Tax Administration of Nonqualified Plans

In Davidson v. Henkel Corp., the U.S. District Court for the Eastern District of Michigan ruled in favor of former employee executives in a class action against their former employer with respect to nonqualified plan benefits.  The employer failed to apply the “special timing rule,” whereby nonqualified plan benefits are subject to FICA tax when deferrals are made, instead of when benefits are received.   Application of the special timing rule often results in $0 of additional FICA tax, because the executive’s income is in excess of the Social Security Wage Base when the income is deferred.  Failing to apply the rule resulted in annual FICA taxation of benefits.  The Court ruled that the employer failed in a plan-specified duty to properly withhold taxes.  The decision is only a district court decision, so it might not hold up on appeal.  However, since there are virtually no legal requirements applicable to nonqualified plans, employers should take a look at the language of their plans to make sure nothing more than what is required is provided (unless a desire exists to provide more).