United States: Court Rules FICA Tax Not Refundable When Deferred Compensation Is Ultimately Not Paid To Employee

In Balestra v. United States, No. 09-283T (Fed. Cl. 2014), the U.S. Court of Federal Claims ruled that the taxpayer, Louis J. Balestra Jr., was not entitled to a refund of Federal Insurance Contributions Act (FICA) taxes he paid on deferred compensation that was ultimately not paid to him because his employer filed for bankruptcy protection.

Balestra was an employee of United Airlines and participated in United's nonqualified deferred compensation plan. In accordance with the "special timing rule" of Treas. Reg. Sec. 31.3121(v)(2)-1(a)(2), the present value of Balestra's deferred compensation was included in his wages subject to FICA tax when the deferred compensation vested. That special timing rule applies to nonqualified deferred compensation and requires that the present value of the compensation be included in FICA wages at the later of when the services are performed or when the compensation vests.

After Balestra's deferred compensation vested, United entered bankruptcy proceedings. As a result, United's obligation to pay Balestra's deferred compensation was discharged. Because FICA taxes were withheld on the present value of the deferred compensation, Balestra effectively paid FICA taxes on wages he will never receive.

Balestra first argued that he was entitled to a refund of the FICA taxes because he would not recognize income related to the deferred compensation. The court disagreed and ruled that the statute and regulations do not permit refunds of FICA taxes in the event of nonpayment because of employer bankruptcy. Balestra then argued that the FICA tax regulations incorrectly prohibit a discount for the probability that payment will not be made because of the unfunded status of the plan.

The court recognized that in other instances the federal tax rules allow a credit risk discount. However, the FICA tax statutory language doesn't state how present value should be determined. Accordingly, the court ruled that the Treasury Department and the IRS did not violate the statute or any other rule in the choice of a present-value method for FICA tax purposes, and that the present value of Balestra's deferred compensation should not be discounted because of the possibility of nonpayment due to bankruptcy.

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