Mishandled FICA and RSUs

Today I discuss recent litigation over mishandled FICA taxes on a nonqualified deferred compensation plan that could also have implications for RSUs.

The Lawsuit

The case involved a company that failed to collect FICA taxes on benefits paid under a nonqualified deferred compensation when the taxes were due.  Because of this, and because the applicable statute of limitations during which the company could go back and amend the return for the year in which FICA should have been paid had elapsed, the company was obligated under IRS regulations to collect FICA when the benefits under the plan were paid out.  The payouts occurred after the employees had retired.

The plan provided for payouts to occur in increments over a period of years, and, because the retirees were no longer actively employed, they had no other wages subject to FICA.  As a result, the payouts were subject to Social Security.  If the company had collected FICA when it should have, the payouts might not have been subject to Social Security because 1) the retirees would have still been employed and would have possibly met the wage cap for Social Security in those years; 2) the wage cap would have been lower; and 3) the entire amount would have been subject to Social Security in the same year, rather than in small increments over many years.  A retiree brought suit against the company essentially claiming that because this was the company's error and the error increased the amount of FICA tax that he has to pay, the company should have to pay his FICA tax for him.

This situation could also come up in the context of RSUs.  Certainly it could apply where RSUs are subject to deferred payout, but more commonly it is likely to be a concern where RSUs provide for accelerated/continued vesting upon retirement and are granted to or held by employees that are eligible to retire. In that circumstance, the RSUs are substantially vested and are subject to FICA before they are paid out. 

I learned a couple of important things from this that are applicable to RSUs.

There Is a Statute of Limitations

Who knew?  If you screw up on FICA withholding for RSUs, you have a limited period of time in which to go back and fix this. That time is approximately three years (although the actual calculation of the statute of limitations is a little more complicated so if this applies to you, talk to your tax advisors).

FICA Taxes Revert Back to Payout

Even more interesting, if you don't find the error and correct it before the statute of limitations runs out, your only choice is to collect FICA when the awards are paid out.  Again, I say, who knew?

No Need to Panic, Yet

All this is interesting, but, of course, our primary interest is whether companies could be liable to participants for mishandled FICA taxes on RSUs. At this point, it's hard to tell. Although there has been one decision in favor of the retiree, this case is far from over (that decision just allows the case to proceed), so who knows if the retire will prevail. And even if he does, the situation in this case isn't fully analogous to RSUs.  For one thing, the retiree is claiming a violation of ERISA, which typically doesn't apply to RSUs. 

Moreover, RSUs typically pay out at the time of retirement, not over a period of years after retirement. Thus, in the case of RSUs, there wouldn't be a question of the payments being subject to Social Security when they otherwise wouldn't have if FICA had been collected on time. The error would only increase FICA taxes through an increase in the stock price (which would mostly apply only to Medicare since Social Security is capped), an increase in the Social Security wage cap, and maybe differences in compensation levels (but only for employees that don't otherwise normally earn enough to max out on Social Security).  Even where employees are subject to tax at the higher 2.35% Medicare rate, it seems unlikely that any of those things would be worth suing over.

For a more complete summary of the case, see the Towers Watson alert "Case Highlights the Risk of Employer Liability for Mishandling FICA Tax."  Thanks to Russ Hall at Towers Watson for helping me sort through how this applies to RSUs.

- Barbara