Deferred compensation and FICA rules under proposed regs.

• Author: Koschik, Julie C.
• Position: IRS regulations

Prop. Regs. Sec. 3121(v) provides clarification on the determination of FICA wages for nonqualified deferred compensation plans. These plans provide many opportunities for employers, not only for deferring or reducing FICA taxes, but also by creating ways to benefit certain classes of employees without the strict discrimination rules of qualified pension plans. These proposed regulations, originally drafted in early 1996 and proposed effective for amounts paid after 1996, are now effective for amounts deferred and benefits paid after 1997.

Under Prop. Regs. Sec. 31.3121(v)(2)-1(b), for a plan to be treated as a nonqualified deferred compensation plan, an arrangement must be established by an employer for the benefit of one or more employees that provides for a legally binding right to receive compensation not actually or constructively received by the employee in the year earned. An employee does not have a legally binding right to compensation if it can potentially be reduced or eliminated. In addition, for these rules to apply, a nonqualified deferred compensation plan is established at the later of the adoption date, effective date or the date the plan is set forth in writing. Certain types of arrangements do not qualify as nonqualified deferred compensation, including (among others) stock options, stock appreciation rights, other stock value rights, restricted property, certain welfare benefits and excess parachute payments.

For nonqualified deferred compensation plans, a special timing rule applies for determining FICA taxable wages. Under Prop. Regs. Sec. 31.3121(v)(2)-1(a), amounts deferred are taken into account as wages for FICA purposes on the later of the date the services are performed or when there is no longer a substantial risk of forfeiture. These regulations rely on Sec. 83 and the regulations thereunder for the definition of substantial risk of forfeiture; a substantial risk of forfeiture exists if a person's rights to full enjoyment of property are conditioned on future performance of substantial services.

The rules effectively accelerate the FICA tax on nonqualified deferred compensation to the year it is earned or risk of forfeiture lapses. However, because most participants in such plans usually earn wages exceeding the Old Age, Survivors, and Disability Insurance (OASDI) wage base, only the Medicare portion of the FICA tax applies. This special timing rule includes a nonduplication rule; if an amount deferred is...