Recently, the Internal Revenue Service (IRS) released updates to its Audit Technique Guide for Nonqualified Deferred Compensation Plans (Audit Guide). The Audit Guide provides valuable information regarding what the IRS will look at in the event it audits a Nonqualified Deferred Compensation Plan (NQDC Plan). This information is especially valuable in light of the IRS’ recent NQDC Plan audit initiative, which it is likely to expand once it finishes with the initial limited phase.
The IRS is concerned, of course, with whether NQDC Plans are complying with IRS rules regarding NQDC Plan design and operation laid out in Internal Revenue Code (Code) Section 409A. The Audit Guide makes it clear, though, that the IRS is also concerned with the other rules governing NQDC Plans. Those other rules include the following:
- Employment Taxes. Specifically the requirement that FICA (Social Security and Medicare) and FUTA taxes are withheld and paid when deferred compensation vests even though employment taxes are not paid until distribution.
- Violations of the Contingent Benefit Rule. Under the “Contingent Benefit Rule” a 401(k) plan cannot condition any other benefit (such as participation in an NQDC Plan) upon the employee’s participation or non-participation in the 401(k) plan. Some NQDC Plan language can violate this rule by, for example, including a provision limiting the total amount that can be deferred between the NQDC Plan and the 401(k) plan.
- Constructive Receipt. Where an employee has “constructive receipt” of amounts held in the NQDC Plan, he or she will be subject to taxation (and likely penalties) when he or she first obtains constructive receipt.
The IRS might consider amounts held in the NQDC Plan to be constructively received by the employee if he or she has any control over it; for example, the ability to borrow from the account.
The IRS is concerned with both plan design and operation. In addition to the above, the Audit Guide contains numerous reporting and recordkeeping issues that seem minor but have the potential to cause very large problems. It is not enough that your document has been reviewed and vetted—you should also have your plan operations and procedures internally audited.
If you have not had both your plan document and your plan operations reviewed, you should have both completed as soon as possible. In some cases, your ability to correct defects without penalty may expire at the end of any calendar year (depending on the defect and the time of the defect). We would be happy to assist you in auditing your NQDC Plan in all respects.
If you have any questions regarding NQDC Plan design or operation or would like additional information on the IRS’ Audit Guide, please contact your Kutak Rock attorney or a member of the Kutak Rock Employee Benefits practice group.