FICA’s Special Timing Rule

 

I do not often read ERISA cases.

ERISA deals with employee retirement plans and refers to federal law: Employee Retirement and Security Act. It is old law (1974), and provides protection for individuals enrolled in private retirement and health plans. It can be as abstruse as the tax Code, and as difficult to follow. It is more in the purview of retirement specialists and not so much that of a general tax practitioner.

What made me think about it was a reference to the Henkel case from 2015.

Henkel involved a top hat plan for selected management and other highly compensated employees. The idea behind a top hat is to provide benefits in excess of those available to employees through regular plans (think 401(k), cafeteria plans and the like.) Top hats are mostly exempt from ERISA because of that select group of covered employees, You and I are unlikely to ever be enrolled in a top hat plan.

In Henkel, select employees were covered by a nonqualified deferred compensation plan. After benefits began, the company (Henkel Corporation) reduced the monthly benefits for federal tax withholding. ERISA has restrictions on reducing someone’s benefits – hence the litigation.

The federal withholding was FICA.

There is an odd rule in the tax Code for FICA taxation of deferred compensation. What sets it up is the income taxation of the deferred compensation itself.

Generally speaking, deferred compensation will include some kind of qualifying event. For example, say that an executive is entitled to 1% of his/her 2025 division profits as compensation, payable in 2028. To be entitled to the bonus, the executive must remain employed with the company through December 31, 2026.

It is that condition subsequent that makes the income taxation tick. It would be unfair to tax the executive in 2025, as he/she may never receive a dime if they are not employed through December 2026. Let’s say that they are employed through December 2026. It would still be unfair to subject the bonus to income taxation in 2026, as there is no cash until 2028. In general (and a big general at that) the tax Code will slow the income tax horses until 2028.

But this is compensation, meaning that there will also be FICA tax due.

When is that tax due?

A reasonable person would expect the FICA and income tax to lock arms and be due at the same time.

A reasonable person would be wrong.

FICA tax will be due at the later of:

The date the employee performs the services causing the deferred compensation (in our case, 2025), or

The date on which the employee is no longer subject to a substantial risk of forfeiting the deferred compensation (in our case, 2026).

Our executive would be subject to FICA tax in 2026.

What about concern for having cash to pay the tax?

It does not appear to apply to the FICA tax, only to income tax.

In practice, this is rarely as big an issue as it may first appear. FICA is divided into two parts: the old age (which is 6.2%) and Medicare (which is 1.45%). The old age (the acronym is OASDI) cuts off at a certain dollar amount. Medicare does not cut off. Odds are that someone in a top hat plan is well over the OASDI limit (meaning no old age tax), leaving only Medicare. 

It is unlikely that one is going to do a lot of tax planning for 1.45%.

This FICA trigger is called the “special timing rule.”

There is an upside to the special timing rule, and it depends on how the deferred compensation is determined.

If one can flat-out calculate the deferred compensation (in our case, 1% of division profits), the plan is referred to as an account balance plan. Granted, one can add interest or whatever to it to allow for the passage of intervening years, but one can calculate the beginning number.

If one pays FICA on an account balance plan under the special timing rule, there is no additional FICA when the plan finally pays out. This means that interest (for example) added to the beginning number is never subject to FICA.

Sweet.

Switch this over to a nonaccount balance plan and FICA can change. FICA is calculated on the actual distribution, but one is given credit for FICA previously paid under the special timing rule. In this case, one would pay FICA on the interest added to the beginning number.

There are also different ways to calculate the FICA under the special timing rule: the estimated method, the lag method, the administrative convenience method and so on.

Throw all the above in a bag, shake thoroughly, and that is how we got the Henkel case. How can the benefits go down? Take a nonaccount balance plan, with FICA being paid later rather earlier.

Is it a reduction in benefits?

Yes and no. It is technically a reduction if one was not thinking about the FICA.

It is not however a reduction for purposes of ERISA.

Our case this time was Davidson v Henkel, USDC, Eastern District of Michigan Southern Division, Case No. 12-cv-14103.

Creating A Tax Practice

 

It has been a couple of months on the blog.

I have been helping a friend and fellow CPA, at least as much as I could.

He is approaching retirement. He sold his practice to a larger firm. I remember talking with him about it:

Him:  What do you think?

CTG: I see the Federation and the Borg. What is your win condition here?

Him:  Yes, but ….

A rationalization that begins with “yes, but” should be a sign that you are about to buy real estate in the dark.

It has gone poorly. Zero surprise. The Borg are like that.

It was a clash of cultures: entrepreneurial versus bureaucratic, advisory versus compliance, real fees versus “valued added.”

He will survive. He may yet be able to retain several clients, reopen an office, and resume practice. He however will never be the same. 

His story has given me pause.

It also reminds me of someone who recently applied for tax-exempt status with the IRS.

More specifically, 501(c)(4) status.

As we have discussed before, Section 501 is the master key - so to speak – to tax-exempt status. The gold standard is 501(c)(3), which is both tax-exempt and contributions to which are tax deductible. That is about as good as it gets. The (c)(4) is a different beast: it is tax-exempt but contributions are not tax deductible. Why the difference? A (c)(4) frequently has an active advocacy role: think AARP, for example. That advocacy can rise to the level that it equals – or exceeds – the nonprofit motivation behind the organization.

Someone had the idea to form a tax practice as a nonprofit.

The nonprofit employs tax professionals licensed as attorneys, CPAs, enrolled agents and tax preparers with years of experience practicing worldwide taxation.”

How will it generate revenues?

The Corporation is a full-time tax service company supported by memberships and donations.”

How does this thing work?

There is a three-tier membership-based structure.

The first tier includes US taxpayers having hardship. The organization will charge per hour for complicated cases but not charge for simple cases.

The second tier is membership-based. One pays X dollars and receives comprehensive tax services.

The third tier is gauzy “feet on the ground” personnel including support volunteers.

I am not seeing it. Tier one is fee-based except for some pro bono work. Tier two is a flat-out copy of a boutique medical practice. I do not even know what tier three is, other than some filler when completing the tax-exempt application.

Why would someone go through this effort?

One of the main reasons for you to apply for the tax-exempt status is to meet the requirements established by TAS (Taxpayer Advocate Service) to be eligible for LITC (Low Income Tax Clinic) grants.”

Ahhh!

Along with one of your Board members personal investment and professional involvements, you have already generated the interest of several high-net-worth prospective donors.”

Methinks we found the motivation here.

The IRS saw it too:

The benefits provided by you are primarily for your paying members and you operate in a manner like organizations operated for profit. Thus, you are not operated exclusively for the promotion of social welfare within the meaning of Section 501(c)(4).”

BTW this is referred to as an “adverse determination” by the IRS. If a practitioner is aware that the IRS will come in adverse, it is not uncommon to withdraw the application. It allows the opportunity to fight another day.

The taxpayer did not withdraw in this case, and the adverse determination was issued as final.

Does this mean that the taxpayer cannot operate an organization with the pro bono and boutique fees and whatever feet-on-the-ground? Of course not. It just means that it will have to file and pay taxes – just like any other profit-seeking business.

What it cannot do is pretend to be tax-exempt.

This time we discussed IRS TEGE Release Number 202539014 dtd 9.26.25.

A Paycheck As A Treasure Trove

 

I am looking at a case where the taxpayer was using Cesarini to argue her position.

COMMENT: Cesarini is one of my favorite tax decisions and a big reason this case caught my eye. The family purchased a piano at auction for $15. Seven years later – while cleaning the piano – they discovered approximately $4,500 in currency. The tax case addressed when the $4,500 was taxable – when they bought the piano, when they found the money, or some other date. It also introduced us to the “treasure trove” doctrine, addressing – not surprisingly – when finding a treasure is taxable.

COMMENT: $4,500 does not strike as that much money in 2025. Cesarini however was decided in 1964, when median U.S. household income was about $6,000. We probably would agree that finding 75% of your annual household income by fluke could be described as a treasure trove.

Let’s introduce Corri Fiege, who worked in Alaska for a U.S. subsidiary of an Australian corporation. She participated in a performance rights plan and was granted 60,000 unvested rights in parent company stock. The rights vested over three years, and she received 20,000 shares on each of July 31, 2011, 2012 and 2013.

There of course was tax involved. She had the company sell 1/3 of the stock and send the cash as federal tax withholding. She owed tax. She paid tax. There was no problem with these years.

In 2013 she received a fresh tranche of rights - 400,000 rights vesting over the four-years ending December 21, 2013, 2014, 2015 and 2016.

This time the grant was a handcuff. The parent company was in financial distress and was firing people left and right. However, they wanted to keep Corri - that is, until they let her go on November 24, 2014.

Vesting did not happen until December 21. She wasn’t going to make it.

But the company did something unexpected: it transferred 100,000 shares of stock into her Charles Schwab account. She assumed they made a mistake, and she was required by plan terms to report if there was a mistake. She called someone in Brisbane, Australia; that person had left. She called another in Houston, Texas. That person had left too. She gave up trying to report the matter to the company.

She received a W-2 showing an additional $75,660 from the stock.

But this time there was no selling 1/3 of the shares for tax withholding. She would be writing a check to Uncle Sam.

What to do?

She did not file a joint income tax return for 2014.

COMMENT: Worst. Possible. Decision.

This was easy picking for the IRS computers.

Off to Tax Court they went.

Corri and the IRS had two very different arguments.

She argued that the treasure trove doctrine applied.

Corri argued that the shares were transferred contrary to the performance rights plan, making the money subject to an ongoing claim by her employer under Alaska law.

I get it: she argued treasure trove because it would delay taxation until the taxpayer had undisputed possession.

This of course put a lot of pressure on her argument that she had disputed possession.

The IRS came from an altogether different angle.

·       Corri had an employment relationship.

·       She was compensated both in cash and property.

·       Under the tax Code, both cash and property are taxable.

·       The Code does have a specific provision (Section 83) for property transferred with restrictions on its further transfer or with a risk of forfeiture. This is what happened here. Corri was awarded rights, exercisable in the future. If she remained employed, the rights were exchangeable for actual shares, which she was free to keep or sell without further restriction. The rights were not taxable when awarded, as Corri had to remain employed until the exercise date. Once she reached that date, the restrictions came off and she had taxable compensation.

The IRS argument proved formidable against Corri. She had no further obligations to the company after she left. In addition, she was not required to refrain from acting (think a covenant not to compete). There was no risk of forfeiture from her acting or not acting. She was also free to sell or otherwise transfer the shares.

And it was there that she lost the argument of disputed possession. In Cesarini nobody knew who the cash had belonged to, and the matter of its possession had to be sorted out under state law. In this case all parties knew who the shares belonged to, and there remained nothing to be sorted out under Alaska law.

There was no treasure trove.

There was no delay.

The IRS won.

There are two things in this case that bother me. Neither are tax driven. I would describe them instead as common sense.

1. The Company had the right to overrule the terms of the performance rights plan and award shares even if plan terms were not met. To rephrase, the company was not allowed to remove a benefit already granted but it was allowed to grant a benefit an employee would otherwise not receive. I believe that is what happened here: Corri was a diligent and valued employee, and the company wanted to show appreciation, even if they had to release her.
2. If an employer gives me free money, why wouldn’t I pay tax? It seems to me that I am still better off than without the free money.

Our case this time was Corri Feige v Commissioner, T.C. Memo 2025-88.