FICA and FUTA taxes for deferred compensation.

• Author: Amoroso, Vincent

Notice 94-96 stated that, until regulations interpreting Secs. 3121(v)(2) and 3306(r)(2) (covering FICA and FUTA taxes on deferred compensation) are issued, the IRS will not challenge FICA and FUTA tax liability determinations by an employer if they are based on a reasonable, good-faith interpretation of those sections. in addition, regulations in this area would be effective no earlier than Jan. 1, 1995.

Secs. 3121(v)(2) and 3306(r)(2) apply FICA and FUTA tax liability to amounts earned under nonqualified deferred compensation plans on the later of (1) the date services are performed or (2) the date the amounts are no longer subject to a substantial risk of forfeiture. Although these provisions have been on the books for years, they were relatively unimportant prior to 1994; employees earning nonqualified deferred compensation were typically highly paid and would have already exceeded the wage base for FICA and FUTA before the deferred compensation amounts were counted. However, the Revenue Reconciliation Act of 1993 extended the wage base for the Hospital Insurance portion (1.45% of wages paid both by the employee and the employer) of the FICA taxes to all wages, effective Jan. 1, 1994.

With this change, beginning in 1994, all employees with deferred compensation are affected by these sections. But there has been no guidance from the Service on a number of issues involved, such as valuing the amount of the deferred compensation, determining exactly "when the services are performed," etc. Employers and others have been clamoring for assistance, but up to now the IRS has been silent, other than to say it is having trouble drafting the regulations because it does not know what the answers should be.

According to Notice 94-96, whether an employer has made a reasonable, good-faith interpretation of Secs. 3121(v)(2) and 3306(r)(2) will be determined based on all the relevant facts and circumstances, including consistency of treatment by the employer. For example, one relevant circumstance could be an employer's effort to achieve more favorable FICA and FUTA tax treatment by using different methods to value the benefits of two participants subject to the same plan provisions. The Service is adamant that treating deferred compensation as earned for FICA and FUTA tax purposes before a deferred compensation plan is adopted will not be a reasonable...