Deferring director salaries may save social security taxes.

Before 1991, it did not matter whether taxpayers elected to defer their wages or director fees for purposes of Social Security taxes; both types of income were included in the Social Security taxable wage base in the year the services were performed rather than in the year the income was received. However, the Revenue Reconciliation Act of 1990 changed this rule for director fees. For tax years beginning after Dec. 31, 1990, director fees are included in the wage base in the year payment is received. This presents a significant new tax savings opportunity. By deferring salary rather than director fees, a taxpayer may be able not only to defer paying income taxes, but to completely avoid paying Social Security taxes that might otherwise be paid in the year the deferred income is received. In some cases, the tax savings can be substantial.

Social Security taxes have two components: an old age survivors' and disability insurance (OASDI) tax and a Medicare tax. For employee wages, these taxes are often referred to as FICA (Federal Insurance Contribution Act) taxes; for self-employment income (such as corporate director fees), they are known as SECA (Self-Employment Contributions Act) taxes. For 1992, the total Social Security tax rates for employees and self-employed individuals are 7.65% and 15.3%, respectively. The Medicare portions of these rates are 1.45% for employees and 2.9% for self-employed individuals. The rates for employees are half the rates for self-employed individuals because FICA taxes are paid by both the employee and the employer, while SECA taxes are paid entirely by the self-employed individual.

For both employees and self-employed individuals, the 1992 wage base is $55,500 for OASDI and $130,200 for Medicare. Thus, if a taxpayer earns employee wages of more than $130,200 in 1992, the taxpayer will still pay FICA taxes on only $130,200 of wages, producing a maximum 1992 FICA tax of $5,329. If the portion of wages in excess of this amount can be deferred to another year pursuant to a nonqualified deferred compensation (NQDC) plan, the deferred amount will permanently escape FICA tax--even if the deferral is received in a year in which the taxpayer is not above the wage base in effect for that year. (See Sec. 3121(v)(2)(B).)

In contrast, if the same taxpayer (who has over $130,200 of wages in 1992) also has corporate director fees and elects to defer all or a portion of the director fees pursuant to an NQDC plan, the amount deferred will be subject to Social Security taxes in the year received, to the extent the taxpayer's wages and self-employment income for that year are less than the wage base in effect for that year. In addition, because director fees are self-employment income rather than wages, the higher SECA tax rates (12.4% OASDI and 2.9% Medicare) will apply to the deferred amount.

By deferring salaries rather than director fees, a client may be able to permanently save a substantial amount of Social Security taxes. For 1992, savings could be as much as $10,246.60--that is, $8,492 (15.3% on $55,500 of income), and possibly an additional $2,166 (2.9% on up to an additional $74,700 ($130,200 -- $55,500) of income). Over a number of years this could add up to significant savings.