Post-retirement payments are subject to self-employment tax

The Tax Court's finding that the pay was nonqualified deferred compensation is upheld on appeal.
By Maria M. Pirrone, CPA, LL.M.

The Eleventh Circuit affirmed the decision of the Tax Court that a retired cosmetics sales consultant's distributions from Mary Kay Inc. were subject to self-employment tax because the plan under which the payments were made was characterized as a Sec. 409A deferred compensation plan.

Facts: Christine Peterson was a successful independent beauty consultant for Mary Kay who reached the level of national sales director (NSD). Peterson entered into two company programs whose agreements provided monthly distributions upon completion of five years of NSD service to, and retirement from, Mary Kay. The distribution amounts were primarily based on a percentage of her average commissions before retirement. The agreements stated that each program was intended to be a nonqualified deferred compensation arrangement that was intended to meet the requirements of Sec. 409A. Peterson retired from Mary Kay in 2009 and received payments of $489,707 under the programs, on which she did not pay self-employment tax.

The IRS issued a notice of deficiency, claiming that the payments received by Peterson were subject to self-employment tax, and assessed $33,594 of self-employment tax. The Tax Court upheld the determination of the IRS. Peterson appealed to the Eleventh Circuit.

Issue: Generally, Sec. 409A(d)(1) defines a nonqualified deferred compensation plan as any plan that provides for the deferral of compensation. Regs. Sec. 1.409A-1(b)(1) states in pertinent part that a plan provides for a deferral of compensation where the service provider has a legally binding right to compensation in a later year.

Holding: The Eleventh Circuit held that under the Danielson rule (Danielson, 378 F.2d 775 (3d Cir. 1967)), Peterson was bound by the program agreements' characterization of the program distributions. Thus, the distributions Peterson received were subject to self-employment tax because the program agreements characterized the programs as Sec. 409A nonqualified deferred compensation plans for tax purposes.

Peterson argued that the payments she received were not deferred compensation but rather payments from the sale of her business or payments for entering a covenant not to compete with Mary Kay after retirement. The Eleventh Circuit, however, found that no sales agreement existed. Additionally, the court rejected the argument that the payments were for the covenant not to compete because Peterson sought employment elsewhere within two years of retirement and Mary Kay still made all the payments due under the program.

  • Peterson, No. 14-15773 (11th Cir. 5/24/16)

—By Maria M. Pirrone, CPA, LL.M., assistant professor of accounting and taxation, St. John's University, Queens, N.Y.

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