimated method,” which allows the employer to simply estimate how much the employee will make in the future. FICA tax can be calculated based on the estimated amount, then paid to the IRS.
  • The “lag method” is another way to calculate FICA tax. The employer treats the deferred amount plus interest as wages no later than three months after the date the amounts would have been taken into account.

Complying with FICA’s special timing rule is mandatory. Employers may be penalized for failing to withhold and pay FICA taxes and for failing to report FICA tax earnings to the IRS.

Talk to Experienced Attorneys About Your Executive Compensation Plans

Failing to comply with tax rules, including FICA’s special timing rule, can lead to devastating penalties to the businesses sponsoring the plan—and the executives participating in the plans.

The attorneys at Hall Benefits Law use their extensive experience to help their clients remain compliant with tax laws. Please call 678-439-6236 to discuss your concerns with an experienced attorney. Our website contains more information about our firm, a Contact Form, and free resources for your review. From our home office in Georgia, we assist clients throughout the United States.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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