Although the tax rules for nonqualified deferred compensation ("deferred comp") plans were overhauled in 2005, it's taken a few years for Uncle Sam to sort through the debris.
Alert: The IRS has issued new proposed regulations providing much-needed guidance. (NPRM REG-148326-5) The new regs explain how employers and employees can determine the tax consequences under comp plans.
The regulations apply to tax years beginning on or after final regs are issued. Other transitional rules may apply.
Here are highlights of the new proposed regs.
Analyze each year separately. If an amount is improperly deferred, all of the plan's prior deferred amounts become taxable, but subsequent deferrals aren't taxable if the plan then complies with the rules. An additional 20% tax is owed on improperly deferred amounts.
Establish the total deferral amount at the end of the employee's tax year. This includes all payments made during the year. Income on deferred comp is counted even though the earnings aren't wages for FICA purposes. The total amount deferred is the present value of all amounts payable under the plan, using reasonable actuarial assumptions.
Amounts deferred during the year of a violation are taxable even if the plan is compliant when the amounts are deferred. Amounts subject to a substantial risk of forfeiture that vest in the same year as the violation are also taxable. For continued failures, any amount improperly deferred from a prior year must be included in that prior year's income.
Determine, for short-term deferrals, if an amount will be paid within 2½ months of the close of the tax year. Amounts aren't currently taxable if the 2½ month period expires in the following year. If the amount hasn't been paid after this period expires, it's taxable in the subsequent year.
Tip: The IRS has also expanded its voluntary correction program for deferred comp plans. (IRS Notice 2008-113)
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