§409A Reporting & Withholding Guidance For Nonqualified Deferred Compensation
Tax Alert, January 2007  

Many employers provide deferred compensation arrangements for their executives. There are various names for nonqualified deferred compensation, including SERPs, phantom stock, SAR Plans, etc. The 2004 American Jobs Creation Act added Section §409A to the Internal Revenue Code — §409A places restrictions on deferred compensation plans. The §409A rules also require new informational reporting and wage withholding obligations and place limitations on other facets of plan design. Penalties for noncompliance are severe — immediate taxation of deferred amounts and substantial penalties that are assessed to the executive, not the employer.

This Tax Alert will focus on the recent interim IRS guidance regarding informational reporting and wage withholding obligations for nonqualified deferred compensation plans. For 2006, employers must comply with the wage withholding requirements. The informational reporting obligations have once again been suspended for 2005 and 2006.

Informational Reporting

The IRS has once again suspended the informational reporting obligations for 2005 and 2006, which would have required employers to also report annual deferrals under a nonqualified deferred compensation plan subject to §409A that are not currently includible in income.

• Employees
  • Employers will be required to include information on employee deferrals on Form W-2 using code Y in box 12.
  • Section 409A did not change Social Security and Medicare wage reporting (collectively, FICA reporting). Amounts deferred will continue to be subject to FICA taxation, generally in the year vested. Employers should continue to report Social Security and Medicare wages from nonqualified deferred compensation plans in boxes 3, 5, and 11 of Form W-2, as appropriate.
• Independent Contractors
  • Information on deferrals for independent contractors will be required to be reported on Form 1099-MISC in box 15a.

If a plan fails to comply with §409A, employers and other payers must now report deferred amounts that were includible in income in 2005 and are includible in 2006. Additionally, employers must withhold income tax for amounts includible in income under §409A for 2006.

If you suspect failure to comply with §409A has occurred, you should consult with legal counsel or a consultant before reporting §409A failures to determine if any exceptions apply.

• Employees
  • Amounts required to be included in gross income due to a failure to comply with §409A will be reported in box 1 of Form W-2, in addition to any other compensation received that year.
  • Such amounts will also be reported in Box 12 of Form W-2 using code Z.
  • An employer must also report such amounts as wages on Form 941, line 2, Employer’s Quarterly Income Tax Return.
  • Amounts includible in gross income under §409A are supplemental wages for purposes of determining the amount of income tax required to be deducted and withheld under §3402.
  • Such amounts will be subject to an additional tax, which will be reported on Form 1040.
  • The amount of income tax should be reported in box 2 of Form W-2, in addition to any other income tax owed that year.
• Independent Contractors
  • Amounts required to be included in gross income due to a failure to comply with 409A will be reported in box 7 of Form 1099-MISC, in addition to any other compensation received that year.
  • Such amounts will also be reported in box 15b of Form 1099.
  • Such amounts will generally be subject to SECA taxation at the time such amount is includible in gross income.

Plans Not in Compliance With §409A — Reporting 2005 Amounts

• Employers and payers are required to file a corrected (or original) information return and furnish an original or corrected payee statement (Form W-2 or 1099-MISC) for calendar year 2005.
• Generally, the corrected (or original) payee statement must be furnished by January 31, 2007 and the corrected (or original) information return must be filed by February 28, 2007.
• An employer or payer is not liable for income tax withholding or penalties for amounts reported on Form W-2 or 1099-MISC for 2005.
• Failure to file information returns and furnish payee statements as specified may result in penalties.

Action Plan

1. Make sure all Nonqualified Deferred Compensation Plans have been reviewed for 409A compliance.
2. All elections by participants to electively defer compensation in 2007 must be made by December 31, 2006.
3. Do not make any changes to the timing or form of distributions without contacting your consultant or legal counsel.
4. Prepare to have plan documentation amended by December 31, 2007.