Is Deferred Compensation Taxable for Social Security?
Understand how deferred compensation impacts your Social Security tax obligations. Learn the key timing differences for various arrangements.
Deferred compensation is an agreement for future payment of services rendered now, often for retirement. Its interaction with Social Security taxes involves specific rules that differ from regular income and vary by plan type.
Fundamentals of Social Security Taxation
Social Security taxes, or FICA taxes, fund Social Security and Medicare. These taxes are split between employer and employee. For 2024, the Social Security tax rate is 6.2% for each (12.4% total) on earnings up to the annual wage base limit. The Medicare tax rate is 1.45% for each (2.9% total), with no wage limit.
Wages for Social Security tax purposes include most employment remuneration: salaries, commissions, and bonuses. The annual wage base is the maximum earnings subject to the Social Security portion of FICA tax. For 2024, this limit is $168,600; earnings above this are not subject to Social Security tax.
Once earnings reach this wage base limit, individuals no longer pay Social Security tax on additional earnings for that year. However, Medicare tax applies to all earnings without limit. The wage base adjusts annually based on changes in the national average wage index.
The Special Timing Rule for Deferred Compensation
Deferred compensation is subject to Social Security (FICA) taxes under the special timing rule. FICA tax liability arises earlier than payment, specifically when services are performed or when the right to compensation vests, whichever is later.
This timing differs from income tax rules, which tax deferred compensation when paid. The special timing rule prevents avoiding FICA taxes by deferring compensation beyond the wage base limit or into retirement. It ensures FICA taxes are collected when compensation is earned and the right to it is established, regardless of disbursement.
For example, if an executive earns a deferred bonus in 2025 that vests in 2027 but is paid in 2030, FICA taxes would likely be due in 2027. This FICA tax is calculated based on the executive’s earnings up to the Social Security wage base for 2027. If other wages for 2027 already exceed the wage base, the deferred bonus would only be subject to the Medicare portion of FICA tax. The FICA tax obligation is tied to the earning and vesting period.
Social Security Tax Treatment of Specific Deferred Compensation Plans
Social Security tax treatment of deferred compensation varies significantly by plan type. Nonqualified deferred compensation (NQDC) plans differ from qualified plans, each with specific FICA taxation rules.
Nonqualified Deferred Compensation (NQDC)
Nonqualified deferred compensation plans do not meet tax-qualified plan requirements. These often include supplemental executive retirement plans (SERPs), deferred bonus plans, or elective deferral arrangements that provide benefits beyond qualified plan limits.
For NQDC, the special timing rule for FICA taxation applies. Deferred amounts are subject to Social Security and Medicare taxes at the later of when services are performed or when rights to compensation vest.
If an executive defers salary or bonus through an NQDC plan, FICA taxes are due in the year services are rendered and the right becomes non-forfeitable. This applies even if payment is scheduled for many years into the future. The employer withholds and remits FICA shares at this earlier inclusion date, which can create a FICA tax liability before cash receipt.
Qualified Plans (e.g., 401(k), 403(b), traditional IRAs)
Contributions to qualified retirement plans (e.g., 401(k), 403(b), traditional IRAs) are treated differently for Social Security tax. Employee elective deferrals and employer contributions are not subject to FICA taxes when contributed. Instead, the wages from which these contributions derive are subject to FICA tax in the year earned, before deferral.
For example, if an employee earns $100,000 and defers $10,000 into a 401(k), the full $100,000 is subject to FICA taxes in the year earned, assuming it is below the wage base. The $10,000 deferral itself is not subject to a separate FICA tax event when contributed.
Earnings within these qualified plans, such as investment gains, are not subject to FICA taxes upon distribution. Distributions from a traditional 401(k), 403(b), or traditional IRA in retirement are subject to income tax but not FICA taxes. This differs from NQDC plans, where deferred amounts are subject to FICA tax at vesting. The underlying wages contributing to these qualified plans were already subject to FICA taxes when earned.