Nonqualified deferred compensation (NQDC) plans pay executives at some time in the future for services to be currently performed.  If you participate in such a plan, or your business offers one as an employee benefit, it’s critical for everyone involved to abide by the applicable tax rules.  Of course, in the hectic course of the average exec’s schedule, keeping up with the details isn’t always easy.

HOW THEY DIFFER

NQDC plans differ from qualified plans, such as 401(k)s, in a variety of ways.  First, these plans can favor certain highly compensated employees.  And though the executive’s tax liability on the deferred income also may be deferred, the employer can’t deduct the NQDC until the executive recognizes it as income.  What’s more, any NQDC plan funding isn’t protected from the employer’s creditors.

WHAT YOU NEED TO KNOW

NQDC plans also differ in terms of some of the rules that apply to them.  Internal Revenue Code (IRC) Section 409A and related IRS guidance have tightened and clarified some of these rules.  Specifics to study up on include: 

  • Timing of initial deferral elections. Executives must make the initial deferral election before the year they perform the services for which the compensation is earned.  So, for instance, if you wish to defer part of your 2019 compensation to 2020 or beyond, you generally must make the election by the end of 2018.
  • Timing of distributions. Benefits must be paid on a specified date, according to a fixed payment schedule or after the occurrence of a specified event – such as death, disability, separation from service, change in ownership or control of the employer, or an unforeseeable emergency. 
  • Elections to change timing or form. The timing of benefits can be delayed but not accelerated. Elections to change the timing or form of a payment must be made at least 12 months in advance.  Also, new payment dates must be at least five years after the date the payment would otherwise have been made.

EMPLOYMENT TAX ISSUES

Another important NQDC tax issues is that FICA taxes are generally due when services are performed or when there’s no longer a substantial risk of forfeiture, whichever is later.  This is true even if the compensation isn’t paid or recognized for income tax purposes until later years. So, if you’re the plan participant, your employer may withhold your portion of the tax from your salary, or ask you to write a check for the liability.  An employer may also pay your portion, in which case you’ll have additional taxable income.

CONSEQUENCES OF NONCOMPLIANCE

The penalties for noncompliance with NQDC plan rules can be severe.  Plan participants may be taxed on plan benefits at the time of vesting, and a 20% penalty and potential interest charges also will apply.  So, if you’re receiving NQDC, check with your employer to make sure it’s addressing any compliance issues.

PUTTING IT ALL TOGETHER

Whether you’re a busy exec who participates in an NQDC plan or an employer offering one, please contact our firm.  We can help incorporate your plan or other executive compensation into your year-end tax planning.

 

TAX CALENDAR

 

October 15

Personal federal income tax returns that received an automatic six-month extension must be filed today and any tax, interest and penalties due must be paid.

  • The Financial Crimes Enforcement Network (FinCEN) Report 114, “Report of Foreign Bank and Financial Accounts” (FBAR), must be filed by today. If not filed already, for offshore bank account reporting.  (This report received an automatic extension to today if not filed by the original due date of April 17.)
  • If a six-month extension was obtained, calendar-year C corporations should file their 2017 Form 1120 by this date.
  • If the monthly deposit rule applies, employers must deposit the tax for payments in September for Social Security, Medicare, withheld income tax and nonpayroll withholding.

October 31

The third quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is due today and any undeposited tax must be deposited. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 13 to file the return.

  • If you have employees, a federal unemployment tax (FUTA) deposit is due if the FUTA liability through September exceeds $500.

November 15

If the monthly deposit rule applies, employers must deposit the tax for payments in October for Social Security, Medicare withheld income tax, and nonpayroll withholding.

December 17

Calendar-year corporations must deposit the fourth installment of estimated income tax for 2018.

  • If the monthly deposit rule applies, employers must deposit the tax for payments in November for Social Security, Medicare, withheld income tax, and nonpayroll withholding.