Final FICA withholding regs. on nonqualified deferred compensation.

• Author: Field, Karen M.
• Position: IRS regulations

In January 1999, the IRS released final regulations on when and how employers must withhold FICA tax on non-qualified deferred compensation. Sec. 3121(v) provides that employers maintaining nonqualified deferred compensation plans must withhold FICA on deferred amounts as of the later of when the contribution is earned or when it is no longer subject to a substantial risk of forfeiture.

In a for-profit company, it may be years before an employee actually receives a distribution from a plan, even though FICA tax has already been collected. In a nonprofit organization, FICA and income taxes are generally due in the same year, the later of the year in which a deferred amount is earned or the year in which the deferred amount is no longer subject to a substantial risk of forfeiture.

Once an amount has been "taken into account" for FICA purposes, it need not be counted again when the amount is distributed. Also, any earnings attributable to an amount taken into account for FICA purposes need not be counted for FICA purposes on distribution. Thus, if the FICA amount (often only the Medicare portion, as many people receiving nonqualified deferred compensation are well above the OASDI Social Security limit) has been timely taken into account, no FICA taxes will be due on the distribution.

One important change in the final regulations is an extended period to correct the 1994 and 1995 years. There are still many employers that do not realize nonqualified deferred compensation is subject to FICA tax. Generally, the question does not even arise until distributions are about to begin and an employer calls a payroll or withholding specialist to ask how to report the distributions. If there has been no FICA tax withholding to date, an employer can generally take the position that an executive was over the FICA limits up through 1993. If so, the only issue is 1994 and later years. Because the Medicare cap was eliminated in 1994, any amounts deferred in that year or later years should have been reported on a Form W-2 as Medicare wages, and Medicare withholding should have been taken on the whole amount. Because 1994 and 1995 are closed years, employers had noway to remedy this, although they could send in amended Forms W-2 and 941 to take into account amounts deferred in later years. The final regulations give employers until April 1,2000 to correct a failure to report, even from 1994. Moreover, the method for correction appears easier than in the proposed...