Refusal to Allow Closing Agreements on FICA Timing May Lead to Challenge
In an IRS Chief Counsel Advice Memorandum released on January 13, the IRS concluded that it should not enter into closing agreements with employers who failed to subject amounts of nonqualified deferred compensation to FICA taxes under the special timing rule in Section 3121(v)(2)(A). In the past, some employers have been able to obtain a closing agreement in such circumstances. In the CCA, the IRS concludes that, because the regulations apply the general timing rule in such situations, closing agreements that would allow the avoidance of the harsh result prescribed by the regulations are inappropriate. The unwillingness of the IRS to issue closing agreements on the issue going forward may bring to a head arguments that the IRS’s regulations under Section 3121(v)(2) are not well supported by the language of the statute. Under the statute, an amount deferred under a “nonqualified deferred compensation plan” is required to be “taken into account” as wages for FICA tax purposes when the services creating the right to that amount are performed, or, if later, the date on which the right to that amount is no longer subject to a substantial risk of forfeiture. Under the “nonduplication rule,” an amount taken into account as wages under this mandatory timing rule (and any income attributable to such amount) are not treated as wages at any later time. In other words, deferrals under a nonqualified deferred compensation plan and the related earnings are subjected to FICA taxation only once—at the time mandated by Section 3121(v)(2)(A). Under the Treasury Regulations, the IRS goes a step further and creates out of whole cloth a second time for including in wages amounts deferred under a nonqualified deferred compensation plan—the time that the deferred amount and earnings would have been taken into account as wages under Section 3121(a) but for the application of Section 3121(v)(2). The IRS’s regulatory approach is arguably contrary to the statutory language, which does not include a “backup” timing rule but instead provides the sole and exclusive rule regarding the time at which such amounts are wages as a matter of statutory law. There is no other Code provision that would override the clear and unambiguous mandate of Section 3121(v)(2)(A) to require, or event permit, amounts deferred under nonqualified deferred compensation plans to be treated as FICA wages in a later year. In the absence of an explicit statutory command that would require the later inclusion in wages of deferred amounts that were not properly subjected to FICA taxation, the approach taken by Treasury and the IRS in the regulations may be vulnerable to attack. With the IRS now refusing to enter into closing agreements on the issue, a cornered taxpayer might seek to do just that.
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