W-2 Reporting of Nonqualified Deferred Compensation
The American Jobs Creation Act of 2004 added a new Section 409A to the Internal Revenue Code which sets out detailed rules that nonqualified deferred compensation plans must follow in order to avoid premature taxation, interest, and penalties. It also amended the wage withholding and reporting sections of the Code to require that employers (1) report annual deferrals under nonqualified deferred compensation plans (regardless of whether such amounts are includible in income for the year) and (2) report and withhold on amounts that are required to be included in income under Section 409A.
See prior FBT updates regarding the new, broader definition of "deferred compensation."
Annual Deferrals to Deferred Compensation Plans
IRS Notice 2007-89 announced that employers are not required to report amounts deferred by or for their employees under nonqualified deferred compensation plans for calendar year 2007 on Form W-2s. In addition, payers to independent contractors are not required to report such amounts on Form 1099-MISCs. For future years, unless the requirement is again waived, employers will be required to report such employee-deferred amounts in box 12 of Form W-2s using code Y, and payers will be required to report such independent contractor-deferred amounts in box 15a of Form 1099-MISCs.
Amounts Paid under Deferred Compensation Plans
Amounts paid to plan participants during 2007 under nonqualified deferred compensation plans should be treated as regular compensation for purposes of tax withholding and reporting under Forms W-2 and 1099-MISC. Note however, that FICA and Medicare taxes, were due when deferred compensation "vests" (or when first deferred in the case of elective salary deferrals) and that, therefore, the income at receipt is just reported as income-taxable wages, not FICA./Medicare.
Amounts Includible in Income Due to Noncompliance with Section 409A
Under Section 409A, amounts voluntarily deferred by an employee or other service provider, or amounts credited by an employer to a plan or agreed program, may be required to be included in income before they are actually paid to participants if the deferred compensation arrangement violates the requirements of Section 409A. If at any time during a taxable year an arrangement fails to meet the rules regarding the timing of deferral elections and the 409A's required fixed time and form for distributions (including the anti-acceleration rules), the compensation (for this and all prior years) is includible in income to the extent not subject to a "substantial risk of forfeiture" (a complex standard described in regulations).
Notice 2007-89 provides that, for violations during 2007, all such amounts should be treated as a payment of wages on December 31, 2007 for purposes of income tax withholding, depositing, and reporting. For employees, these amounts should be included in box 1 of the Form W-2s as wages, reported in box 12 of the Form W-2s as Section 409A income using code Z, and treated as supplemental wages for income tax withholding. For nonemployees, these amounts should be included as nonemployee compensation in box 7 of the Form 1099-MISCs and reported as Section 409A income in box 15b of Form 1099-MISCs.
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The IRS delayed the effective date of final 409A regulations for another year, so we are still in a transition period regarding compliance with the Section 409A final regulations. The deadline to amend plan documents to comply with the final regulations is December 31, 2008. If your deferral arrangement is in "good-faith" compliance with the new laws, or a violation is corrected promptly, income reporting and excise taxes might be avoided. Talk to one of our Employee Benefits/Executive Compensation Practice Group members before reporting unpaid amounts as payments violating 409A, since doing so has expensive tax consequences to the service provider.
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