Payroll Tax Considerations of SERPS and Other Deferred Compensation

Tax Considerations Related to SERP
Confusion arises around the payroll tax considerations such as FICA and Medicare tax and how they apply to SERP payments. For purposes of FICA and Medicare tax, earned SERP deferrals are generally taxable at the later of when earned or when there is no longer a substantial risk of forfeiture (i.e., when the executive becomes vested in the deferral). An example of a substantial risk of forfeiture would be if an executive was required to remain in the employ of a bank for at least five years in order to be vested in the future SERP payments. In this situation, the executive and the bank would be subject to FICA and Medicare tax in the year that the executive becomes vested after reaching the five year threshold. The amount of income for FICA and Medicare tax purposes would be the net present value of the total future SERP payments currently vested.

Exception to Every Rule
As is the case with many tax laws, there is an exception to the general rule. If the ultimate SERP payout amounts cannot be definitively determined at vesting, then FICA and Medicare tax payments may be deferred until such time as the future SERP payments can be definitively determined. For example, if an executive’s SERP payout is computed by using the average of the individual’s three highest salaries during their last five years of employment, the amount of the payout may not be definitively determined until the last year of employment. In this situation, you will want to be sure to withhold FICA and Medicare tax in this last year of employment because, in most instances the executive will have maxed out for FICA tax purposes and will only be subject to the Medicare tax. This could result in significant tax savings for the bank and the employee.

Witholding Amounts
In some cases the withholding amount, even if it is only Medicare tax being paid, can be substantial. For that reason, the bank should make arrangements ahead of time for the executive to remit the withholding amount to the bank so the bank can then remit it to the IRS. This may be done in the last payroll of the year.

Reporting the SERP vesting and payments on Form W-2 varies depending upon the situations that were just mentioned. If reporting the FICA and Medicare tax for a year in which the executive is still employed at the bank, the net present value of the total future SERP payments is added to box 5 with the resulting employee portion of Medicare tax reported in box 6. The same amount is added to box 3, but only up to the FICA maximum amount (currently $110,100 for 2012) with the applicable FICA tax entered in box 4.

Upon reporting at retirement with SERP payments in the same year of reporting, the net present value of the total future SERP payments is added to box 5 with the related tax reported in box 6. The same amount is added to box 3, but again, only up to the maximum FICA amount with the related tax amount in box 4. The current year SERP payments are reported in boxes 1 and 11. For future years when the individual is no longer an employee of the bank, SERP payments would continue to be reported on Form W-2 in boxes 1 and 11. There would be nothing reported in boxes 3, 4, 5 or 6 related to the SERP because all related FICA and Medicare taxes were paid in prior years.

This article assumes that all requirements of Internal Revenue Code Section 409A are met. Further, this article contains only a brief discussion of these somewhat complex rules.

For more information about this topic please contact Erin P. Magaletta, Tax Supervisor at 617-428-5417 or emagaletta@wolfandco.com.

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This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting, tax or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use. The information in this publication is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this publication. Copyright 2012.