How Special Is the Special Timing Rule? Analyzing the Timing of FICA Taxation in Nonqualified Deferred Compensation Plans

Authors

Alan J. Ponce, Georgia State University College of LawFollow

Document Type

Article

Abstract

Many employers offer nonqualified deferred compensation plans as a benefit to select employees, and those plans allow the employees to prepare for retirement in a tax-efficient manner. For employers,designing and administering such plans in compliance with federal law represents a paramount concern in order to achieve the tax advantages such plans entail. However, for these employers, there remains an inherent ambiguity in the tax code regarding how and when employers should withhold Federal Insurance Contribution Act (FICA) taxes—that is, Social Security and Medicare taxes—on deferred compensation in nonqualified retirement plans.

Tax regulations provide two distinct methods for withholding FICA taxes on nonqualified plans: the “general timing rule” and the “special timing rule.” Which method the employer uses can substantially impact the total amount of taxes an employee owes. For this reason, employers must understand whether the tax code requires one method versus the other in a given situation or else risk litigation from employees adversely impacted by the withholding method used.

In 2015, the Henkel Corporation learned this lesson the hard way when it lost a class action suit filed by a former employee under these very circumstances. Davidson v. Henkel Corp. is the first case to demonstrate the implications of an employer’s failure to use the special timing rule and shows that the stakes can be significant. Yet,whether the tax code mandates method versus the other remains an unsettled question in the context of nonqualified deferred compensation plans.

Part I of this Note provides background on FICA taxation and the special timing rule and introduces the Henkel case. Part II explores the inherent ambiguity that exists and argues that—despite language to the contrary in Henkel—federal regulations mandate that employers must use the special timing rule for FICA withholding in the context of nonqualified deferred compensation plans. Part III proposes a solution to resolve the ambiguity going forward.

Recommended Citation

Alan J. Ponce, How Special Is the Special Timing Rule? Analyzing the Timing of FICA Taxation in Nonqualified Deferred Compensation Plans, 34 Ga. St. U. L. Rev. 427 (2018).
Available at: https://readingroom.law.gsu.edu/gsulr/vol34/iss2/4