IRS Publishes NQDC Plan Audit Guide

The Internal Revenue Service (IRS) has published the Nonqualified Deferred Compensation Audit Techniques Guide (June 2015).

Good for plan rules through its June 9 publication date, the guide serves as an alert for plan sponsors about what auditors will examine and as a reminder of nonqualified deferred compensation (NQDC) plan rules.              

For example, examiners are told to look at when deferred amounts are includible in an employee’s gross income. Under the constructive receipt doctrine, for unfunded plans, 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.

Under the economic benefit doctrine, for funded plans, 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.

In general, compensation amounts are deductible by the employer when the amount is includible in the employee’s income.

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.

Among the specific items they are told to review, IRS agents will look to see if the employer's compensation deduction matches 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, agents will review the ledger accounts/account statements for each plan participant, noting current year deferrals, distributions, and loans, and compare the distributions to amounts reported on the employee's Form W-2 for deferred compensation distributions. The agents will determine the reason for each distribution, and 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 IRS says.

The agency notes that a NQDC plan that references the employer's 401(k) plan may contain a provision that could cause disqualification of the 401(k) plan. Regulations provide that 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. Examiners will look for NQDC plan provisions that limit the total amount that can be deferred between the NQDC plan and the 401(k) plan, as well as any which state that participation is limited to employees who elect not to participate in the 401(k) plan.

The NQDC audit guide is here.