I have a
family member who has accepted in position in, and will be moving to, Chicago.
You can bet that we have discussed the compensation package, and I am to review
the deferred compensation package when provided. His is a “C suite” position,
so deferred compensation means more than just the 401(k) with which you and I are
familiar.
I find
myself reviewing a Federal Court of Claims decision on an airline pilot that
got on the wrong side of FICA taxation of deferred compensation.
His name is
Louis Balestra, and he was a pilot with United Airlines from 1979 until his retirement
in 2004. There may have been no tax case, except that United Airlines filed for
bankruptcy in 2002.
Let’s talk
about the “general timing rule” for FICA taxation. It is easy: you pay FICA
when you are paid. No pay, no tax. No fair to not cash your paycheck!
We also have
deferred compensation, more specifically “nonqualified” deferred compensation,
which means a retirement plan which deviates, either a little or a lot, from somewhat
rigid IRS requirements in order to be “qualified.” There is then a ‘special
timing rule” (I am not making this up, I swear), the purpose of which is to
speed-up when the income is taxed for FICA. The Code section is 3121(v)(2):
3121(v)(2) TREATMENT OF CERTAIN
NONQUALIFIED DEFERRED COMPENSATION PLANS.—
3121(v)(2)(A)
IN GENERAL.— Any amount deferred under a nonqualified deferred
compensation plan shall be taken into account for purposes of this chapter as
of the later of—
3121(v)(2)(A)(i) when the services are performed, or
3121(v)(2)(A)(ii) when there is no substantial risk of forfeiture of the
rights to such amount.
We have a
new shiny: “substantial risk of forfeiture.” If the company funds your benefit,
for example, chances are that your FICA tax will be accelerated, perhaps many
years before you actually receive any money.
Let’s work
through this with an extremely simplified example. The company agrees to pay
you $100,000 five years from now. Let’s also posit that you clear the second
requirement of “no substantial risk of forfeiture.” Congratulations, you have
FICA tax. Right now.
Being a tax
accountant by training if not by temperament, I have to ask the question: how
do I calculate the income to be taxed? Is it $100,000? That doesn’t make sense,
as you will receive the money five years from now. A hundred grand then is not
the same as a hundred grand now, if for no other reason than you could put it n
a CD (if you received it now) and have more than a hundred grand five years hence.
Is it the present value of the $100,000, discounted at some interest rate and for
five years? That makes more sense, and that is the guidance provided by the Regulations.
Remember
what I said about United Airlines filing for bankruptcy in 2002, two years
before Balestra retired? Shouldn’t we take into consideration that United
Airlines might not pay everything to which Balestra is entitled?
Makes sense
to me. For example, Balestra paid FICA on approximately $289,000 of deferred
compensation. United actually paid him approximately $63,000. He had paid FICA
on that entire $289,000, and he wanted some of it back.
CLARIFICATION: It would be more correct to say that he paid
the Medicare portion of FICA, as the social security side only applies up to an
income limit. Let’s continue. We are on
a roll.
Balestra sued.
And the Court
was looking at the Shakespearean prose of Reg 31.3121(v)(2)-1(c):
(ii) Present value defined.— For purposes of this section, present
value means the value as of a specified date of an amount or series of
amounts due thereafter, where each amount is multiplied by the probability that
the condition or conditions on which payment of the amount is contingent will
be satisfied, and is discounted according to an assumed rate of interest to
reflect the time value of money. For purposes of this section, the present
value must be determined as of the date the amount deferred is required to be
taken into account as wages under paragraph (e) of this section using actuarial
assumptions and methods that are reasonable as of that date. For this purpose,
a discount for the probability that an employee will die before commencement of
benefit payments is permitted, but only to the extent that benefits will be
forfeited upon death. In addition, the present value cannot be discounted for
the probability that payments will not be made (or will be reduced) because of
the unfunded status of the plan, the risk associated with any deemed or actual
investment of amounts deferred under the plan, the risk that the employer, the
trustee, or another party will be unwilling or unable to pay, the possibility
of future plan amendments, the possibility of a future change in the law, or
similar risks or contingencies.
Balestra
tried, but he could not overcome the fact that the Regulations did not include “employer
bankruptcy” as a possible reason to discount the amount of income accelerated
for FICA tax – or, at least, to allow some of the FICA to be refunded once the actual
payments are known.
Balestra
lost his case.
The Court
did realize the unfairness of the law, however.
It might have been wiser to have selected as a trigger
something other than there being ‘no substantial risk of forfeiture’ … and
instead considered the financial solvency of the employer – or to have deferred
taxation while an employer is in bankruptcy, rather than until promised
benefits are ‘reasonable ascertainable.”
You think?
But these are matters for law makers, not judges – suboptimal
laws are still valid tax laws.”
I know. I would
be more optimistic if I had any regard for the suboptimals in Congress.
Tile 26 of the United States Code would be a good deal
shorter if the unwise tax laws could be purged by the judiciary.”
You must
admit, it is easy to like this Court.
