Now's the Time to Comply with NQDC Regs: Help Clients Avoid Problems with Nonqualified Deferred Compensation
[ILLUSTRATION OMITTED] EXECUTIVE SUMMARY * IRC [section] 409A and related regulations and guidance have transformed tax treatment of nonqualified deferred compensation (NQDC) by prescribing rules for its election, timing, distribution and funding. Noncompliant plans may subject the plan participant to inclusion of deferred income and an excise tax of 20% of the amount required to be included, plus interest. * Compensation may be considered constructively received by the plan participant unless it is subject to a substantial risk of forfeiture. The rules also restrict under what circumstances distributions may be made, when and in what form. Deferral elections must also follow a stricter regime than formerly. * Many plans are affected, including some that may not previously have been considered deferred compensation. * The IRS has granted transition relief for most provisions until the end of this year, which means CPAs may be called upon now to review plans' compliance. Considerations to be weighed now include making new payment elections, whether elections linked with those of a qualified employer plan should be separated from it and whether to take advantage of grandfathering provisions for amounts that qualify to be exempt from section 409A. ********** In April 2007, the IRS issued final regulations under section 409A pertaining to nonqualified deferred compensation (NQDC) plans. The regulations represent a culmination of efforts to bring uniformity to a field that Congress perceived was too prone to abuse of income timing, especially by executives and other highly compensated individuals. But despite reams of guidance so far, those efforts in Washington are far from over, and many affected companies may be just beginning to comply, as transition relief has extended the effective date of most provisions. CPAs and others administering employee benefits must therefore master this voluminous new body of regulations and help companies and individuals achieve and monitor compliance. Failure to satisfy the regulations' requirements by Dec. 31, 2008, (extended from one year earlier, but note caveats under "Plethora of IRS Guidance") can result in severe consequences. WHAT NQDC Is AND Is NOT IRC [section] 409A, enacted in 2004, and related regulations govern the timing of elections, distributions and funding to avoid inclusion by the "service provider" of deferred income at vesting. It establishes rules for constructive receipt of income deferred under a nonqualified plan. If the plan fails to meet certain requirements or is not operated according to them, then all income deferred under the plan "to the extent not subject to a substantial risk of forfeiture" becomes includible in gross income in the year of the failure. An additional excise tax of 20% of the amount of compensation required to be included may be imposed, plus any interest. "Service provider" most often means an employee, but can also mean a corporate entity Payments to independent contractors with multiple clients usually will not be subject to section 409A, under rules of Treas. Reg. [section] 1.409A-1(1). NQDC doesn't include qualified employer plans, such as a 401(k) retirement plan, or any bona fide vacation leave, sick leave, compensatory time, disability pay or death benefit plan. An NQDC plan has three main requirements: Distributions. The plan must provide that compensation deferred under it may not be distributed earlier than (1) separation from service (with special rules for certain "specified" key employees); (2) the date a participant becomes disabled; (3) death; (4) a time specified under the plan; (5) to the extent provided in the regulations--see Treas. Reg. [section] 1.409A-3(i)(5)--a change in the ownership or effective control of the organization; or (6) an illness, accident, casualty loss or other unforeseeable emergency that creates a financial hardship for the participant. …