Current issues involving deferred compensation and employment taxes.

• Author: Sutten, Stephen

In providing nonqualified deferred compensation opportunities to certain members of the workforce, employers in the for-profit, tax-exempt, and public sectors may overlook a number of issues involving the application of the employment tax rules. With a new emphasis on nonqualified arrangements following the enactment of Sec. 409A and its subsequent interpretation, and the income tax rules of Sec. 457 for tax-exempt and public sector employers, the timing seems right to revisit several of these issues. Included in this overview are employment tax matters that affect the sponsorship and administration of state retirement systems and of "FICA replacement plans" that are part of retirement planning in the public sector. Here are several facets that are often overlooked in correctly applying employment tax rules.

FICA and FUTA tax treatment regarding "employer-sourced" contributions to Sec. 457(b) "eligible" plans of deferred compensation: In a Sec. 457(b) plan of nonqualified deferred compensation, any contribution, whether it is in the form of a deferral elected by an employee or a matching or "nonelective" contribution made by the employer, will be treated as a deferral and be subject to Federal Insurance Contributions Act (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes when the services are performed or the contribution is no longer subject to a substantial risk of forfeiture. Thus, if a Sec. 457(b) plan provides annual deferrals that are fully and immediately vested, these deferrals are subject to Social Security, Medicare, and FUTA taxes at the time of deferral. However, if the annual deferrals are not fully and immediately vested but are subject to a substantial risk of forfeiture, the annual deferrals (and their earnings) are generally taken into account for purposes of Social Security, Medicare, and FUTA at the time the amounts are no longer subject to a substantial risk of forfeiture.

Since public sector Sec. 457(b) plans usually permit participation by all eligible employees, whether highly compensated or not, special attention should be given to FICA taxation when employer matching or nonelective contributions are provided, particularly when those contributions are subject to a vesting schedule. This treatment should be differentiated from the rules that apply to qualified retirement plans, such as Sec. 401(k) plans, where employer matching and nonelective contributions are not taken into account for purposes of reporting...