Reprint permission from the May, 1994 issue of Crain's Small Business.

It may no longer pay to wait.

Until now, it was smart for a company director to defer receiving director's fees until after retirement, when a lower income tax bracket might apply.

Typically, directors for small companies include principal shareholder owners, who often receive director's fees as part of their compensation packages; minority shareholders or members of a family that owns a business, or outside upper-level managers who have been brought into a company and given a board seat.

Since many companies pay interest on deferred fees, the funds grow as if the director had invested them, but the tax liability is post-poned.

Under the new tax law, however, the advantages of deferred payment may be outweighed by disadvantages.

Deferment might save a director income taxes now, while increasing future taxes on Social Security benefits and self-employment taxes.

Fortunately, an attractive compromise has emerged.

Starting in 1994, if a married taxpayer's "provisional income" -- adjusted gross income (including director's fees when they are received), tax-exempt interest and half of one's Social Security benefits -- is between $32,000 and $44,000, then 50% of the Social Security benefits are taxed.

If provisional income is more than $44,000, the taxable portion jumps to 85%.

So, a director who postpones receiving fees until retirement age might well see his or her Social Security benefits taxed at 85% instead of 50%.

Self-employment tax, including Medicare and Social Security -- known officially as Old Age, Survivor Disability Insurance (OAS-DI) -- poses other problems.

In 1994, self-employment tax is a flat 12.4% of the first $60,600 of earned income.

A director whose earned income exceeds $60,600 will pay no OASDI tax on director's fees taken this year.

One who waits may find the cap raised, the rate raised or other income too small to see the director's fees free of OASDI.

Until this year, Medicare tax applied only to the first $135,000 of earned income.

Now, all earned income is subject to the 2.9% tax.

Those who defer receipt of fees run the risk that future rates and rules may prove even more onerous.

Deciding whether to defer fees is part elbow grease, part prognostication.

For those who simply aren't sure, a compromise may make the most sense.

A director can take fees now, yet defer a portion of them through a Keogh retirement plan.

Contributions under the plan are fully tax-deductible, and its earnings grow tax-free until they are distributed.

Because director's fees are considered self-employed earnings separate from other income, a director may fund a Keogh even if he or she is already covered under another qualified retirement plan.

And now, even "inside" directors (those who own 5% or more of the company) can take advantage of this tax deferral.

The Internal Revenue Service had proposed a controversial regulation that would have treated such a Keogh as an employee benefit plan of any company that retains an inside director, creating all kinds of challenges for the Keogh and the company's other qualified retirement plans.

This proposal was recently withdrawn by the IRS, clearing the way for all directors to pursue this strategy without risk.

Marc J. Lane (mlane@marcjlane.com) is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law.