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University required to make FICA contributions for participants in its ?Section 403-b Tax Deferred Annuity Plan.?

University required to make FICA contributions for particpants in its ?Section 403-b Tax Deferred Annuity Plan.?
University of Chicago v United States of America, CA 7th Circuit, Docket # No.07-3686

The University of Chicago did not pay, report, or withhold Federal Insurance Contributions Act (FICA) tax between 2000 and 2003 for payments made under its employee retirement plans, including its ?Section 403-b Tax Deferred Annuity Plan.?

The Internal Revenue Service (IRS) assessed FICA tax plus penalties and interest on contributions made under the University?s tax deferred retirement plan and Chicago appealed.

In this instance, FICA tax liability turns upon whether the payments made under the plans were pursuant to ?salary reduction agreements,? typically called ?tax deferred annuities.? The Circuit Court of Appeals affirmed a federal district court ruling in favor of the United States.

In this complex opinion, made more so by some of the convoluted language used in the controlling statutes, the court held that although ?Wages? includes ?all remuneration for employment,? certain kinds of payments are excepted. The exception at issue here concerned ?any payment made to, or on behalf of, an employee or his beneficiary . . . under or to an annuity contract described in section 403(b), other than a payment for the purchase of such contract which is made by reason of a salary reduction agreement (whether evidenced by a written instrument or otherwise).?

In 1965, the IRS issued a revenue ruling responding to advice sought by an employer as to whether amounts used to purchase an annuity contract for an employee under an agreement that reduced the employee?s salary constituted employer contributions (not subject to FICA) or employee contributions (subject to FICA) [Rev. Rul. 65-208, 1965-2 C.B.383]. The ruling held that the amounts should be considered employee contributions and thus they were subject to FICA.

The issue to be resolved was whether a reduction in an employee?s salary where the funds were used to purchase annuity contracts for retirement was subject to FICA taxation, even though it was not subject to income tax withholding. The Court concluded that the funds were considered employee-contributed and subject to FICA tax, even though they were treated as employer-contributed for purposes of determining the individual's personal income tax liability.

If, said the court, the employer did not contribute a salary-reduced amount to a §403(b) plan, then the amount would be used instead to pay the employee?s salary. Either would result in the same FICA taxation for the employer.

For purposes of calculating Social Security benefits, the term ?wages? is defined generally as all remuneration except payments ?under or to an annuity contract described in section 403(b) of the Internal Revenue Code of 1986, other than a payment for the purchase of such contract which is made by reason of a salary reduction.? Salary reduction agreements, therefore, only count for Social Security benefits purposes if they are counted for FICA-taxation purposes.

The University was held liable for the payments of FICA contributions for the period in question and for penalties associated with its failure to make such payments in a timely fashion.

N.B. Insofar as the Section 403-b Tax Deferred Annuity Plans offered by the State University of New York, the community colleges and the statutory contract colleges at Cornell and Alfred Universitites [The Special Annuity Program] are concerned, Section 399.7 of the Education Law provides as follows: ?7. Any payroll deduction, other than income tax withholdings as required by law, which may be required or authorized pursuant to law, contract, agreement, or any other instrument, the amount of which is determined in relation to an employee's earnings, shall be based on the salary of such employee without regard to reduction thereof pursuant to any agreement authorized by this article.? In other words, FICA contributions on the employee?s wages will be base on his or her compensation before the ?salary reduction? for the purposes of making contributions to a Section 403-b tax deferred annuity offered by these institutions.

The full text of the decision is posted on the Internet at:

http://www.ca7.uscourts.gov/tmp/I40VM7VM.pdf

Full post as published by New York Public Personnel Law on November 04, 2008 (boomark / email).