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Tax Topic: When are RSUs "Deferred Compensation" For FICA Purposes?

By Elizabeth Drigotas ·

            The purpose of this article is to focus on restricted stock units (RSUs) as “deferred compensation” for purposes of social security taxes (FICA).  Whether the compensation is deferred compensation is particularly important for amounts that vest at the end of a calendar year but are paid shortly after.  The IRS has recently commented on this topic in the form of a generic legal advice memorandum (GLAM), dated May 18, 2020, which covered the timing of income inclusion and of tax deposit obligations for a stock-settled option, stock appreciation right (SAR) and restricted stock unit (RSU). We covered those aspects of the GLAM in a prior post, which you can read here. But today, we’ll discuss the GLAM’s discussion of the timing for deposit of FICA taxes on RSUs.

FICA Timing

            The general rule for FICA, under Code Section 3121(a), is that FICA is due when wages are paid, and wages are “paid” when received.  Treas. Reg. §31.3121-1(a)-2.  However, section 3121(v)(2) provides a different rule for amounts that are classified as “deferred compensation”.  Under this provision, wages are included when the right to the wages are vested, or the services are provided, if later.   As discussed further below, deferred compensation arrangements involve delays in timing for the actual payment.

            The regulations provide relief to allow for employers to manage the timing of employment tax deposits that do not coincide with payment events.  Under the rule of administrative convenience, an employer can select a date from the vesting date to the end of the year of vesting and use the value of the vested amount as of that date as the amount of “wages.”  Treas. Reg. §31.3121(v)(2)-1(e)(5).  A second method, the lag method, allows an employer to pick any valuation date up to three months before the date of tax deposit, provided the amount of wages is increased by interest.  Treas. Reg. 31-3121(v)(2)-1(f)(3).  Amounts included under the lag method in the year after vesting are taken into account for the FICA wage base in the later year. 

            For example, if a payment that vests December 31, and is settled on February 15 is classified as deferred compensation for this purpose, the deposit obligations would be based on the value as of December 31.  Because that is the last day of the calendar year, the rule of administrative convenience does not provide additional time.  The lag method would apply to allow a deposit up to three months later, but the amount of wages would be the value as of December 31, increased by interest through February 15, which is likely to be different from the amount actually paid on February 15. 

            If the same amount were not considered deferred compensation, however, the regular rule would not apply, and the wages would be taken into account on the date of payment, based on the February 15 payment.  For this reason, it is important to determine whether or not the payment is “deferred compensation”, in order to support the timing and amount of FICA withholding.

RSUs as Deferred Compensation

            There is no single definition of “deferred compensation” under the Code. There is a definition for purposes of section 409A, in Treas. Reg. § 1.409A-1(b)(4), but that definition applies only to determine if a payment is exempt from the requirements of section 409A, and does not apply for FICA purposes. 

For FICA purposes, Treas. Reg. 1.3121(v)(2)-1(b)(3)(iii) provides an exception for short-term deferrals:

If, under a nonqualified deferred compensation plan, there is a deferral of compensation . . . that causes an amount to be deferred from a calendar year to a date that is not more than a brief period of time after the end of that calendar year, then, at the employer's option, that amount may be treated as if it were not subject to the special timing rule described in paragraph (a)(2) of this section.

In addition, this regulation provides that “whether compensation is deferred to a date that is not more than a brief period of time after the end of a calendar year is determined in accordance with § 1.404(b)-1T, Q&A-2, of this chapter.”

            Treas. Reg. 1.404(b)-1T, Q&A-2, relates to the timing of deductions, and is another instance when whether amounts are “deferred compensation” is relevant.  Under the general rule, deductions for deferred compensation are allowed in the employer’s year that includes the end of the year in which the employee includes the compensation in income, rather than under the employer’s normal method of accounting.  Amounts are considered deferred compensation if payable under an arrangement that defers receipt “more than a brief period of time after the end of the employer's taxable year in which the services creating the right to such compensation or benefits are performed.”   The brief period of time is the 15th day of the third month after the end of the employer’s taxable year.  Treas. Reg. 1.404(b)-1T, Q&A-2(b).

            Although Treas. Reg. 1.404(b)-1T refers to the employer’s taxable “year,” singular, in which the services are performed, the IRS issued guidance that interprets this as the year of vesting.  A Technical Advice Memorandum, TAM 199923045, involved restricted stock units with three-year cliff vesting:   the grants were made in one year, with vesting through continued service at the end of three years.  The TAM concludes that the third year is the one by which the short-term deferral period is measured.  Under this analysis, a grant made in 2020 that vests on December 31, 2023, and pays in January 2024 would not be considered “deferred compensation” for purposes of section 404, and the employer’s normal method of accounting would apply. 

            But what about FICA timing?  The GLAM states that the RSUs under consideration were granted January 2, 2020, vested on December 29, 2021, and the shares werein the employee’s account by December 31, 2021.  Under the analysis in the TAM, this RSU would not be considered deferred compensation for purposes of section 404.    Without discussion other than that a RSU is not within the stock rights exception under the FICA regulations, the GLAM states that this RSU is deferred compensation, subject to the special timing rule.  This conclusion applied the short-term deferral timing to the first year of grant, not the year of vesting.  This conclusion must be based on a reading of the brief period of time as referring to a singular “year,” but as there is no discussion of why the conclusion for this purpose is different form that in the TAM for section 404, it’s not clear. 

Avoiding  Unnecessary Complexity in FICA Collection

How short-term deferral is defined for this purpose is significant because many awards vest December 31 and settle early in the next year.  The GLAM’s conclusion would mean the FICA point is in the first year, not the year of payment.  The lag method under the 3121(v)(2) regulation would allow remission of the FICA tax in year two, but the income amount will be based on the FMV at December 31, increased with interest, not the FMV at the time the employer initiates the transfer in year two.  As a result, the income inclusion and FICA amounts are almost guaranteed to be different. 

Conclusion

Of course, income “wages” and FICA “wages” don’t have to be the same amount, but generally speaking, stock plan administration is easier when they are.  In this case, given the short timing between vesting and payment and the lack of predictable effect on overall FICA collection, as the fluctuations between the two methods could result in higher or lower FICA wages, there does not seem a good reason to apply a definition that is different from that under section 404.  Given that this conclusion is just in a GLAM, and presented without analysis, many employers can be expected to continue to analyze “deferred compensation” by taking into account the reference to the section 404 regulations and the TAM, and continue to treat an RSU like the one outlined in the GLAM as current compensation, with wages for FICA purposes determined when paid.