Davidson v Henkel: Mishandling the Special Timing Rule Can Severely Impact Plan Sponsors and Participants
In the case Davidson v. Henkel Corporation, a former employee and participant in the company’s Nonqualified Deferred Compensation (NQDC) plan sought to recover plan benefits that were reduced because the employer failed to recognize the Internal Revenue Code’s “Special Timing Rule” for the withholding of FICA taxes on vested contributions to the NQDC plan.
A former employee, John Davidson, had been receiving distributions from his NQDC plan since retiring in 2003. In 2011, Davidson and other plan participants were notified that FICA taxes had not been properly withheld from the company’s nonqualified plans. The Henkel’s Corporation Director of Benefits sent a letter to participants, which stated the following:
“During recent compliance reviews performed by an independent consulting firm, it was determined that Social Security FICA payroll taxes associated with your nonqualified retirement benefits have not been properly withheld…”
“At the time of your retirement, FICA taxes were payable on the present value of all future nonqualified retirement payments. Therefore, you are subject to FICA Taxes on your nonqualified retirement payments on a “pay as you go” basis for 2008 and beyond, which are the tax years that are still considered “open” for retroactive payment purposes.”
Employers should withhold and pay federal employment taxes that are due on current annual compensation. Unfortunately, many employers may not fully understand the laws for calculating and paying taxes on nonqualified plans. NQDC plans are subject to “Special Timing” regulations where contributions to the plan are treated as wages under FICA taxation as the latter of:
(i) the date on which the services creating the right to that amount are performed; or
(ii) the date on which the employee’s right to the deferred compensation is no longer subject to a “substantial risk of forfeiture.”
These regulations also include “Nonduplication Rules”, which says that once NQDC funds have been treated as FICA wages, those amounts, and the associated earnings, will not again be treated as FICA wages.
Upon receipt of this letter, Davidson filed suit against his former employer alleging that it failed to properly withhold FICA taxes on its nonqualified plans. His claim argued that the Henkel Corporation violated the terms of the plan document under ERISA, which should entitle him to remedies under the statutes civil enforcement provisions. The Henkel Corporation answered the complaint, arguing that it had complied with all IRC regulations by establishing a “pay as you go” basis once the company became aware of their “special timing” error.
The Court ruled in favor of John Davidson and found that the Henkel Corporation violated the terms of the plan document when it failed to properly withhold FICA taxes at the time of retirement. This error resulted in depriving the retired participants of the benefits of the Internal Revenue Code’s “Special Timing” and “Nonduplication Rules.” By doing so, the retired participants were required to pay taxes that they normally would not have been subject to. Sadly, this error resulted in a reduction in benefits for the retired participants.
The Davidson v. Henkel case shows how unclear language in the plan document could be interpreted in a way as to provide participants with unintended rights. Furthermore, it emphasizes the importance of using an experienced nonqualified plan recordkeeper. Due to the complicated intricacies of nonqualified plans, it is prudent to seek an experienced nonqualified plan recordkeeper to ensure that nonqualified plans fully and clearly comply with all regulations.
About Nolan Financial
For more than twenty-five years, Nolan Financial has specialized in the custom design, enrollment, funding and administration of non-qualified retirement plans for the benefit of the senior executives of mid to large size public, private and tax exempt organizations. Nolan Financial has an office in Maryland and an administrative center in Texas. Nolan Financial Group is not an affiliate of Lincoln Financial Advisors Corp. For more information about Nolan Financial, visit www.nolanfinancial.com.
Registered associates of Nolan Financial Group are registered representatives of Lincoln Financial Advisors Corp. Lincoln Financial Advisors does not offer legal or tax advice. Securities offered through Lincoln Financial Advisors Corp., a broker/dealer. Insurance offered through Lincoln affiliates and other fine companies. Branch Office: 6720-B Rockledge Drive, Suite 140, Bethesda, MD 20817. CRN-1075246-120914