Contact: Donald S. Nemerov, Managing Director; FGMK, LLC (Chicago, Illinois, USA)
Executive Compensation – Tax Planning to Increase Take-home Amounts
As we near year-end, it is important to consider some tax planning approaches that can apply in the context of executive compensation plans. This article covers a few planning ideas that may apply to your situation, or to highly-compensated employees in your business. FGMK’s Compensation Advisory Services practice can guide you in applying these planning ideas and reducing the tax cost of your compensation arrangements.
Payroll Taxes and Deferred Compensation
The “Special Timing Rule” in the Internal Revenue Code (“Code”), which is unique to non-qualified deferred compensation (NQDC) plans, results in a different date for the payment of payroll (FICA) taxes vs. income taxes. This rule impacts plans such as elective deferral and phantom stock plans, also referred to as “account balance plans,” as well as supplemental executive retirement plans (SERPs,) also referred to as “non-account balance plans.”
By way of background, FICA comprises two components: OASDI (Social Security) and HI (Medicare). In addition, most employees who participate in the NQDC plans noted above also are subject to the Medicare excise tax. FICA taxes are due with respect to account balance plans when the balance in the account becomes vested, and may be accelerated under certain rules for non-account balance plans. The vested balance, when distributed, is not subject to FICA at the time of distribution. If the special timing rule is not met, then the payroll taxes become due upon distribution of the account balance, along with any income taxes that may be payable at that time. Most employees that participate in such plans are above the OASDI limit in the year that the amount becomes vested or payable, but not when the compensation is distributed in later years. The savings from meeting the special timing rule can be significant for both the employer and the employee.
For plans that include elective deferrals with interest accrued or investment credited on the deferred account, and for phantom stock plans that can appreciate significantly in value over time, complying with the special timing rule can result in significant payroll tax savings.
