Taxpayers should never be taxed on income they don't receive. But it happens. It occurred in a recent decision, Koopmann v.
In Koopmann, the taxpayer retired from
The tax rub in this scenario is that notwithstanding the deferred nature of the compensation, there is a special timing rule under which taxpayers still pay FICA on compensation they receive under a non-qualified deferred compensation plan. Under the “special timing rule” FICA tax is assessed only once, at the later of either: (A) the date services are performed or (B) the date when there is no substantial risk of forfeiture of the rights to such amount. See 26 C.F.R. § 31.3121(v)(2)-1.
For the taxpayer in Koopmann, he paid FICA taxes on
Koopmann's main argument hinged on the Fifth Amendment - specifically, that it would violate the Due Process Clause to bar a refund on statute of limitations grounds when the purported eligibility for that refund --- the discharge of
In future cases, taxpayers and their advisors might explore different approaches that do not depend on arguments that may be viewed as asking courts to re-write the statute of limitations in Section 6511, or Constitutional arguments which, in Federal tax cases, courts take seriously in very narrow sets of circumstances. Foremost, filing protective refund claims as soon as there's any sign of a bankruptcy or other substantial risk of forfeiture should be considered as a way to preserve the taxpayer's right to a refund. There also may be more promising legal theories that do not require overcoming the statute of limitations. For example, in the year of the discharge, taxpayers might consider claiming a bad debt deduction under Section 166, with the excess taxes paid as the deductible basis. There also may be room to argue that under the special timing rule the FICA remitted should be treated as a deposit. Seeking a legislative fix may also be appropriate given the harsh inequities of paying tax on amounts never received and the absence of a clear path to remedy the inequities.
Given the ongoing struggle to contain the Covid pandemic, and fully open the economy, it would not be surprising to continue to see the rate of bankruptcies climb. With this trajectory, Koopmann is unlikely to be the last victim to paying FICA on deferred compensation that is discharged in bankruptcy. Potentially affected taxpayers and their advisors should consider proactive measures and remedial actions to avert the fate of Koopmann and others before him.
Originally Published by Chamberlain Hrdlicka,
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Mr
Chamberlain, Hrdlicka, White, Williams & Aughtry
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