The IRS has issued proposed regulations on failures to comply with the timing rules of Sec. 409A (REG-148326-05). The Service also issued guidance on reporting and withholding requirements for amounts includible in income under Sec. 409A (Notice 2008-115).
Sec. 409A generally provides that if certain requirements are not met at any time during a tax year, amounts deferred under a nonqualified deferred compensation (NQDC) plan for that year and all previous tax years are currently includible in the service provider's (i.e., the employee's) gross income to the extent they are not subject to a substantial risk of forfeiture and were not previously included in gross income.
Final regulations under Sec. 409A took effect January 1, 2009, but the final regulations do not address the calculation of the amount includible in income under Sec. 409A if a plan fails to meet the Sec. 409A requirements. The final regulations also do not address how to calculate the additional taxes applicable to such income. The proposed regulations address the calculation of these amounts and related issues. Notice 2008-115 provides interim guidance on these calculations for tax years beginning in 2008.
Note: The proposed regulations and the notice do not address the application of Sec. 409A(b), which generally applies to a transfer of assets to a trust, or to a restriction of assets, for purposes of paying NQDC, in certain circumstances.
Subsequent Compliance After Failure to ComplyOne question the proposed regulations address is how Sec. 409A(a) applies if a plan fails to comply during a tax year and the service provider continues to have amounts deferred under the plan in subsequent years during which the plan otherwise complies with Sec. 409A(a). The language of Sec. 409A could be construed to provide that a failure is treated as continuing during tax years beyond the year in which the initial failure occurred, if the failure continues to affect amounts deferred under the plan.
To prevent this result, under the proposed regulations, a failure to meet the requirements of Sec. 409A(a) during a service provider's tax year generally would not affect the taxation of amounts deferred under the plan for a subsequent tax year during which the plan complies with Sec. 409A(a). This would be true even though the amount deferred under the plan includes amounts deferred during years the plan failed to comply with Sec. 409A(a), as long as there was no failure under the plan in a later year. Because there would be no continuing or permanent failure with respect to a plan that fails to comply with Sec. 409A(a) during an earlier year, each tax year would be analyzed independently to determine if there was a failure. As a result, assessment of tax liabilities due to a plan's failure to comply with the requirements of Sec. 409A(a) in a closed year would be time barred.
Nonvested AmountsUnder the proposed regulations, if all a taxpayer's deferred amounts under a plan are nonvested and the taxpayer makes an impermissible deferral election or accelerates the time of payment for some or all of the nonvested deferred amount, the nonvested deferred amount generally would not be includible in income under Sec. 409A(a) in the year of the impermissible change in time and form of payment. However, if vested amounts were deferred under the plan, these amounts would be includible in income under Sec. 409A(a). In the subsequent tax year in which the service provider becomes vested in the deferred amount, the plan might comply with Sec. 409A(a) in form and in operation so that no income inclusion would be required and no additional taxes would be due for that year as a result of the late deferral election or acceleration of payment.
In proposing to adopt this interpretation of Sec. 409A, the Service does not intend to create an opportunity for taxpayers who ignore the requirements of Sec. 409A(a) with respect to nonvested amounts to avoid the payment of taxes that would otherwise be due as a result of such a failure to comply. To ensure that this rule does not become a means for taxpayers to ignore the Sec. 409A requirements, the proposed regulations would disregard a substantial risk of forfeiture for purposes of determining the amount includible in income under Sec. 409A with respect to certain nonvested deferred amounts, if the facts and circumstances indicate that the service recipient (i.e., the employer) has a pattern or practice of permitting such impermissible changes in the time and form of payment for nonvested deferred amounts (regardless of whether such changes also apply to vested deferred amounts).
Reporting and Withholding RequirementsNotice 2008-115 provides guidance to payors and employers on their reporting and wage withholding requirements for amounts includible in income under Sec. 409A. It also provides guidance on reporting requirements for deferrals of compensation.
Under the notice, an employer is not required to report amounts deferred under an NQDC plan in box 12 of Form W-2 using code Y. A payor is not required to report such amounts in box 15a of Form 1099-MISC.
Employers must treat amounts includible in income under Sec. 409A as wages for income tax withholding purposes. The employer reports such amounts in box 12 of Form W-2 using code Z. These amounts are treated as supplemental wages for determining the amount of tax that must be withheld under Sec. 3402(a). (They are treated as supplemental wages regardless of whether the employer paid the employee any regular wages during the year.)