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Tax News: Employment Tax Issues in Connection with Deferred Compensation

Winter 1995

Employers are reminded that amounts credited to deferred compensation accounts for employees are subject to the Social Security and Medicare employment taxes. Thus, additional amounts must be withheld from the cash wages paid to employees to cover these employment taxes. For example, assume that an employee defers $20,000 of his bonus into a deferred compensation plan; his other wages were $100,000. The $20,000 will be subject to the Medicare tax of 1.45% each for the employer and employee. The employee's share of the tax, or $290 (1.45% x $50,000), will have to be withheld from other wages of the employee and paid by the employer. There would be no Social Security tax on the $20,000 deferred in the example since other wages exceed the 1995 limit of $61,200.

In addition, other deferred compensation, and possibly severance plans, are subject to employment tax withholding when vested. This includes Supplemental Executive Retirement Plans ("SERPs"). The Internal Revenue Service expects to issue further guidance in this area before year-end. Whether withholding is required, the timing for such withholding and the amount of the withholding can be complicated issues dependent on the facts of the situation.

Self-employed individuals, such as non-employee directors of corporations, who participate in deferred compensation plans are not subject to self-employment tax until amounts deferred are actually paid.

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