IRS Updates NQDC Audit Guide

For the first time in more than a decade, the IRS has published an update for its Audit Technique Guide for Nonqualified Deferred Compensation Plans.

An analysis by Winston & Strawn LLP notes that the IRS ATG highlighted several key areas where the IRS continues to see problems — and which it may be important to inform clients — notably:

• The Timing of FICA and FUTA Tax Withholding. Deferred amounts are taxable for FICA and FUTA at the later of either: (1) when the services creating the right to the amounts are performed; or (2) when the amounts are no longer subject to a substantial risk of forfeiture.

• Violations of the Contingent Benefit Rule. Since a 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, the ATG suggests that IRS reviewers will be “looking for a provision that limits the total amount that can be deferred between the NQDC plan and the IRC §401(k) plan,” and “any NQDC provision which states that participation is limited to employees who elect not to participate in the §401(k) plan.”

• Constructive Receipt. If the employee may borrow, transfer or use the amounts as collateral, or there may be some other signs of ownership exercisable by the employee, which should result in current taxation for the employee.

Reporting and Recordkeeping

A little further off the beaten path, the ATG also highlights some of reporting and recordkeeping issues, including verifying that:

• The amount of deducted deferred compensation matches the amount reported on the Forms W-2 that were furnished and filed for the year.

• 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.

• The employer made appropriate Schedule M adjustments in prior years for amounts distributed and for which the employer took a deduction in the current year.

• For current year distributions that are excluded from wages for FICA taxes, that these amounts were taken into account in prior years.

• Current year distributions are reported in Box 1 as wages on Form W-2 and are also reported in Box 11.