Tax

Court Holds Employer Responsible for Improper FICA Withholding

February 2015

The recent U.S. District Court decision in Davidson v. Henkel Corporation highlights the importance of properly withholding and paying Federal Insurance Contributions Act (FICA) taxes when administering a nonqualified deferred compensation plan. The court concluded the employer failed to remit FICA taxes in line with the plan agreement, resulting in increased tax liability to the participants. Because the employer’s plan was subject to Employee Retirement Income Security Act (ERISA) civil enforcement provisions, the participants could bring a class action suit to recover the benefits they lost due to the increased FICA tax liability.

Under the general rule, compensation is subject to FICA tax when paid to employees. However, employers may apply a special timing rule, which subjects nonqualified deferred compensation to FICA tax when earned or vested rather than when the compensation is paid. This rule allows FICA taxes only to be paid on the deferred compensation amount, not on the accumulated investment earnings. If employers don’t apply the special timing rule to deferred compensation, FICA taxes apply as the account balance is paid to participants, subjecting the deferred amount and any earnings generated by the wages during deferral to FICA tax.

This was the situation at issue in Davidson v. Henkel Corporation. The court found that Henkel failed to apply the special timing rules to its nonqualified deferred compensation plan as outlined in the plan documents. Henkel argued that since it properly withheld taxes under the general rule, the employees had no recourse to recover the benefits they lost due to the additional tax. The court agreed that Henkel properly withheld tax under the general rule but didn’t properly administer the plan, subjecting it to an ERISA lawsuit.

The case serves as a reminder that when it comes to nonqualified deferred compensation plan administration, the details can be complex. For plans that qualify for the special timing rules, using the general FICA rule could expose the administering company to potential liability and lawsuits.

If you have questions about the requirements or administration of nonqualified deferred compensation plans, contact your BKD advisor.

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