IRS discussed correcting FICA failures under a nonqualified deferred compensation plan

Plain-English summary

The IRS advised that when amounts deferred under a nonqualified deferred compensation plan were not treated as FICA wages at deferral, the deferred amounts and related income are subject to FICA upon distribution. It generally opposed using a closing agreement to avoid the nonduplication rule for years that are no longer open. For years with mixed compliance, the regulations provide a method to prorate distributions so FICA applies only to amounts tied to noncompliant periods. The memo also noted that taxpayers may be able to correct still-open years with Forms 941-X without a closing agreement.

Ruling snapshot

• Question: How should FICA noncompliance under a nonqualified deferred compensation plan be corrected for open and closed years?
• Outcome: Advice given
• Key authorities: IRC § 3121(v)(2); regulations under IRC § 3121(v)(2); Form 941-X.

Full text (IRS public release)

ID: CCA_2010052114041432 Number: 201025053
Release Date: 6/25/2010
Office: -----------------------------
UILC: 3121.16-02

From: --------------------
Sent: Friday, May 21, 2010 2:04:23 PM
To: ------------------
Cc: ---------------------
Subject: RE: Voluntary Disclosure

You are probably familiar with the nonduplication rule in section 3121(v)(2). Under that rule, if the
taxpayer fails to take amounts deferred under a NQDC plan into account as FICA wages at the time of
deferral, then the amounts deferred and the income attributable to those amounts are subject to FICA
upon distribution. My view is that generally we should not allow taxpayers to avoid the nonduplication
rule by entering into closing agreements that "fix" their noncompliance for years that are no longer open.
The regs under section 3121(v)(2) have specific guidance for how to deal with the situation where
taxpayers failed to comply for some years, but actually paid FICA properly for other years. Essentially,
taxpayers are supposed to pro-rate amounts distributed so that FICA is paid on only amounts attributable
to periods where they failed to comply with 3121(v)(2). It's not simple, but our regs do provide a
methodology for taking care of this problem, so why would we enter into a closing agreement that allows
taxpayers to avoid compliance with our own regs (not to mention the nonduplication rule in the statue).

I don't have any problem with the taxpayer wanting to fix years that are still open under the statute of
limitations. For this, I'm not entirely sure they need a closing agreement because taxpayers file 941-Xs to
pay back taxes all the time without entering into closing agreements. I'm having difficulty understanding
all of the formulas the taxpayer is using for -----------, though.