No Refund Available for FICA Taxes on Compensation Deferred but Never Received.

(Parker Tax Publishing January 27, 2015)

A retired airline pilot was denied a refund for FICA taxes paid on deferred compensation he never received, as the statute allowing taxes on deferred compensation did not provide for such a refund. Balestra v. U.S., 2014 PTC 610 (Ct. Fed. Cl. 2014).

Louis Balestra, Jr. was a pilot for United Airlines (United) from January 1979, until his retirement in October 2004. Balestra had a vested right in deferred compensation under a retirement benefits plan through United, the full present value of which was included in the FICA tax base in the year of his retirement. United entered bankruptcy proceedings in 2002, two years before Balestra's retirement, and as a result, United's obligation to pay the deferred compensation was discharged, with the majority of the benefits never having been paid.

United made the final payments required under its bankruptcy reorganization plan and consequently Balestra will not receive any additional benefits from this retirement plan. Because United withheld FICA tax from Balestra based on a present value calculation of his retirement benefits at the time of his retirement, Balestra effectively paid tax on wages he will never receive. In total, Balestra paid tax on $289,601 worth of nonqualified deferred compensation, of which he only received $63,032. He paid $4,199 of FICA tax on these benefits, which reflects the tax rate applied to the $289,601 present value of the benefits.

Dissatisfied with this tax result, Balestra pursued a suit in the Court of Federal Claims for a refund of $3,285, an amount reflecting the FICA tax attributable to the portion of the deferred compensation he did not receive.

The IRS argued the FICA "special timing rule" was properly applied to Balestra's benefits, and, as neither the statutes nor the regulations provide for a refund for FICA taxes imposed on wages that are never received, the court should rule in the IRS's favor. Balestra, by contrast, argued he was entitled to the refund because the regulations enacted under Code Sec. 3121(v)(2) were arbitrary and irrational in not providing for a "true-up" (i.e., refund) in the event of plan-failure, nor allowing the risk of nonpayment to be included in the calculation of the present value of deferred compensation subject to tax under the special timing rule.

Under the general timing rule, FICA taxes are imposed on wages in the year that they are actually or constructively paid by employers to employees (Code Sec. 3101). Under the special timing rule, any amount deferred under a nonqualified deferred compensation plan is taken into account at the later of

(1) when the services are performed, or

(2) when there is no substantial risk of forfeiture (as defined under Code Sec. 83) of the rights to such amount (Code Sec. 3121(v)(2)(A)).

The rights of a person in property are subject to a substantial risk of forfeiture if such person's rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual (Code Sec. 83(c)(1)).

Nonqualified deferred compensation benefits may be taxed before they are paid, and such benefits taxed under the special timing rule are taxed at their "present value," which is calculated with reference to actuarial projections concerning life expectancy and a discount rate is applied to account for the time value of money (Reg. Sec. 31.3121(v)(2)-1). However, the present value of retirement benefits cannot be discounted for the probability that payments will not be made (or will be reduced) because of the risk that the employer will be unwilling or unable to pay (Reg. Sec. 31.3121(v)(2)-1(c)(2)(ii)).

The court disagreed with Balestra's principal argument that the use of the words "income of every individual" means that FICA taxes are a type of income tax computed with reference to "wages received," and that "wages" are a subset of "income," and thus if an item is not "income" it must, by definition, also not be "wages" subject to tax under FICA. The court reasoned that under the plain language of the Code, remuneration for employment can be "wages" for FICA purposes although not "income" for income tax purposes. Additionally, the court reasoned that the plain meaning of Code Sec. 3121(v)(2) treats certain benefits as taxable FICA wages before they have become part of an employee's income, and that section must impose taxes on wages before they are considered income, otherwise it would be meaningless.

Balestra's also argued that Congress, by imposing a portion of FICA taxes on a non-cash basis, must have intended to employ an accrual accounting basis and that while the provision would allow benefits to be taxed prior to receipt, it must implicitly require that some sort of deduction or adjustment to be made when it can be determined that the benefits will never be received. However, the court pointed out that while it was true that Congress accelerated the taxation of deferred benefits such as those promised Balestra, the "substantial risk of forfeiture" trigger it selected essentially means the employee has satisfied all of the requirements under his employment contract to earn the right to the deferred compensation, which does not concern any risk of nonpayment. Moreover, the court determined there was no reason to believe that by taxing deferred compensation under a provision that references "income," Congress intended to silently incorporate the features of accrual accounting, as it would have done so by explicit reference if it had desired. The court mentioned it may have been wiser to select a different trigger, but that was a matter for law makers to address, not judges.

Finally, Balestra argued it was unreasonable for the Treasury to forbid a bankrupt employer from discounting its unsecured promises for the risk of non-payment when calculating the present value of those promises, explaining that courts generally treat the concept of present value as including both a credit risk discount and a time value of money adjustment. The court disagreed, noting that Code Sec. 3121(v)(2)(A) says nothing about how any "amount deferred" is to be calculated, and with no guidance from Congress on how to calculate present value, no rule is violated by the Treasury's choice of a present value method. Absent evidence of any uniform practice regarding present value that the Treasury typically employs contrary to the regulations under Code Sec. 3121(v)(2), and considering the clear, contemporaneous explanation of the rationale for the valuation method (minimizing administrative costs and complexities), the Court could not say the choice of method was irrational.

Finding Balestra's arguments unpersuasive, the Court of Federal Claims ruled that he was not entitled to a refund for the FICA taxes paid on compensation he never received.

For a discussion of the imposition of FICA taxes, see Parker Tax. ¶213,135. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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