Are You Entitled to a Tax Refund From Your Supplemental Executive Retirement Plan (SERP)?

Many companies offer executives supplemental executive retirement plans (SERPs). SERPs are a way to reward and retain key employees and executives whose qualified plan contributions are limited. As nonqualified plans, SERPs are designed to provide benefits beyond those covered in other retirement plans like an IRA or 401(k).

Now, a recent Ohio Supreme Court decision has shed some much-needed light on SERP tax liability—and the implications bode well for SERP owners.

If you are from Ohio you know too well most cities in this state have an income tax— 235 to be exact. And you have probably received a letter or two from the city tax department where you live or work.

For one retired bank executive, that letter was a bill from the city of Cleveland to the tune of $182,140.26.

In MacDonald v. Cleveland Income Tax Bd. of Rev., having worked at National City Corporation for 38 years, most recently as one of its top executives— Mr. MacDonald was entitled to participate in the company’s SERP.

The present value of the SERP future payments was reported to Mr. MacDonald in his 2006 W-2 for Medicare tax purposes. He did not pay any federal income tax on the SERP in 2006 because he did not begin receiving payments until 2007, and federal income tax is only imposed when payments are received.

The city of Cleveland, however, assessed tax on the present value of those future payments.

Had the city taxed each payment when received, maybe Mr. MacDonald would not have kicked up much of a fuss— but that big tax bill likely prompted his protesting of the assessment— and the question of whether a SERP is subject to Cleveland’s income tax made it all the way to the Ohio Supreme Court.

Cleveland city ordinance unambiguously excludes “pensions” from income tax. The exclusion is meant to encompass amounts “not in the nature of compensation for services rendered.” The city of Cleveland maintained that the exclusion does not apply to the SERP for four reasons— but mainly that the SERP is compensation for services rendered (i.e. “qualifying wages”), and that it is specifically taxable as a nonqualified deferred-compensation plan under another city ordinance.

The court reasoned that virtually any pension comes about as a result of someone having performed services for an employer. The phrase “compensation for services rendered” therefore must have a more limited scope than that which Cleveland gives it. And, although considered a nonqualified deferred compensation plan under federal law, Mr. MacDonald’s SERP did not involve any deferral of current wages owed or set aside in a segregated account by the employer.

The court concluded that the definition of “qualifying wages” in Cleveland Codified Ordinances does not override the exclusion of the SERP from the city income tax as a pension. As a result, Mr. Macdonald’s SERP income is not subject to Cleveland city income tax.

If you live in Ohio and have a SERP, you may be entitled to a refund. The tax professionals at Marcum can review your city income tax returns to see if you paid tax on your income from your SERP and determine if you are eligible for a refund. To schedule your review, contact your Marcum representative at (855) MARCUM1.