Source: https://www.irs.gov/businesses/corporations/nonqualified-deferred-compensation-audit-techniques-guide
Timestamp: 2019-04-24 00:31:29+00:00

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Excess Benefit Plans are NQDC plans that provide benefits solely to employees whose benefits under the employer's qualified plan are limited by IRC § 415.
An unfunded arrangement is one where the employee has only the employer's "mere promise to pay" the deferred compensation benefits in the future, and the promise is not secured in any way. The employer may simply keep track of the benefit in a bookkeeping account, or it may voluntarily choose to invest in annuities, securities, or insurance arrangements to help fulfill its promise to pay the employee. Similarly, the employer may transfer amounts to a trust that remains a part of the employer's general assets, subject to the claims of the employer's creditors if the employer becomes insolvent, in order to help keep its promise to the employee. To obtain the benefit of income tax deferral, it is important that the amounts are not set aside from the employer's creditors for the exclusive benefit of the employee. If amounts are set aside from the employer's creditors for the exclusive benefit of the employee, the employee may have currently includible compensation.
A funded arrangement generally exists if assets are set aside from the claims of the employer's creditors, for example in a trust or escrow account. A qualified retirement plan is the classic funded plan. A plan will generally be considered funded if assets are segregated or set aside so that they are identified as a source to which participants can look for the payment of their benefits. For NQDC purposes, it is not relevant whether the assets have been identified as belonging to the employee. What is relevant is whether the employee has a beneficial interest in the assets, such as having the amounts shielded from the employer’s creditors or the employee has the ability use these amounts as collateral. If the arrangement is funded, the benefit is likely taxable under IRC §§ 83 and 402(b).
NQDC plans may be formal or informal, but they must be in writing. While many plans are set forth in extensive detail, some are referenced by nothing more than a few provisions contained in an employment contract. In either event, the form (in terms of plan language) of a NQDC arrangement is just as important as the way the plan is carried out. Review the plan documents to identify provisions that fail to comply with the requirements of IRC § 409A (document compliance). The NQDC plan must also comply with the operational requirements applicable under IRC § 409A(a) (operational compliance). That is, while the parties may have a valid NQDC arrangement on paper, they may not operate the plan according to the plan's provisions.
A NQDC plan examination should focus on when the deferred amounts are includible in the employee's gross income and when those amounts are deductible by the employer. Two principle issues stemming from deferred compensation arrangements include the doctrines of constructive receipt and economic benefit. The Examiner should also address if deferred amounts were properly taken into account for employment tax purposes. The timing rules for income tax and for FICA/FUTA taxes are different. Each of these concerns is discussed below.
I. When are deferred amounts includible in an employee's gross income?
a. Constructive Receipt Doctrine -- Unfunded Plans Cash basis taxpayers must include gains, profits, and income in gross income for the taxable year in which they are actually or constructively received. Under the constructive receipt doctrine [codified in IRC § 451(a)], income although not actually in the taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. See § 1.451-2(a) of the regulations.
b. Economic Benefit -- Funded Plans Under the economic benefit doctrine, if an individual receives any economic or financial benefit or property as compensation for services, the value of the benefit or property is currently includible in the individual's gross income. More specifically, the doctrine requires an employee to include in current gross income the value of assets that have been unconditionally and irrevocably transferred as compensation into a fund for the employee's sole benefit, if the employee has a non-forfeitable interest in the fund.
For purposes of IRC § 83, the term "property" includes real and personal property other than money or an unfunded and unsecured promise to pay money in the future. However, the term also includes a beneficial interest in assets, including money that is transferred or set aside from claims of the creditors of the transferor, for example, in a trust or escrow account.
Property is subject to a substantial risk of forfeiture if the individual's right to the property is conditional on the future performance of substantial services or on the nonperformance of services. In addition, a substantial risk of forfeiture exists if rights in the transferred property are conditioned upon the occurrence of a condition related to a purpose of the transfer and there is a substantial possibility that the property will be forfeited if the condition does not occur.
Property is considered transferable if a person can transfer his or her interest in the property to anyone other than the transferor from whom the property was received. However, property is not considered transferable if the subsequent transferee's rights in the property are subject to a substantial risk of forfeiture.
The employer's compensation deduction is governed by IRC §§ 83(h) and 404(a)(5). In general, the amounts are deductible by the employer when the amount is includible in the employee's income. Interest or earnings credited to amounts deferred under nonqualified deferred compensation plans do not qualify as interest deductible under IRC § 163. Instead, it represents additional deferred compensation deductible under IRC § 404(a)(5).
NQDC amounts are taken into account for FICA tax purposes at the later of when the services are performed or when there is no substantial risk of forfeiture with respect to the employee's right to receive the deferred amounts in a later calendar year. Thus, amounts are subject to FICA taxes at the time of deferral, unless the employee is required to perform substantial future services in order for the employee to have a legal right to the future payment. If the employee is required to perform future services in order to have a vested right to the future payment, the deferred amount (plus earnings up to the date of vesting) is subject to FICA taxes when all the required services have been performed. FICA taxes apply up to the annual wage base for Social Security taxes and without limitations for Medicare taxes.
NQDC amounts are taken into account for FUTA purposes at the later of when services are performed or when there is no substantial risk of forfeiture with respect to the employee's right to receive the deferred amounts up to the FUTA wage base.
A non-account balance plan will not have “hypothetical” bookkeeping accounts that record the employee’s deferrals and employee “contributions” and investment earnings. The amount deferred for a period is not necessarily an amount the worker has elected not to receive. Rather, the amount deferred, and thus required to be taken into account, is the present value of the payments the plan participant has a right to receive in the future. See Treas. Reg. 31.3121(v)(2)-1(c)(2)(i). Conceptually, the plan is similar to a defined benefit plan. Thus, if a NQDC plan credits the deferral with excessive interest, or pays benefits based on unreasonable actuarial assumptions, additional amounts are taken into account when the excessive or unreasonable amounts are credited to the participant's account. If the employer does not take the excess amount into account, then the excess amount plus earnings on that amount are FICA taxable upon payment.
Is there any other written communication between the employer and the employees that sets forth "benefits," "perks," "savings," "severance plans," or "retirement arrangements"?
B. amounts have been set aside for the exclusive benefit of the employee. Amounts are set aside if they are not available to the employer's general creditors if the employer becomes bankrupt or insolvent. Also confirm that no preferences have been provided to employees over the employer's other creditors in the event of the employer's bankruptcy or insolvency. If amounts have been set aside for the exclusive benefit of the employee, or if the employee receives preferences over the employer/service recipient's general creditors, the employee has received a taxable economic benefit. Also verify whether the arrangements result in the employee receiving something that is the equivalent of cash.
Review the executive compensation disclosures in Securities and Exchange Commission filings such as the corporation's proxy statements and exhibits to Form 10-K. These can be located by performing an Edgar search for the company's "DEF 14A" filings. Also, review the notes to the financial statements. If the stockholders are asked to vote on a compensation plan, the proxy for that particular meeting will have an exhibit of the plan as an attachment containing detailed disclosures.
Determine whether the company paid a benefits consulting firm for the executive's wealth management. Review a copy of the contract between the consulting firm and the corporation. Determine who is administering the plan. Determine what documents are created by the administrator and who is maintaining the documents.
Review the ledger accounts/account statements for each plan participant, noting current year deferrals, distributions, and loans. Compare the distributions to amounts reported on the employee's Form W-2 for deferred compensation distributions. Determine the reason for each distribution. Check account statements for any unexplained reduction in account balances. Any distributions other than those for death, disability, or termination of employment need to be explored in-depth, and Counsel may need to be contacted.
The employer's deduction must match the employee’s inclusion of the compensation in income. The employer must be able to show that the amount of deducted deferred compensation matches the amount reported on the Forms W-2 that were furnished and filed for the year. In addition, the employer's deduction may be limited by IRC § 162(m).
Verify that a Schedule M adjustment was made to the Form 1120 for the amount of deferred compensation expensed on the employer's books but was not deductible because the compensation was not includible in income by the employees.
Generally, the current year's deferrals should be adjusted on the Schedule M. Note that the employer may have netted the current year's deferrals against distributions made during the year. This might obscure the amount that is not deductible. In the year the deferred compensation is paid, the employer will make an adjustment on the Schedule M for a deduction that was not expensed on its books that decreases taxable income.
If available, analyze the database of Forms W-2 for discrepancies between Box 1 wages and Box 5 Medicare wages. Generally, Box 1 wages plus 401(k) contributions will equal Medicare wages. If NQDC plans exist, large differences will occur. Excess Medicare wages generally represent current year deferrals of income, while shortages indicate current year distributions. The Kane-Kurz database, which is available on the under LB&I CAS web page “Tom Kane’s W-2/1099 File Analysis,” is programmed to analyze Forms W-2 and generate a report including this information.
Employer matching contributions are offered in some NQDC plans. Any employer contribution should be taken into account for FICA and FUTA taxes at the later of when the services were performed creating the right to that employer contribution or when the contribution is no longer subject to a substantial risk of forfeiture. Additionally, the employer cannot take a tax deduction for the matching contributions until the amounts are includible in the employees' income.
A NQDC plan that references the employer's IRC § 401(k) plan may contain a provision that could cause disqualification of the IRC § 401(k) plan. IRC § 401(k)(4)(A) and Treas. Reg. § 1.401(k)-1(e)(6) provide that an IRC § 401(k) plan may not condition any other benefit (including participation in a NQDC) upon the employee's participation or nonparticipation in the § 401(k) plan. Review NQDC plans looking for a provision that limits the total amount that can be deferred between the NQDC plan and the IRC § 401(k) plan. Also look for any NQDC provision which states that participation is limited to employees who elect not to participate in the § 401(k) plan. Contact Employee Plans in the TEGE Operating Division or Counsel in TEGE if provisions such as these are encountered.

References: § 415
 § 409
 § 409
 § 451
 § 1
 § 83
 § 163
 § 404
 § 162
 § 401
 § 401
 § 401
 § 1
 § 401
 § 401
 § 401
 § 401