Tax Considerations of NQDC Plans: Meeting 409(A) Requirements, Remitting FICA, Vested Withholding Payments

Description

Deferred compensation is the portion of earnings that is earned in one year but paid in another. Contributions can be made by the employee or employer and can include stock, salary, property, other in-kind items, and certain incentive arrangements. Properly structured, deferring compensation allows deferral of income tax on the amount deferred and any interest or investment return credited to the plan.

NQDCs offer employers the flexibility to provide deferred compensation to certain selected employees without the burden of discrimination and compliance testing. With this flexibility comes significant compliance obligations. Section 409A stipulates that these plans must be in writing and must include specifics outlining how and when to pay the amounts deferred. The repercussions of noncompliance are severe and impact both the employer and employee. The amount deferred and its earnings could be immediately taxable to the employee and subject the employee to a 20 percent penalty plus an enhanced underpayment interest penalty.

Unless limited by the plan itself, an NQDC plan has no contribution limits. However, these plans lack the protection from creditors in the event of the employer's insolvency that is afforded qualified deferred compensation plans. Tax professionals working with businesses and individuals participating in or considering these plans must have a solid understanding of these employers' and employees' tax and compliance obligations.

Listen as our panel of deferred compensation experts explains the caveats and considerations of NQDC plans.