[Federal Register Volume 64, Number 19 (Friday, January 29, 1999)]
[Rules and Regulations]
[Pages 4542-4568]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1663]
[[Page 4542]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 31 and 602
[TD 8814]
RIN 1545-AT27
Federal Insurance Contributions Act (FICA) Taxation of Amounts
Under Employee Benefit Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations under section
3121(v)(2) of the Internal Revenue Code (Code) that provide guidance as
to when amounts deferred under or paid from a nonqualified deferred
compensation plan are taken into account as wages for purposes of the
employment taxes imposed by the Federal Insurance Contributions Act
(FICA). Section 3121(v)(2), relating to treatment of certain
nonqualified deferred compensation, was added to the Code by section
324 of the Social Security Amendments of 1983. These regulations
provide guidance to employers who maintain nonqualified deferred
compensation plans and to participants in those plans.
DATES: Effective Date: These regulations are effective January 29,
1999.
Applicability Date: These regulations are applicable on and after
January 1, 2000. In addition, these regulations provide certain
transition rules for amounts deferred and benefits paid before January
1, 2000, including allowing employers to use a reasonable, good faith
interpretation of section 3121(v)(2).
FOR FURTHER INFORMATION CONTACT: Janine Cook, Linda E. Alsalihi, or
Margaret A. Owens, (202) 622-6040 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this final rule has been
reviewed and, pending receipt and evaluation of public comments,
approved by the Office of Management and Budget (OMB) under 44 U.S.C.
3507 and assigned control number 1545-1643.
The collection of information in this regulation is in
Sec. 31.3121(v)(2)-1(b)(2). This information is required to implement
Code section 3121(v). This information will be used to identify the
material terms of a plan. The collection of information is required to
obtain a benefit. The likely recordkeepers are business or other for-
profit institutions.
Comments on the collection of information should be sent to the
Office of Management and Budget, Attn: Desk Officer for the Department
of the Treasury, Office of Information and Regulatory Affairs,
Washington, DC 20503, with copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.
Comments on the collection of information should be received by March
30, 1999.
Comments are specifically requested concerning:
Whether the collection of information is necessary for the proper
performance of the functions of the IRS, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the collection
of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the collection of information may
be minimized, including through the application of automated collection
techniques or other forms of information technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The estimated total annual recordkeeping burden for
Sec. 31.3121(v)(2)-1(b)(2) is 12,500 hours. The annual estimated burden
per recordkeeper varies from 2 hours to 10 hours, depending on the
individual circumstances, with an estimated average of 5 hours. The
estimated number of recordkeepers is 2,500.
Estimates of the reporting burden in Sec. 31.3121(v)(2)-1(f) and
(g) are reflected in the burden estimates of Form 941, Employer's
Quarterly Federal Tax Return, Form 941c, Supporting Statement To
Correct Information, Form W-2, Wage and Tax Statement, and Form W-2c,
Corrected Wage and Tax Statement.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
These regulations amend the Employment Tax Regulations (26 CFR part
31) under section 3121(v)(2). Section 3121(v)(2) was added to the
Internal Revenue Code (Code) by section 324 of the Social Security
Amendments of 1983 (1983 Amendments). Section 2662(f)(2) of the Deficit
Reduction Act of 1984 (DEFRA) amended section 324 of the 1983
Amendments.
Notice 94-96 (1994-2 C.B. 564) provides that until final
regulations are issued, the IRS will not challenge an employer's
determination of FICA tax liability with respect to a nonqualified
deferred compensation plan for periods before the effective date of any
final regulations if the determination is based on a reasonable, good
faith interpretation of section 3121(v)(2). On January 25, 1996, a
notice of proposed rulemaking (EE-142-87) under section 3121(v)(2) was
published in the Federal Register (61 FR 2194), providing guidance
related to the Federal Insurance Contributions Act (FICA) tax treatment
of amounts deferred under or paid from certain nonqualified deferred
compensation plans. On December 24, 1997, a notice of proposed
rulemaking (REG-209484-87 and REG-209807-95) under section 3121(v)(2)
extending the proposed general effective date of the regulations to
January 1, 1998, was published in the Federal Register (62 FR 67304).
Comments regarding the 1996 proposed regulations were received from
the public, and on June 24, 1996, the IRS held a public hearing
concerning the proposed amendments. After consideration of the public
comments received and the statements made at the public hearing, the
proposed regulations are adopted as revised by this Treasury decision.
Explanation of Provisions
Sections 3101 and 3111 impose FICA tax on employees and employers,
respectively. FICA tax consists of the Old-Age, Survivors, and
Disability Insurance (OASDI) tax and the Hospital Insurance (HI) tax.
Generally, FICA tax is computed as a percentage of wages (as defined in
section 3121(a)) with respect to employment. Subject to specific
exceptions, section 3121(a) defines wages as all remuneration for
employment. Section 31.3121(a)-2(a) provides that FICA tax is imposed
at the time the remuneration is actually or constructively paid.
1983 Amendments
Prior to the 1983 Amendments, benefits under a nonqualified
deferred
[[Page 4543]]
compensation plan generally were wages subject to FICA tax at the time
they were actually or constructively paid, unless certain retirement-
related exclusions applied. These exclusions (former section
3121(a)(2)(A), (a)(3), and (a)(13)(A)(iii)) were repealed by the 1983
Amendments. Thus, under the 1983 Amendments, which generally apply to
remuneration paid after December 31, 1983, retirement payments are no
longer excluded from wages. Instead, the 1983 Amendments added section
3121(v)(2), which provides a special timing rule for wages (within the
meaning of section 3121(a)) that constitute an amount deferred under a
nonqualified deferred compensation plan.\1\
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\1\ The 1983 Amendments did not amend the definition of net
earnings from self-employment under section 1402(a) or the timing of
the tax on self-employment income under section 1401. Accordingly,
the special timing rule under section 3121(v)(2) does not apply to
nonqualified deferred compensation that constitutes net earnings
from self-employment.
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Under section 3121(v)(2)(A), any amount deferred under a
nonqualified deferred compensation plan must be taken into account as
wages for FICA tax purposes as of the later of (1) when the services
are performed or (2) when there is no substantial risk of forfeiture of
the rights to such amount. This special timing rule may result in
imposition of FICA tax before the benefit payments under the plan
begin.
Section 3121(v)(2)(B) provides a special exclusion (the
nonduplication rule) that prevents double taxation. Once an amount
deferred under a nonqualified deferred compensation plan is taken into
account as wages under the special timing rule, the nonduplication rule
provides that neither that amount nor the income attributable to that
amount is again treated as FICA wages. Thus, benefit payments under a
nonqualified deferred compensation plan are not subject to FICA tax
when actually or constructively paid (i.e., under the general timing
rule for wage inclusion) if the benefit payments consist of amounts
deferred under the plan that were previously taken into account as FICA
wages under the special timing rule plus attributable income.
Conversely, benefits under a nonqualified deferred compensation plan
are subject to FICA tax when actually or constructively paid to the
extent the benefits relate to an amount deferred that was not
previously taken into account under the special timing rule.
Repeal of Wage Based Limitation
Section 3121(a)(1) imposes a dollar limit on the annual amount of
wages subject to the OASDI portion of FICA tax. Section 13207 of the
Omnibus Budget Reconciliation Act of 1993 repealed the dollar limit on
the annual amount of wages subject to the HI portion of FICA tax,
effective for 1994 and later years.
Application of these Regulations to Taxes Imposed by the Railroad
Retirement Tax Act
In accordance with the cross-reference in section 3231(e)(8)(B),
the provisions of section 3121(v)(2) and these final regulations also
apply for purposes of the taxes imposed by the Railroad Retirement Tax
Act under sections 3201 through 3231.
Overview of Final Regulations
In general, comments received on the proposed regulations were
favorable and, accordingly, the final regulations retain the general
structure and substance of the proposed regulations, including a wide
variety of examples illustrating the substance of the final
regulations. However, commentators made a number of specific
recommendations for modifications and clarifications of the
regulations. In response to these comments, the final regulations
incorporate the modifications and clarifications described below.
The proposed regulations provided that certain types of
benefits do not result from the deferral of compensation and,
accordingly, are not subject to the special timing rule under section
3121(v)(2). The final regulations generally retain these rules.
However, in response to comments, the final regulations allow certain
cost-of-living adjustments provided to former employees to be treated
as deferred compensation for purposes of section 3121(v)(2) and provide
transition relief for window programs that begin before the effective
date of the final regulations. The final regulations also clarify the
rules under which stock options, death benefits, disability benefits,
and severance pay are excluded from the special timing rule.
The final regulations retain the distinction between the
method of calculating the amount deferred (and the income on that
amount) for account balance plans and the method for nonaccount balance
plans, but provide additional guidance simplifying those calculations.
The final regulations provide that a plan that bases benefits on an
account balance but permits optional forms (such as annuities) can use
the simple methodology that applies to account balance plans if the
plan terms preclude a subsidized optional form. Also, a nonaccount
balance plan that provides multiple benefit distribution options or
commencement dates under plan terms that preclude subsidized optional
forms and commencement dates can determine the amount deferred by
assuming that a participant elects to receive the normal form of
payment (regardless of which option is actually elected).
The final regulations clarify the rules governing when
income under an account balance plan is excluded from FICA wages. The
final regulations also provide that, while the determination of whether
an account balance plan is using a reasonable interest rate generally
is made annually, a rate that is specified for a fixed period of up to
five years is treated as reasonable for that period if it was
reasonable when it was specified (even if it ceases to be reasonable
during the period for which it is specified).
The final regulations retain the structure of the rules in
the proposed regulations under which FICA tax payments are not required
to be made on amounts that are not reasonably ascertainable until
certain uncertainties related to benefit payments are resolved. Those
rules permit earlier inclusion with a true-up at the resolution date,
when those uncertainties are resolved. However, the final regulations
modify the calculation of the true-up to eliminate the risk that
additional amounts will have to be taken into account at the resolution
date because of changes in interest rates between the early inclusion
date and the resolution date.
The final regulations permit an employer to choose how the
amounts deferred under a plan over a series of years can be allocated
among those years when the plan formula does not do so by its terms
(for example, where the plan has a benefit formula that includes an
offset of another plan's benefit).
The final regulations retain the flexibility provided in
the proposed regulations permitting an employer to delay the date on
which amounts deferred are taken into account to a later date within
the year, and also broaden and simplify two options that provide
additional time to calculate the amount deferred. The first option
permits an employer to estimate the amount deferred and then adjust it
at any time within three months. Alternatively, FICA tax payment can be
postponed by treating the entire amount deferred as if it were deferred
on a date that is within
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three months of the date the amount is otherwise required to be taken
into account, provided that the amount deferred is increased by
interest at the applicable federal rate \2\ (AFR) until it is included
in wages.
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\2\ The regulations define the applicable federal rate as the
mid-term applicable federal rate, as defined pursuant to section
1274(d), for January 1 of the calendar year, compounded annually.
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The final regulations include a number of special
transition rules that provide relief to employers that, prior to the
effective date of the regulations, followed a reasonable, good faith
interpretation of section 3121(v)(2). Under the final regulations,
amounts deferred for 1994 and 1995 can be taken into account, without
interest, as late as March 31, 2000. Further, the final regulations
reflect the transition rule in the proposed regulations under which
amounts deferred that would have been required or permitted to be taken
into account before 1994 are treated as having been correctly taken
into account before 1994.
Summary of Comments Received and Changes Made
a. Application of the Special Timing Rule
The special timing rule provided under section 3121(v)(2) is set
forth in paragraph (a) of the regulations. The special timing rule
imposes FICA tax on amounts deferred under nonqualified deferred
compensation plans at the later of the date when the services creating
the right to the amount deferred are performed and the date on which
the right to that amount is no longer subject to a substantial risk of
forfeiture. This date usually is earlier than when any benefit is paid.
Several commentators requested clarification as to whether the special
timing rule is elective and whether failure to comply with the special
timing rule may lead to the imposition of interest or penalties. The
special timing rule is not elective and, if an employer does not take
an amount deferred into account (including payment of any resulting
FICA tax) when required by section 3121(v)(2), interest and penalties
may be imposed. Moreover, to the extent that the amount deferred is not
taken into account in accordance with the special timing rule, the
nonduplication rule, under which amounts deferred that are properly
taken into account under the special timing rule are excluded from FICA
wages upon payment, does not apply.
b. Amounts or Benefits That Do Not Result From the Deferral of
Compensation
The definition of a nonqualified deferred compensation plan for
purposes of section 3121(v)(2) is set forth in paragraph (b) of the
regulations. A number of comments were received on the rules in the
proposed regulations for determining whether an amount or benefit
results from the deferral of compensation subject to the special timing
rule of section 3121(v)(2). The final regulations make several
clarifications and changes to reflect these comments. The regulations
clarify that the grant (as well as the exercise) of stock options,
stock appreciation rights, and other stock value rights generally is
not subject to section 3121(v)(2). Thus, FICA tax is not imposed at the
time of grant, but is generally imposed at the time of exercise. No
inference is intended as to whether or not these options and rights are
deferred compensation for any tax purposes other than section
3121(v)(2).
The final regulations retain the rule in the proposed regulations
that benefits established after termination of employment are not
subject to section 3121(v)(2). However, in response to comments, the
final regulations provide an exception under which certain payments to
which the employee obtains a legally binding right after termination of
employment that are in the nature of cost-of-living adjustments are
nonetheless subject to section 3121(v)(2).
The final regulations retain the rule in the proposed regulations
that window benefits do not result from the deferral of compensation.
However, the final regulations include a transition rule under which
window benefits can be treated as subject to section 3121(v)(2) if the
window program commences prior to January 1, 2000 (the general
effective date of the final regulations). Payments made pursuant to a
window program that qualifies for the transition rule are not subject
to FICA tax under the general timing rule at the time payment is made,
provided that the present value of the window benefits has been taken
into account under section 3121(v)(2) on a timely basis.
c. Account Balance Plans
Paragraph (c) of the regulations defines account balance plan and
provides that, for purposes of section 3121(v)(2), the amount deferred
under an account balance plan generally is based on the amount of
principal credited to the account. Commentators asked whether a plan
that permits optional forms of benefit can be treated as an account
balance plan. The final regulations provide that if the plan's terms
preclude subsidies of optional forms of benefit (for example, if, under
the terms of the plan at the time the amount is deferred, alternative
forms of payment will be actuarially equivalent to the account balance
based on a rate of interest that will be reasonable at the time the
optional form is elected), the plan does not fail to be an account
balance plan merely because of the availability of optional forms of
benefit.
d. Income and Reasonable Rate of Interest
Under paragraph (d) of the proposed regulations, if an account
balance plan credits income based on a reasonable rate of interest or a
rate of return that does not exceed the rate of return on a
predetermined actual investment specified under the plan, FICA tax
would not be imposed on that income. A number of commentators requested
clarification as to whether a rate of interest that was fixed for an
extended period could be reasonable for this purpose. The final
regulations clarify that the determination of whether interest credited
under an account balance plan is reasonable is generally made annually.
However, a rate that is specified for a fixed period of up to five
years and that was reasonable when it was specified is treated as
continuing to be reasonable (even if it subsequently ceases to be
reasonable during the period for which it is specified).
The final regulations also clarify what constitutes a predetermined
actual investment and provide rules for determining the amount deferred
in cases in which income is credited under a plan that uses neither a
predetermined actual investment nor a reasonable interest rate. In
these cases, the final regulations generally provide for the income
credited in excess of AFR to be treated as an additional amount
deferred. However, the final regulations provide that if the employer
takes into account as an additional amount deferred the income credited
to the extent it exceeds a reasonable rate of interest calculated by
the employer, the remaining income (which is no greater than a
reasonable rate of interest) is excluded from FICA wages.
Some commentators suggested that the employer's creditworthiness
should be permitted to be considered in determining whether the
interest rate credited under a plan of the employer is reasonable. The
final regulations, like the proposed regulations, permit the amount
deferred to be calculated after application of a discount to reflect
the
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time value of money and the risk that benefits will not be paid due to
death. However, no discount is permitted for the risk that the amount
deferred will not be paid by the employer. Permitting employers to
implicitly achieve the same result through the interest rate credited
under an account balance plan would be inconsistent with this
restriction. Accordingly, the final regulations do not permit the
employer's creditworthiness to be considered in determining whether the
interest rate credited under a plan of the employer is reasonable.
e. Treatment of Amounts Deferred That Are Not Reasonably Ascertainable
Paragraph (e) of the final regulations retains the rule in the
proposed regulations that the amount deferred need not be taken into
account until it is reasonably ascertainable. This rule addresses the
difficulty of determining the appropriate amount to be taken into
account for a plan that provides benefits that are not fixed until
certain future events occur, such as a nonaccount balance plan with
subsidized optional forms or a long-term incentive plan that depends on
subsequent corporate performance. The final regulations retain the rule
in the proposed regulations that allows optional inclusion of these
amounts at an earlier date with a true-up at the resolution date when
the amount deferred becomes reasonably ascertainable.
Under the proposed regulations, the early inclusion amount was to
be accumulated to the resolution date at an interest rate (and with a
mortality assumption, if appropriate) that was reasonable at the early
inclusion date. That accumulated amount was then compared to the
present value of payments using actuarial assumptions that were
reasonable at the resolution date. This methodology exposes the
employer to the risk that an additional amount could be required to be
taken into account at the resolution date solely as a result of changes
in interest rates between the early inclusion date and the resolution
date. In response to comments, this true-up methodology has been
modified.
Under the final regulations, in performing the true-up, the amount
taken into account at the early inclusion date is converted to an
actuarially equivalent benefit payment stream in the form, and with the
commencement date, in which benefits are actually paid. The conversion
is done using actuarial assumptions that were reasonable as of the
early inclusion date. The benefit payment stream thus derived is
compared to the benefits actually payable. To the extent the benefit
payment stream actually payable exceeds the benefit payment stream that
is actuarially equivalent to the amount taken into account at the early
inclusion date, the present value of the excess (determined using
actuarial assumptions that are reasonable as of the resolution date)
must be taken into account on the resolution date. If the benefit
payment stream that is actuarially equivalent to the amount taken into
account at the early inclusion date equals (or exceeds) the actual
benefit payment stream, no additional amount is required to be taken
into account at the resolution date, regardless of any changes in
interest rates between the early inclusion date and the resolution
date. This method--an annuity purchase model--eliminates the risk that
the employer will be required to take additional amounts into account
merely because of interest rate changes between the early inclusion
date and the resolution date.
In addition, the final regulations provide that an amount deferred
under certain nonaccount balance plans that permit optional forms of
benefit or alternative commencement dates will not fail to be
reasonably ascertainable merely because the form or commencement date
has not been selected. If the terms of a nonaccount balance plan, at
the time an amount is deferred, provide that the amount payable under
each optional form and commencement date will be equivalent using
actuarial assumptions that are reasonable at the resolution date
(generally, the time the optional form and commencement date are
selected) the amount deferred can be calculated based solely on the
normal form of payment commencing at normal commencement date
(regardless of which optional form or commencement date is ultimately
selected). For this purpose, the normal form of benefit commencing at
normal commencement date is the form and date of commencement under
which the payments due to an employee under the plan are expressed,
before adjustments for form or timing of commencement of payments.
The final regulations clarify how to allocate amounts deferred
among periods for purposes of the early inclusion rules, including a
rule requested by commentators concerning plan offsets. For example,
the final regulations provide a rule to determine how amounts deferred
are to be allocated among years in cases in which an employee obtains a
legally binding right in each of several years to receive payments from
a nonqualified deferred compensation plan that provides a specified
gross benefit for the years which is to be offset by the benefits
payable under a qualified plan. Under this rule, the amount deferred in
the first year may be treated as equal to the gross benefit for the
year, reduced by the offset applicable at the end of the first year
(even if the offset increases after the end of that year). The same
method applies to subsequent years, with adjustments for amounts
allocated to an earlier year.
The regulations also retain the rule of administrative convenience
that was in the proposed regulations under which the amount deferred
during a year can be treated as required to be taken into account at
any later date during the year, provided that income attributable to
the amount deferred through that date is included. Thus, in a
nonaccount balance plan this rule permits the present value of amounts
deferred throughout a year to be determined as of the end of the year
based on the employee's age and appropriate actuarial assumptions at
the end of the year.
f. Withholding Rules
For purposes of withholding and depositing FICA tax, paragraph (f)
of the final regulations provides that an amount deferred under a
nonqualified deferred compensation plan generally is treated as wages
paid by the employer and received by the employee at the time it is
taken into account under section 3121(v)(2) and these regulations.
However, in certain situations, the employer may be unable to readily
calculate the amount deferred for a given year by December 31 of that
year. The proposed regulations provided relief in these situations by
allowing employers to use either of two alternative methods, the
estimated method and the lag method, for withholding and depositing
FICA tax.
The final regulations provide broader relief by permitting these
methods to be used as of any date during the year and for the methods
to be available without regard to whether the amount deferred can be
readily calculated. Thus, the final regulations provide that, under the
estimated method, an employer may make a reasonable estimate of the
amount deferred as of the date the amount deferred is required to be
taken into account. If the employer underestimates the amount deferred
that should have been taken into account and, therefore, deposits less
FICA tax than the amount due, the employer may treat the shortfall as
wages either on the estimate date or on any date that is within three
months thereafter. If the
[[Page 4546]]
employer overestimates the amount deferred that should have been taken
into account as wages on the estimate date, the employer may claim a
refund or credit in accordance with sections 6402, 6413, and 6511. If
the employer treats any shortfall as wages on the estimate date or
overestimates the amount deferred on the estimate date, the employer
must correct any previously-reported wage information.
Further, the final regulations provide that, under the second
alternative method, the lag method, an employer may treat the amount
deferred on any date as wages paid on any date that is no later than
three months following the date the amount deferred is required to be
taken into account. In addition, in response to comments, the final
regulations simplify use of the lag method by permitting the FICA tax
due to be calculated using a fixed rate of interest, not less than AFR,
rather than on the basis of income under the plan.
Effective Dates
These final regulations are applicable on and after January 1,
2000. However, the final regulations include certain special transition
provisions for periods before January 1, 2000.
For amounts deferred and benefits paid before the January 1, 2000
general effective date, an employer may rely on a reasonable, good
faith interpretation of section 3121(v)(2), taking into account Notice
94-96. The final regulations specifically provide that an employer will
be deemed to have determined FICA tax liability and satisfied FICA tax
withholding requirements in accordance with a reasonable, good faith
interpretation of section 3121(v)(2) if that liability is determined in
accordance with the final regulations and the withholding method and
timing comply with the final regulations. An employer will also be
deemed to have determined FICA tax liability and satisfied FICA tax
withholding requirements in accordance with a reasonable, good faith
interpretation of section 3121(v)(2) if that liability is determined in
accordance with the proposed regulations and the withholding method and
timing comply with the proposed regulations. Whether an employer has
made a reasonable, good faith interpretation of section 3121(v)(2) will
be determined based on the relevant facts and circumstances, including
consistency of treatment by the employer and the extent to which the
employer has resolved unclear issues in its favor.
The regulations address consistency in the treatment of stock
options, stock appreciation rights, or other stock value rights that
are exercised before the January 1, 2000 general effective date. Under
the final regulations, the grant of these options and rights cannot be
treated as subject to section 3121(v)(2) after December 31, 1999, and
FICA tax generally applies at exercise. For periods before January 1,
2000, an employer that treats the grant of such an option or right as
subject to section 3121(v)(2) has not acted in accordance with a
reasonable, good faith interpretation of section 3121(v)(2) if the
employer has not treated that grant and all earlier grants as subject
to section 3121(v)(2).
The final regulations include a transition rule for periods
3 before 1994 that applies if the employer acted in
accordance with a reasonable, good faith interpretation of section
3121(v)(2). Under this rule, an amount deferred that would be required
or permitted to be taken into account in any period that ends prior to
January 1, 1994, under the final regulations, is treated as if it had
been taken into account in accordance with the final
regulations.4 For example, in the case of an amount deferred
before 1994 that was not reasonably ascertainable, the employer is
treated as having taken the amount deferred into account at an early
inclusion date before 1994 using a method permitted in the final
regulations, including anticipation of the actual form in which the
benefit payments attributable to the amount deferred are paid and the
actual date of commencement. Thus, the employer is not required to pay
any additional FICA tax when the amount deferred becomes reasonably
ascertainable or when the benefit payments attributable to the amount
deferred are actually or constructively paid.
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\3\ For purposes of FICA tax, the period of limitations is
generally based on calendar quarters (whereas, for purposes of the
Federal Unemployment Tax Act (FUTA) tax, the period of limitations
is based on calendar years). See section 6501.
\4\ The proposed regulations (as amended in 1997) included a
similar rule applicable to periods that were closed as of January 1,
1998 (which generally would have been periods before 1994).
Commentators recommended that this rule apply even if the period is
kept open beyond the normal period of limitations, such as by
agreement with the IRS or by a claim for refund. In response to
those comments, the final regulations provide that this rule applies
to all periods prior to 1994 regardless of whether the period
remains open.
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The final regulations include a new transition rule for amounts
deferred that were required to be taken into account in 1994 or 1995.
Under the final regulations, an employer will be treated as taking the
amount deferred into account under the final regulations to the extent
the employer takes the amount into account by treating it as wages paid
by the employer and received by the employee as of any date prior to
April 1, 2000. The amount taken into account before April 1, 2000, is
not required to be increased by attributable income or interest.
These and the other transition provisions of the final regulations
are in addition to the interest-free adjustment procedures that are
available under section 6205 at any time before the period of
limitations has expired. Thus, for example, with respect to a FICA tax
return (Form 941) for a period before the effective date, an employer
may make an adjustment to take an amount deferred under a nonqualified
deferred compensation plan into account in accordance with the final
regulations if the period is still open.
Section 31.3121(v)(2)-2 of the final regulations provides special
rules relating to a March 24, 1983 agreement and certain agreements
adopted after March 24, 1983, and before January 1, 1984. The final
regulations also include certain clarifications to the transition rules
that have been made in response to comments on the proposed
regulations, including clarification of the effect of post-1983
amendments.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking was issued prior to March 29, 1996, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on their impact on small business.
Drafting Information
The principal authors of these regulations are Janine Cook, Linda
E. Alsalihi, and Margaret A. Owens, Office of the Associate Chief
Counsel (Employee Benefits and Exempt Organizations). However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects
26 CFR Part 31
Employment taxes, Income taxes, Penalties, Pensions, Railroad
retirement,
[[Page 4547]]
Reporting and recordkeeping requirements, Social security,
Unemployment compensation.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 31 and 602 are amended as follows:
PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE
Paragraph 1. The authority citation for part 31 continues to read
in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Sections 31.3121(v)(2)-1 and 31.3121(v)(2)-2 are added to
read as follows:
Sec. 31.3121(v)(2)-1 Treatment of amounts deferred under certain
nonqualified deferred compensation plans.
(a) Timing of wage inclusion--(1) General timing rule for wages.
Remuneration for employment that constitutes wages within the meaning
of section 3121(a) generally is taken into account for purposes of the
Federal Insurance Contributions Act (FICA) taxes imposed under sections
3101 and 3111 at the time the remuneration is actually or
constructively paid. See Sec. 31.3121(a)-2(a).
(2) Special timing rule for an amount deferred under a nonqualified
deferred compensation plan--(i) In general. To the extent that
remuneration deferred under a nonqualified deferred compensation plan
constitutes wages within the meaning of section 3121(a), the
remuneration is subject to the special timing rule described in this
paragraph (a)(2). Remuneration is considered deferred under a
nonqualified deferred compensation plan within the meaning of section
3121(v)(2) and this section only if it is provided pursuant to a plan
described in paragraph (b) of this section. The amount deferred under a
nonqualified deferred compensation plan is determined under paragraph
(c) of this section.
(ii) Special timing rule. Except as otherwise provided in this
section, an amount deferred under a nonqualified deferred compensation
plan is required to be taken into account as wages for FICA tax
purposes as of the later of--
(A) The date on which the services creating the right to that
amount are performed (within the meaning of paragraph (e)(2) of this
section); or
(B) The date on which the right to that amount is no longer subject
to a substantial risk of forfeiture (within the meaning of paragraph
(e)(3) of this section).
(iii) Inclusion in wages only once (nonduplication rule). Once an
amount deferred under a nonqualified deferred compensation plan is
taken into account (within the meaning of paragraph (d)(1) of this
section), then neither the amount taken into account nor the income
attributable to the amount taken into account (within the meaning of
paragraph (d)(2) of this section) is treated as wages for FICA tax
purposes at any time thereafter.
(iv) Benefits that do not result from a deferral of compensation.
If a nonqualified deferred compensation plan (within the meaning of
paragraph (b)(1) of this section) provides both a benefit that results
from the deferral of compensation (within the meaning of paragraph
(b)(3) of this section) and a benefit that does not result from the
deferral of compensation, the benefit that does not result from the
deferral of compensation is not subject to the special timing rule
described in this paragraph (a)(2). For example, if a nonqualified
deferred compensation plan provides retirement benefits which result
from the deferral of compensation and disability pay (within the
meaning of paragraph (b)(4)(iv)(C) of this section) which does not
result from the deferral of compensation, the retirement benefits
provided under the plan are subject to the special timing rule in this
paragraph (a)(2) and the disability pay is not.
(v) Remuneration that does not constitute wages. If remuneration
under a nonqualified deferred compensation plan does not constitute
wages within the meaning of section 3121(a), then that remuneration is
not taken into account as wages for FICA tax purposes under either the
general timing rule described in paragraph (a)(1) of this section or
the special timing rule described in this paragraph (a)(2). For
example, benefits under a death benefit plan described in section
3121(a)(13) do not constitute wages for FICA tax purposes. Therefore,
these benefits are not included as wages under the general timing rule
described in paragraph (a)(1) of this section or the special timing
rule described in this paragraph (a)(2), even if the death benefit plan
would otherwise be considered a nonqualified deferred compensation plan
within the meaning of paragraph (b)(1) of this section.
(b) Nonqualified deferred compensation plan--(1) In general. For
purposes of this section, the term nonqualified deferred compensation
plan means any plan or other arrangement, other than a plan described
in section 3121(a)(5), that is established (within the meaning of
paragraph (b)(2) of this section) by an employer for one or more of its
employees, and that provides for the deferral of compensation (within
the meaning of paragraph (b)(3) of this section). A nonqualified
deferred compensation plan may be adopted unilaterally by the employer
or may be negotiated among or agreed to by the employer and one or more
employees or employee representatives. A plan may constitute a
nonqualified deferred compensation plan under this section without
regard to whether the deferrals under the plan are made pursuant to an
election by the employee or whether the amounts deferred are treated as
deferred compensation for income tax purposes (e.g., whether the
amounts are subject to the deduction rules of section 404). In
addition, a plan may constitute a nonqualified deferred compensation
plan under this section whether or not it is an employee benefit plan
under section 3(3) of the Employee Retirement Income Security Act of
1974 (ERISA), as amended (29 U.S.C. 1002(3)). For purposes of this
section, except where the context indicates otherwise, the term plan
includes a plan or other arrangement.
(2) Plan establishment--(i) Date plan is established. For purposes
of this section, a plan is established on the latest of the date on
which it is adopted, the date on which it is effective, and the date on
which the material terms of the plan are set forth in writing. For
purposes of this section, a plan will be deemed to be set forth in
writing if it is set forth in any other form that is approved by the
Commissioner. The material terms of the plan include the amount (or the
method or formula for determining the amount) of deferred compensation
to be provided under the plan and the time when it may or will be
provided.
(ii) Plan amendments. In the case of an amendment that increases
the amount deferred under a nonqualified deferred compensation plan,
the plan is not considered established with respect to the additional
amount deferred until the plan, as amended, is established in
accordance with paragraph (b)(2)(i) of this section.
(iii) Transition rule for written plan requirement. For purposes of
this section, an unwritten plan that was adopted and effective before
March 25, 1996, is treated as established under this section as of the
later of the date on which it was adopted or became effective, provided
that the material
[[Page 4548]]
terms of the plan are set forth in writing before January 1, 2000.
(3) Plan must provide for the deferral of compensation--(i)
Deferral of compensation defined. A plan provides for the deferral of
compensation with respect to an employee only if, under the terms of
the plan and the relevant facts and circumstances, the employee has a
legally binding right during a calendar year to compensation that has
not been actually or constructively received and that, pursuant to the
terms of the plan, is payable to (or on behalf of) the employee in a
later year. An employee does not have a legally binding right to
compensation if that compensation may be unilaterally reduced or
eliminated by the employer after the services creating the right to the
compensation have been performed. For this purpose, compensation is not
considered subject to unilateral reduction or elimination merely
because it may be reduced or eliminated by operation of the objective
terms of the plan, such as the application of an objective provision
creating a substantial risk of forfeiture (within the meaning of
section 83). Similarly, an employee does not fail to have a legally
binding right to compensation merely because the amount of compensation
is determined under a formula that provides for benefits to be offset
by benefits provided under a plan that is qualified under section
401(a), or because benefits are reduced due to investment losses or, in
a final average pay plan, subsequent decreases in compensation.
(ii) Compensation payable pursuant to the employer's customary
payment timing arrangement. There is no deferral of compensation
(within the meaning of this paragraph (b)(3)) merely because
compensation is paid after the last day of a calendar year pursuant to
the timing arrangement under which the employer ordinarily compensates
employees for services performed during a payroll period described in
section 3401(b).
(iii) Short-term deferrals. If, under a nonqualified deferred
compensation plan, there is a deferral of compensation (within the
meaning of this paragraph (b)(3)) that causes an amount to be deferred
from a calendar year to a date that is not more than a brief period of
time after the end of that calendar year, then, at the employer's
option, that amount may be treated as if it were not subject to the
special timing rule described in paragraph (a)(2) of this section. An
employer may apply this option only if the employer does so for all
employees covered by the plan and all substantially similar
nonqualified deferred compensation plans. For purposes of this
paragraph (b)(3)(iii), whether compensation is deferred to a date that
is not more than a brief period of time after the end of a calendar
year is determined in accordance with Sec. 1.404(b)-1T, Q&A-2, of this
chapter.
(4) Plans, arrangements, and benefits that do not provide for the
deferral of compensation--(i) In general. Notwithstanding paragraph
(b)(3)(i) of this section, an amount or benefit described in any of
paragraphs (b)(4)(ii) through (viii) of this section is not treated as
resulting from the deferral of compensation for purposes of section
3121(v)(2) and this section and, thus, is not subject to the special
timing rule of paragraph (a)(2) of this section.
(ii) Stock options, stock appreciation rights, and other stock
value rights. The grant of a stock option, stock appreciation right, or
other stock value right does not constitute the deferral of
compensation for purposes of section 3121(v)(2). In addition, amounts
received as a result of the exercise of a stock option, stock
appreciation right, or other stock value right do not result from the
deferral of compensation for purposes of section 3121(v)(2) if such
amounts are actually or constructively received in the calendar year of
the exercise. For purposes of this paragraph (b)(4)(ii), a stock value
right is a right granted to an employee with respect to one or more
shares of employer stock that, to the extent exercised, entitles the
employee to a payment for each share of stock equal to the excess, or a
percentage of the excess, of the value of a share of the employer's
stock on the date of exercise over a specified price (greater than
zero).
Thus, for example, the term stock value right does not include a
phantom stock or other arrangement under which an employee is awarded
the right to receive a fixed payment equal to the value of a specified
number of shares of employer stock.
(iii) Restricted property. If an employee receives property from,
or pursuant to, a plan maintained by an employer, there is no deferral
of compensation (within the meaning of section 3121(v)(2)) merely
because the value of the property is not includible in income (under
section 83) in the year of receipt by reason of the property being
nontransferable and subject to a substantial risk of forfeiture.
However, a plan under which an employee obtains a legally binding right
to receive property (whether or not the property is restricted
property) in a future year may provide for the deferral of compensation
within the meaning of paragraph (b)(3) of this section and,
accordingly, may constitute a nonqualified deferred compensation plan,
even though benefits under the plan are or may be paid in the form of
property.
(iv) Certain welfare benefits--(A) In general. Vacation benefits,
sick leave, compensatory time, disability pay, severance pay, and death
benefits do not result from the deferral of compensation for purposes
of section 3121(v)(2), even if those benefits constitute wages within
the meaning of section 3121(a).
(B) Severance pay. Benefits that are provided under a severance pay
arrangement (within the meaning of section 3(2)(B)(i) of ERISA) that
satisfies the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii) are
considered severance pay for purposes of this paragraph (b)(4)(iv). If
benefits are provided under a severance pay arrangement (within the
meaning of section 3(2)(B)(i) of ERISA), but do not satisfy one or more
of the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii), then
whether those benefits are severance pay within the meaning of this
paragraph (b)(4)(iv) depends upon the relevant facts and circumstances.
For this purpose, relevant facts and circumstances include whether the
benefits are provided over a short period of time commencing
immediately after (or shortly after) termination of employment or for a
substantial period of time following termination of employment and
whether the benefits are provided after any termination or only after
retirement (or another specified type of termination). Benefits
provided under a severance pay arrangement (within the meaning of
section 3(2)(B)(i) of ERISA) are in all cases severance pay within the
meaning of this paragraph (b)(4)(iv) if the benefits payable under the
plan upon an employee's termination of employment are payable only if
that termination is involuntary.
(C) Death benefits and disability pay--(1) General definition.
Payments made under a nonqualified deferred compensation plan in the
event of death are death benefits within the meaning of this paragraph
(b)(4)(iv), but only to the extent the total benefits payable under the
plan exceed the lifetime benefits payable under the plan. Similarly,
payments made under a nonqualified deferred compensation plan in the
event of disability are disability pay within the meaning of this
paragraph (b)(4)(iv), but only to the extent the disability benefits
payable under the plan exceed the lifetime benefits payable under the
plan. Accordingly, any benefits that a nonqualified deferred
compensation plan provides in the event of death or disability that are
associated with an amount deferred under this section are
[[Page 4549]]
disregarded in applying this section to the extent the benefits payable
under the plan in the event of death or in the event of disability have
a value in excess of the lifetime benefits payable under the plan.
(2) Total benefits payable defined. For purposes of paragraph
(b)(4)(iv)(C)(1) of this section, the term total benefits payable under
a plan means the present value of the total benefits payable to or on
behalf of the employee (including benefits payable in the event of the
employee's death) under the plan, disregarding any benefits that are
payable only in the event of disability and determined separately with
respect to each form of distribution or other election that may apply
with respect to the employee.
(3) Disability benefits payable defined. For purposes of paragraph
(b)(4)(iv)(C)(1) of this section, the term disability benefits payable
under a plan means the present value of the benefits payable to or on
behalf of the employee under the plan, including benefits payable in
the event of the employee's disability but excluding death benefits
within the meaning of this paragraph (b)(4)(iv).
(4) Lifetime benefits payable defined. For purposes of paragraph
(b)(4)(iv)(C)(1) of this section, the term lifetime benefits payable
under a plan means the present value of the benefits that could be
payable to the employee under the plan during the employee's lifetime,
determined under the plan's optional form of distribution or other
election that is or was available to the employee at any time with
respect to the amount deferred and that provides the largest present
value to the employee during the employee's lifetime of any such form
or election so available.
(5) Rules of application. For purposes of determining present value
under this paragraph (b)(4)(iv)(C), present value is determined as of
the time immediately preceding the time the amount deferred under a
nonqualified deferred compensation plan is required to be taken into
account under paragraph (e) of this section, using actuarial
assumptions that are reasonable as of that date but taking into
consideration only benefits that result from the deferral of
compensation, as determined under this paragraph (b), and benefits
payable in the event of death or disability. In addition, for purposes
of paragraph (b)(4)(iv)(C)(4) of this section, present value must be
determined without any discount for the probability that the employee
may die before benefit payments commence and without regard to any
benefits payable solely in the event of disability.
(v) Certain benefits provided in connection with impending
termination--(A) In general. Benefits provided in connection with
impending termination of employment under paragraph (b)(4)(v)(B) or (C)
of this section do not result from the deferral of compensation within
the meaning of section 3121(v)(2).
(B) Window benefits--(1) In general. For purposes of this paragraph
(b)(4)(v), except as provided in paragraph (b)(4)(v)(B)(3) of this
section, a window benefit is provided in connection with impending
termination of employment. For this purpose, a window benefit is an
early retirement benefit, retirement-type subsidy, social security
supplement, or other form of benefit made available by an employer for
a limited period of time (no greater than one year) to employees who
terminate employment during that period or to employees who terminate
employment during that period under specified circumstances.
(2) Special rule for recurring window benefits. A benefit will not
be considered a window benefit if an employer establishes a pattern of
repeatedly providing for similar benefits in similar situations for
substantially consecutive, limited periods of time. Whether the
recurrence of these benefits constitutes a pattern of amendments is
determined based on the facts and circumstances. Although no one factor
is determinative, relevant factors include whether the benefits are on
account of a specific business event or condition, the degree to which
the benefits relate to the event or condition, and whether the event or
condition is temporary or discrete or is a permanent aspect of the
employer's business.
(3) Transition rule for window benefits. In the case of a window
benefit that is made available for a period of time that begins before
January 1, 2000, an employer may choose to treat the window benefit as
a benefit that results from the deferral of compensation if the sole
reason the window benefit would otherwise fail to be provided pursuant
to a nonqualified deferred compensation plan is the application of
paragraph (b)(4)(v)(B)(1) of this section.
(C) Termination within 12 months of establishment of a benefit or
plan. For purposes of this paragraph (b)(4)(v), a benefit is provided
in connection with impending termination of employment, without regard
to whether it constitutes a window benefit, if--
(1) An employee's termination of employment occurs within 12 months
of the establishment of the plan (or amendment) providing the benefit;
and
(2) The facts and circumstances indicate that the plan (or
amendment) is established in contemplation of the employee's impending
termination of employment.
(vi) Benefits established after termination. Benefits established
with respect to an employee after the employee's termination of
employment do not result from a deferral of compensation within the
meaning of section 3121(v)(2). However, cost-of-living adjustments on
benefit payments under a nonqualified deferred compensation plan
(within the meaning of paragraph (b) of this section) shall not be
considered benefits established after the employee's termination of
employment for purposes of this paragraph (b)(4)(vi) merely because the
employee does not obtain the right to the adjustment until after the
employee's termination of employment. For purposes of the preceding
sentence, cost-of-living adjustments are payments that satisfy
conditions similar to those of 29 CFR 2510.3-2(g)(1)(ii) and (iii).
(vii) Excess parachute payments. An excess parachute payment (as
defined in section 280G(b)) under an agreement entered into or renewed
after June 14, 1984, in taxable years ending after such date, does not
result from the deferral of compensation within the meaning of section
3121(v)(2). For this purpose, any contract entered into before June 15,
1984, that is amended after June 14, 1984, in any relevant significant
aspect, is treated as a contract entered into after June 14, 1984.
(viii) Compensation for current services. A plan does not provide
for the deferral of compensation within the meaning of section
3121(v)(2) if, based on the relevant facts and circumstances, the
compensation is paid for current services.
(5) Examples. This paragraph (b) is illustrated by the following
examples:
Example 1. (i) In December of 2001, Employer L tells Employee A
that, if specified goals are satisfied for 2002, Employee A will
receive a bonus on July 1, 2003, equal to a specified percentage of
2002 compensation. Because Employee A meets the specified goals,
Employer L pays the bonus to Employee A on July 1, 2003, consistent
with its oral commitment.
(ii) This arrangement is not a nonqualified deferred
compensation plan under this section because its terms were not set
forth in writing and, therefore, it was not established in
accordance with paragraph (b)(2) of this section.
Example 2. (i) In 2004, Employer M establishes a compensation
arrangement for Employee B under which Employer M agrees to pay
Employee B a specified amount based on a percentage of his salary
for 2004. The amount due is to be paid out of the general assets of
Employer M and is payable in 2008.
(ii) Employee B has a legally binding right during 2004 to an
amount of compensation
[[Page 4550]]
that has not been actually or constructively received and that,
pursuant to the terms of the arrangement, is payable in a later
year. Therefore, the arrangement provides for the deferral of
compensation.
Example 3. (i) Employer N establishes a nonqualified deferred
compensation plan (within the meaning of paragraph (b)(1) of this
section) for Employee C in 1984. The plan is amended on January 1,
2001, to increase benefits, and the amendment provides that the
increase in benefits is on account of Employee C's performance of
services for Employer N from 1985 through 2000.
(ii) The additional benefits that resulted from the plan
amendment cannot be taken into account as amounts deferred for 1985
through 2000, even though the plan was established before then.
Pursuant to paragraphs (b)(2)(ii) and (e)(1) of this section, the
additional benefits cannot be taken into account before the latest
of the date on which the amendment is adopted, the date on which the
amendment is effective, or the date on which the material terms of
the plan, as amended, are set forth in writing.
Example 4. (i) In 2002, Employer O, a state or local government,
establishes a plan for certain employees that provides for the
deferral of compensation and that is subject to section 457(a).
(ii) Paragraph (b)(1) of this section provides that nonqualified
deferred compensation plan means any plan that is established by an
employer and that provides for the deferral of compensation, other
than a plan described in section 3121(a)(5). Section 3121(a)(5)
lists, among other plans, an exempt governmental deferred
compensation plan as defined in section 3121(v)(3). Under section
3121(v)(3)(A), this definition does not include any plan to which
section 457(a) applies. Thus, the plan established by Employer O is
not an exempt governmental deferred compensation plan described in
section 3121(v)(3) and, consequently, is not a plan described in
section 3121(a)(5). Accordingly, the plan is a nonqualified deferred
compensation plan within the meaning of section 3121(v)(2) and
paragraph (b)(1) of this section.
(iii) However, the general timing rule of paragraph (a)(1) of
this section and the special timing rule of paragraph (a)(2) of this
section apply only to remuneration for employment that constitutes
wages. Under section 3121(b)(7), certain service performed in the
employ of a state, or any political subdivision of a state, is not
employment. Thus, even though the plan is a nonqualified deferred
compensation plan, the extent to which section 3121(v)(2) applies to
a participating employee will depend on whether or not the service
performed for Employer O is excluded from the definition of
employment under section 3121(b)(7).
Example 5. (i) In 2000, Employer P establishes a plan that
provides for bonuses to be paid to employees based on an objective
formula that takes into account the employees' performance for the
year. Employer P does not have the discretion to reduce the amount
of any employee's bonus after the end of the year. The bonus is not
actually calculated until March 1 of the following year, and is paid
on March 15 of that following year.
(ii) The plan provides for the deferral of compensation because
the employees have a legally binding right, as of the last day of a
calendar year, to an amount of compensation that has not been
actually or constructively received and, pursuant to the terms of
the plan, that compensation is payable in a later year. However,
because the bonuses under the plan are paid within a brief period of
time after the end of the calendar year from which they are
deferred, Employer P may choose, pursuant to paragraph (b)(3)(iii)
of this section, to treat all the bonuses as if they are not subject
to the special timing rule of paragraph (a)(2) of this section.
(iii) If the employer uses the special timing rule, the amount
deferred would be taken into account as wages on December 31, 2000.
If the employer chooses not to use the special timing rule, the
amount of the bonus is wages on the date it is actually or
constructively paid, March 15, 2000.
Example 6. (i) Employer Q establishes a plan under which bonuses
based on performance in one year may be paid on February 1 of the
following year at the discretion of the board of directors. The
board of directors meets in January of each year to determine the
amount, if any, of the bonuses to be paid based on performance in
the prior year.
(ii) Because an employee does not have a legally binding right
to any bonus until January of the year in which the bonus is paid,
any bonus paid under the plan in that year is not deferred from the
preceding calendar year, and the plan does not provide for the
deferral of compensation within the meaning of paragraph (b)(3)(i)
of this section.
Example 7. (i) Employer R maintains a plan for employees that
provides nonqualified stock options described in Sec. 1.83-7(a) of
this chapter. Under the plan, employees are granted in 2001 the
option to acquire shares of employer stock at the fair market value
of the shares on the date of grant ($50 per share). The options can
be exercised at any time from the date of grant through 2010. The
options do not have a readily ascertainable fair market value for
purposes of section 83 at the date of grant, and shares are issued
upon the exercise of the options without being subject to a
substantial risk of forfeiture within the meaning of section 83. In
2005, when the fair market value of a share of employer stock is
$80, Employee D exercises an option to acquire 1,000 shares.
(ii) Under paragraph (b)(4)(ii) of this section, neither the
grant of a stock option nor amounts received currently as a result
of the exercise of a stock option result from the deferral of
compensation for purposes of section 3121(v)(2). Thus, under the
general timing rule of paragraph (a)(1) of this section, the $30,000
spread between the amount paid for the shares ($50,000) and the fair
market value of the shares on the date of exercise ($80,000) is
taken into account as wages for FICA tax purposes in the year of
exercise.
(iii) If the options had been granted at $45 per share, $5 per
share below the fair market value on date of grant, the $35,000
spread between the amount paid for the shares ($45,000) and the fair
market value of the shares on the date of exercise ($80,000) would
similarly be taken into account as wages for FICA tax purposes in
the year of exercise.
Example 8. (i) Employer T establishes a phantom stock plan for
certain employees. Under the plan, an employee is credited on the
last day of each calendar year with a dollar amount equal to the
fair market value of 1,000 shares of employer stock. Upon
termination of employment for any reason, each employee is entitled
to receive the value on the date of termination, in cash or employer
stock, of the shares with which he or she has been credited.
(ii) Because compensation to which the employee has a legally
binding right as of the last day of one year is paid in a subsequent
year, the phantom stock plan provides for the deferral of
compensation. The phantom stock plan does not provide stock value
rights within the meaning of paragraph (b)(4)(ii) of this section
because it provides for awards equal in value to the full fair
market value of a specified number of shares of Employer T stock,
rather than the excess of that fair market value over a specified
price.
Example 9. (i) Employer U establishes a severance pay
arrangement (within the meaning of section 3(2)(b)(i) of ERISA)
which provides for payments solely upon an employee's death,
disability, or dismissal from employment. The amount of the payments
to an employee is based on the length of continuous active service
with Employer U at the time of dismissal, and is paid in monthly
installments over a period of three years.
(ii) Because benefits payable under the plan upon termination of
employment are payable only upon an employee's involuntary
termination, the plan is a severance pay plan within the meaning of
paragraph (b)(4)(iv)(B) of this section. Thus, the benefits are not
treated as resulting from the deferral of compensation for purposes
of section 3121(v)(2).
Example 10. (i) Employer V establishes a nonqualified deferred
compensation plan under which employees will receive benefit
payments commencing at age 65 as a life annuity or in one of several
actuarially equivalent annuity forms. If an employee dies before
benefit payments commence under the plan, a benefit is payable to
the employee's designated beneficiary in a single sum payment equal
to the present value of the employee's annuity benefit. This benefit
(sometimes called a full reserve death benefit) is calculated using
the applicable interest rate specified in section 417(e) and, for
the period after age 65, the applicable mortality table specified in
section 417(e), both of which are reasonable actuarial assumptions.
During 2002, Employee E obtains a legally binding right to an
annuity benefit under the plan, payable at age 65. This annuity
benefit has a present value of $10,000 at the end of 2002,
determined using the same assumptions as are used under the plan to
calculate the full reserve death benefit.
(ii) The present value, at the end of 2002, of the total
benefits payable to or on behalf of Employee E (i.e., the sum of the
present
[[Page 4551]]
value of the annuity benefit commencing at age 65, and the present
value of the full reserve death benefit, with both determined using
the actuarial assumptions described in paragraph (i) of this Example
10, except also taking into account the probability of death prior
to age 65) is $10,000. This present value does not exceed the
present value of the annuity benefits that could be payable to
Employee E under the plan during Employee E's lifetime determined
without a discount for the possibility that Employee E might die
before age 65 (also $10,000). Thus, the benefit payable in the event
of the Employee E's death is not a death benefit for purposes of
paragraph (b)(4)(iv) of this section.
(iii) The same result would apply in the case of a plan that
bases benefits on an interest bearing account balance and pays the
account balance at termination of employment or death (because the
sum of the deferred benefits payable in the future if the employee
terminates employment before death with a discount for the
probability of death before that date plus the present value of the
benefit payable in the event of death necessarily equals the present
value of the deferred benefits payable with no discount for the
probability of death).
Example 11. (i) The facts are the same as in Example 10, except
that, in lieu of the full reserve death benefit, the plan provides a
monthly life annuity benefit to an employee's spouse in the event of
the employee's death before benefit payments commence equal to 100
percent of the monthly annuity that would be payable to the employee
at age 65 under the life annuity form. Employee E is age 63 and has
a spouse who is age 51. The sum of the present value of Employee E's
annuity benefit commencing at age 65 determined with a discount for
the possibility that Employee E might die before age 65 and the
present value of the 100 percent annuity death benefit for Employee
E's spouse exceeds $10,000.
(ii) The amount deferred for 2002 is $10,000 (because the 100
percent annuity death benefit for Employee E's spouse is disregarded
to the extent that the total benefits payable to or on behalf of
Employee E exceeds the present value of the annuity benefits that
could be payable to Employee E under the plan during the Employee
E's lifetime without a discount for the probability of Employee E's
death before benefit payments commence).
Example 12. (i) On January 1, 2001, Employer W establishes a
plan that covers only Employee F, who owns a significant portion of
the business and who has 30 years of service as of that date. The
plan provides that, upon Employee F's termination of employment at
any time, he will receive $200,000 per year for each of the
immediately succeeding five years. Employee F terminates employment
on March 1, 2001.
(ii) Because Employee F terminates employment within 12 months
of the establishment of the plan and the facts and circumstances set
forth above indicate that the plan was established in contemplation
of impending termination of employment, the plan is considered to be
established in connection with impending termination within the
meaning of paragraph (b)(4)(v) of this section. Therefore, the
benefits provided under the plan are not treated as resulting from
the deferral of compensation for purposes of section 3121(v)(2).
Example 13. (i) Employer X establishes a plan on January 1,
2004, to supplement the qualified retirement benefits of recently
hired 55-year old Employee G, who forfeited retirement benefits with
her former employer in order to accept employment with Employer X.
The plan provides that Employee G will receive $50,000 per year for
life beginning at age 65, regardless of when she terminates
employment. On April 15, 2004, Employee G unexpectedly terminates
employment.
(ii) The facts and circumstances indicate that the plan was not
established in contemplation of impending termination. Thus, even
though Employee G terminated employment within 12 months of the
establishment of the plan, the plan is not considered to be
established in connection with impending termination within the
meaning of paragraph (b)(4)(v) of this section. Benefits provided
under the plan are treated as resulting from the deferral of
compensation for purposes of section 3121(v)(2).
Example 14. (i) Employer Y establishes a plan to provide
supplemental retirement benefits to a group of management employees
who are at various stages of their careers. All employees covered by
the plan are subject to the same benefit formula. Employee H is
planning to (and actually does) retire within six months of the date
on which the plan is established.
(ii) Even though Employee H terminated employment within 12
months of the establishment of the plan, the plan is not considered
to have been established in connection with Employee H's impending
termination within the meaning of paragraph (b)(4)(v) of this
section because the facts and circumstances indicate otherwise.
Example 15. (i) Employee J owns 100 percent of Employer Z, a
corporation that provides consulting services. Substantially all of
Employer Z's revenue is derived as a result of the services
performed by Employee J. In each of 2001, 2002, and 2003, Employer Z
has gross receipts of $180,000 and expenses (other than salary) of
$80,000. In each of 2001 and 2002, Employer Z pays Employee J a
salary of $100,000 for services performed in each of those years. On
December 31, 2002, Employer Z establishes a plan to pay Employee J
$80,000 in 2003. The plan recites that the payment is in recognition
of prior services. In 2003, Employer Z pays Employee J a salary of
$20,000 and the $80,000 due under the plan.
(ii) The facts and circumstances described above indicate that
the $80,000 paid pursuant to the plan is based on services performed
by Employee J in 2003 and, thus, is paid for current services within
the meaning of paragraph (b)(4)(viii) of this section. Accordingly,
the plan does not provide for the deferral of compensation within
the meaning of section 3121(v)(2), and the $80,000 payment is
included as wages in 2003 under the general timing rule of paragraph
(a)(1) of this section.
(c) Determination of the amount deferred--(1) Account balance
plans--(i) General rule. For purposes of this section, if benefits for
an employee are provided under a nonqualified deferred compensation
plan that is an account balance plan, the amount deferred for a period
equals the principal amount credited to the employee's account for the
period, increased or decreased by any income attributable to the
principal amount through the date the principal amount is required to
be taken into account as wages under paragraph (e) of this section.
(ii) Definitions--(A) Account balance plan. For purposes of this
section, an account balance plan is a nonqualified deferred
compensation plan under the terms of which a principal amount (or
amounts) is credited to an individual account for an employee, the
income attributable to each principal amount is credited (or debited)
to the individual account, and the benefits payable to the employee are
based solely on the balance credited to the individual account.
(B) Income. For purposes of this section, income means any increase
or decrease in the amount credited to an employee's account that is
attributable to amounts previously credited to the employee's account,
regardless of whether the plan denominates that increase or decrease as
income.
(iii) Additional rules--(A) Commingled accounts. A plan does not
fail to be an account balance plan merely because, under the terms of
the plan, benefits payable to an employee are based solely on a
specified percentage of an account maintained for all (or a portion of)
plan participants under which principal amounts and income are credited
(or debited) to such account.
(B) Bifurcation permitted. An employer may treat a portion of a
nonqualified deferred compensation plan as a separate account balance
plan if that portion satisfies the requirements of this paragraph
(c)(1) and the amount payable to employees under that portion is
determined independently of the amount payable under the other portion
of the plan.
(C) Actuarial equivalents. A plan does not fail to be an account
balance plan merely because the plan permits employees to elect to
receive their benefits under the plan in a form of benefit other than
payment of the account balance, provided the amount of benefit payable
in that other form is actuarially equivalent to payment of the account
balance using actuarial assumptions that are reasonable. Conversely, a
plan is not an account
[[Page 4552]]
balance plan if it provides an optional form of benefit that is not
actuarially equivalent to the account balance using actuarial
assumptions that are reasonable. For this purpose, the determination of
whether forms are actuarially equivalent using actuarial assumptions
that are reasonable is determined under the rules applicable to
nonaccount balance plans under paragraph (c)(2)(iii) of this section.
(2) Nonaccount balance plans--(i) General rule. For purposes of
this section, if benefits for an employee are provided under a
nonqualified deferred compensation plan that is not an account balance
plan (a nonaccount balance plan), the amount deferred for a period
equals the present value of the additional future payment or payments
to which the employee has obtained a legally binding right (as
described in paragraph (b)(3)(i) of this section) under the plan during
that period.
(ii) Present value defined. For purposes of this section, present
value means the value as of a specified date of an amount or series of
amounts due thereafter, where each amount is multiplied by the
probability that the condition or conditions on which payment of the
amount is contingent will be satisfied, and is discounted according to
an assumed rate of interest to reflect the time value of money. For
purposes of this section, the present value must be determined as of
the date the amount deferred is required to be taken into account as
wages under paragraph (e) of this section using actuarial assumptions
and methods that are reasonable as of that date. For this purpose, a
discount for the probability that an employee will die before
commencement of benefit payments is permitted, but only to the extent
that benefits will be forfeited upon death. In addition, the present
value cannot be discounted for the probability that payments will not
be made (or will be reduced) because of the unfunded status of the
plan, the risk associated with any deemed or actual investment of
amounts deferred under the plan, the risk that the employer, the
trustee, or another party will be unwilling or unable to pay, the
possibility of future plan amendments, the possibility of a future
change in the law, or similar risks or contingencies. Nor is the
present value affected by the possibility that some of the payments due
under the plan will be eligible for one of the exclusions from wages in
section 3121(a).
(iii) Treatment of actuarially equivalent benefits--(A) In general.
In the case of a nonaccount balance plan that permits employees to
receive their benefits in more than one form or commencing at more than
one date, the amount deferred is determined by assuming that payments
are made in the normal form of benefit commencing at normal
commencement date if the requirements of paragraph (c)(2)(iii)(B) of
this section are satisfied. Accordingly, in the case of a nonaccount
balance plan that permits employees to receive their benefits in more
than one form or commencing at more than one date, unless the
requirements of paragraph (c)(2)(iii)(B) of this section are satisfied,
the amount deferred is treated as not reasonably ascertainable under
the rules of paragraph (e)(4)(i)(B) of this section until a form of
benefit and a time of commencement are selected.
(B) Use of normal form commencing at normal commencement date. The
requirements of this paragraph (c)(2)(iii)(B) are satisfied by a
nonaccount balance plan if the plan has a single normal form of benefit
commencing at normal commencement date for the amount deferred and each
other optional form is actuarially equivalent to the normal form of
benefit commencing at normal commencement date using actuarial
assumptions that are reasonable. For this purpose, each form of benefit
for payment of the amount deferred commencing at a date is a separate
optional form. For purposes of this paragraph (c)(2)(iii)(B), each
optional form is actuarially equivalent to the normal form of benefit
commencing at normal commencement date only if the terms of the plan in
effect when the amount is deferred provide for every optional form to
be actuarially equivalent and further provide for actuarial assumptions
to determine actuarial equivalency that will be reasonable at the time
the optional form is selected, without regard to whether market
interest rates are higher or lower at the time the optional form is
selected than at the time the amount is deferred. Thus, a plan that
provides for every optional form to be actuarially equivalent satisfies
this paragraph (c)(2)(iii)(B) if it provides for actuarial equivalence
to be determined--
(1) When an optional form is selected or when benefit payments
under the optional form commence, based on assumptions that are
reasonable then;
(2) Based on an index that reflects market rates of interest from
time to time (for example, the plan specifies that all benefits will be
actuarially equivalent using the applicable interest rate and
applicable mortality table specified in section 417(e)); or
(3) Based on actuarial assumptions specified in the plan and
provides for those assumptions to be revised to be reasonable
assumptions if they cease to be reasonable assumptions.
(C) Fixed mortality assumptions permitted. A plan does not fail to
satisfy paragraph (c)(2)(iii)(B) of this section merely because the
plan specifies a fixed mortality assumption that is reasonable at the
time the amount is deferred, even if that assumption is not reasonable
at the time the optional form is selected. (But see paragraph
(c)(2)(iii)(E) of this section for additional rules that apply if the
mortality assumption is not reasonable at the time the optional form is
selected.)
(D) Normal form of benefit commencing at normal commencement date
defined. For purposes of this paragraph (c)(2)(iii), the normal form of
benefit commencing at normal commencement date under the plan is the
form, and date of commencement, under which the payments due to the
employee under the plan are expressed, prior to adjustments for form or
timing of commencement of payments.
(E) Rule applicable if actuarial assumptions cease to be
reasonable. If the terms of the plan in effect when an amount is
deferred provide for actuarial assumptions to determine actuarial
equivalency that will be reasonable at the time the optional form is
selected or payments commence as provided in paragraph (c)(2)(iii)(B)
of this section, but, at that time, the actuarial assumptions used
under the plan are not reasonable, the employee will be treated as
obtaining a legally binding right at that time (or, if earlier, at the
date on which the plan is amended to provide actuarial assumptions that
are not reasonable) to any additional benefits that result from the use
of an unreasonable actuarial assumption. This might occur, for example,
if the plan specifies that the actuarial assumptions will be reasonable
assumptions to be set at the time the optional form is selected and the
assumptions used are in fact not reasonable at that time.
(3) Separate determination for each period. The amount deferred
under this paragraph (c) is determined separately for each period for
which there is an amount deferred under the plan. In addition,
paragraphs (d) and (e) of this section are applied separately with
respect to the amount deferred for each such period. Thus, for example,
the fraction described in paragraph (d)(1)(ii)(B) of this section and
the amount of the true-up at the resolution date described in paragraph
(e)(4)(ii)(B) of this section are determined separately with respect to
each amount deferred. See paragraph (e)(4)(ii)(D) of this section
[[Page 4553]]
for special rules for allocating amounts deferred over more than one
year.
(4) Examples. This paragraph (c) is illustrated by the following
examples. (The examples illustrate the rules in this paragraph (c) and
include various interest rate and mortality table assumptions,
including the applicable section 417(e) mortality table, the GAM 83
(male) mortality table, and UP-84 mortality table. These tables can be
obtained from the Society of Actuaries at its internet site at http://
www.soa.org.) The examples are as follows:
Example 1. (i) Employer M establishes a nonqualified deferred
compensation plan for Employee A. Under the plan, 10 percent of
annual compensation is credited on behalf of Employee A on December
31 of each year. In addition, a reasonable rate of interest is
credited quarterly on the balance credited to Employee A as of the
last day of the preceding quarter. All amounts credited under the
plan are 100 percent vested and the benefits payable to Employee A
are based solely on the balance credited to Employee A's account.
(ii) The plan is an account balance plan. Thus, pursuant to
paragraph (c)(1) of this section, the amount deferred for a calendar
year is equal to 10 percent of annual compensation.
Example 2. (i) Employer N establishes a nonqualified deferred
compensation plan for Employee B. Under the plan, 2.5 percent of
annual compensation is credited quarterly on behalf of Employee B.
In addition, a reasonable rate of interest is credited quarterly on
the balance credited to Employee B's account as of the last day of
the preceding quarter. All amounts credited under the plan are 100
percent vested, and the benefits payable to Employee B are based
solely on the balance credited to Employee B's account. As permitted
by paragraph (e)(5) of this section, any amount deferred under the
plan for the calendar year is taken into account as wages on the
last day of the year.
(ii) The plan is an account balance plan. Thus, pursuant to
paragraph (c)(1) of this section, the amount deferred for a calendar
year equals 10 percent of annual compensation (i.e., the sum of the
principal amounts credited to Employee B's account for the year)
plus the interest credited with respect to that 10 percent principal
amount through the last day of the calendar year. If Employer N had
not chosen to apply paragraph (e)(5) of this section and, thus, had
taken into account 2.5 percent of compensation quarterly, the
interest credited with respect to those quarterly amounts would not
have been treated as part of the amount deferred for the year.
Example 3. (i) Employer O establishes a nonqualified deferred
compensation plan for a group of five employees. Under the plan, a
specified sum is credited to an account for the benefit of the group
of employees on July 31 of each year. Income on the balance of the
account is credited annually at a rate that is reasonable for each
year. The benefit payable to an employee is equal to one-fifth of
the account balance and is payable, at the employee's option, in a
lump sum or in 10 annual installments that reflect income on the
balance.
(ii) The plan is an account balance plan notwithstanding the
fact that the employee's benefit is equal to a specified percentage
of an account maintained for a group of employees.
Example 4. (i) The facts are the same as in Example 3, except
that the plan also permits an employee to elect a life annuity that
is actuarially equivalent to the account balance based on the
applicable interest rate and applicable mortality table specified in
section 417(e) at the time the benefit is elected by the employee.
(ii) Under paragraphs (c)(1)(iii)(C) and (c)(2)(iii) of this
section, the plan does not fail to be an account balance plan merely
because the plan permits employees to elect to receive their
benefits under the plan in a form that is actuarially equivalent to
payment of the account balance using actuarial assumptions that are
reasonable at the time the form is selected.
Example 5. (i) Employer P establishes a nonqualified deferred
compensation plan for a group of employees. Under the plan, each
participating employee has a fully vested right to receive a life
annuity, payable monthly beginning at age 65, equal to the product
of 2 percent for each year of service and the employee's highest
average annual compensation for any 3-year period. The plan also
provides that, if an employee dies before age 65, the present value
of the future payments will be paid to his or her beneficiary. As
permitted under paragraph (e)(5) of this section, any amount
deferred under the plan for a calendar year is taken into account as
FICA wages as of the last day of the year. As of December 31, 2002,
Employee C is age 60, has 25 years of service, and high 3-year
average compensation of $100,000 (the average for the years 2000
through 2002). As of December 31, 2003, Employee C is age 61, has 26
years of service, and has high 3-year average compensation of
$104,000. As of December 31, 2004, Employee C is age 62, has 27
years of service, and has high 3-year average compensation of
$105,000. The assumptions that Employer P uses to determine the
amount deferred for 2003 (a 7 percent interest rate and, for the
period after commencement of benefit payments, the GAM 83 (male)
mortality table) and for 2004 (a 7.5 percent interest rate and, for
the period after commencement of benefit payments, the GAM 83 (male)
mortality table) are assumed, solely for purposes of this example,
to be reasonable actuarial assumptions.
(ii) As of December 31, 2002, Employee C has a legally binding
right to receive lifetime payments of $50,000 (2 percent x 25
years x $100,000) per year. As of December 31, 2003, Employee C
has a legally binding right to receive lifetime payments of $54,080
(2 percent x 26 years x $104,000) per year. Thus, during 2003,
Employee C has earned a legally binding right to additional lifetime
payments of $4,080 ($54,080-$50,000) per year beginning at age 65.
The amount deferred for 2003 is the present value, as of December
31, 2003, of these additional payments, which is $28,767 ($4,080 x
the present value factor for a deferred annuity payable at age 65,
using the specified actuarial assumptions for 2003). Similarly,
during 2004, Employee C has earned a legally binding right to
additional lifetime payments of $2,620 (2 percent x 27 years x
$105,000, minus $54,080) per year beginning at age 65. The amount
deferred for 2004 is the present value, as of December 31, 2004, of
these additional payments, which is $18,845 ($2,620 x the present
value factor for a deferred annuity payable at age 65, using the
specified actuarial assumptions for 2004).
Example 6. (i) Employer Q establishes a nonqualified deferred
compensation plan for Employee D on January 1, 2001, when Employee D
is age 63. During 2001, Employee D obtains a fully vested right to
receive a life annuity under the nonqualified deferred compensation
plan equal to the excess of $200,000 over the life annuity benefits
payable to Employee D under a qualified defined benefit pension plan
sponsored by Employer Q. The life annuity benefit payable annually
under the qualified plan is the lesser of $200,000 and the section
415(b)(1)(A) limitation in effect for the year, where the section
415(b)(1)(A) limitation is automatically adjusted to reflect changes
in the cost of living. Benefits under both the qualified and
nonqualified plan are payable monthly beginning at age 65. For
purposes of this example, the section 415(b)(1)(A) limit for 2001 is
assumed to be $140,000. The nonqualified plan provides no benefits
in the event Employee D dies prior to commencement of benefit
payments. As permitted under paragraph (e)(5) of this section, any
amount deferred under the plan for a calendar year is taken into
account as FICA wages as of the last day of the year. The
assumptions that Employer Q uses to determine the amount deferred
for 2001 (a 7 percent interest rate, a 3 percent increase in the
cost of living and the GAM 83 (male) mortality table) are assumed,
solely for purposes of this example, to be reasonable actuarial
assumptions. As of December 31, 2001, Employee D has a legally
binding right to receive lifetime payments as set forth in the
following table:
[[Page 4554]]
----------------------------------------------------------------------------------------------------------------
Assumed
qualified plan Net annual
Year Annual gross annual payment payment under
amount (based on cost nonqualified
of living) plan
----------------------------------------------------------------------------------------------------------------
2003............................................................ $200,000 $145,000 $55,000
2004............................................................ 200,000 150,000 50,000
2005............................................................ 200,000 155,000 45,000
2006............................................................ 200,000 160,000 40,000
2007............................................................ 200,000 165,000 35,000
2008............................................................ 200,000 170,000 30,000
2009............................................................ 200,000 175,000 25,000
2010............................................................ 200,000 180,000 20,000
2011............................................................ 200,000 185,000 15,000
2012............................................................ 200,000 190,000 10,000
2013............................................................ 200,000 195,000 5,000
2014 and thereafter............................................. 200,000 205,000 or
greater 0
----------------------------------------------------------------------------------------------------------------
(ii) The amount deferred for 2001 is the present value, as of
December 31, 2001, of the net lifetime payments under the
nonqualified plan, or $223,753.
(d) Amounts taken into account and income attributable thereto--(1)
Amounts taken into account--(i) In general. For purposes of this
section, an amount deferred under a nonqualified deferred compensation
plan is taken into account as of the date it is included in computing
the amount of wages as defined in section 3121(a), but only to the
extent that any additional FICA tax that results from such inclusion
(including any interest and penalties for late payment) is actually
paid before the expiration of the applicable period of limitations for
the period in which the amount deferred was required to be taken into
account under paragraph (e) of this section. Because an amount deferred
for a calendar year is combined with the employee's other wages for the
year for purposes of computing FICA taxes with respect to the employee
for the year, if the employee has other wages that equal or exceed the
wage base limitations for the Old-Age, Survivors, and Disability
Insurance (OASDI) portion (or, in the case of years before 1994, the
Hospital Insurance (HI) portion) of FICA for the year, no portion of
the amount deferred will actually result in additional OASDI (or HI)
tax. However, because there is no wage base limitation for the HI
portion of FICA for years after 1993, the entire amount deferred (in
addition to all other wages) is subject to the HI tax for the year and,
thus, will not be considered taken into account for purposes of this
section unless the HI tax relating to the amount deferred is actually
paid. In determining whether any additional FICA tax relating to the
amount deferred is actually paid, any FICA tax paid in a year is
treated as paid with respect to an amount deferred only after FICA tax
is paid on all other wages for the year.
(ii) Amounts not taken into account--(A) Failure to take an amount
deferred into account under the special timing rule. If an amount
deferred for a period (as determined under paragraph (c) of this
section) is not taken into account, then the nonduplication rule of
paragraph (a)(2)(iii) of this section does not apply, and benefit
payments attributable to that amount deferred are included as wages in
accordance with the general timing rule of paragraph (a)(1) of this
section. For example, if an amount deferred is required to be taken
into account in a particular year under paragraph (e) of this section,
but the employer fails to pay the additional FICA tax resulting from
that amount, then the amount deferred and the income attributable to
that amount must be included as wages when actually or constructively
paid.
(B) Failure to take a portion of an amount deferred into account
under the special timing rule. If, as of the date an amount deferred is
required to be taken into account, only a portion of the amount
deferred (as determined under paragraph (c) of this section) has been
taken into account, then a portion of each subsequent benefit payment
that is attributable to that amount is excluded from wages pursuant to
the nonduplication rule of paragraph (a)(2)(iii) of this section and
the balance is subject to the general timing rule of paragraph (a)(1)
of this section. The portion that is excluded from wages is fixed
immediately before the attributable benefit payments commence (or, if
later, the date the amount deferred is required to be taken into
account) and is determined by multiplying each such payment by a
fraction, the numerator of which is the amount that was taken into
account (plus income attributable to that amount determined under
paragraph (d)(2) of this section through the date the portion is fixed)
and the denominator of which is the present value of the future benefit
payments attributable to the amount deferred, determined as of the date
the portion is fixed. For this purpose, if the requirements of
paragraph (c)(2)(iii)(B) of this section are satisfied, the present
value is determined by assuming that payments are made in the normal
form of benefit commencing at normal commencement date. In addition, if
the employer demonstrates that the amount deferred was determined using
reasonable actuarial assumptions as determined by the Commissioner, the
present value of the future benefit payments attributable to the amount
deferred is determined using those assumptions. In any other case, see
paragraph (d)(2)(iii) of this section.
(2) Income attributable to the amount taken into account--(i)
Account balance plans--(A) In general. For purposes of the
nonduplication rule of paragraph (a)(2)(iii) of this section, in the
case of an account balance plan, the income attributable to the amount
taken into account means any amount credited on behalf of an employee
under the terms of the plan that is income (within the meaning of
paragraph (c)(1)(ii)(B) of this section) attributable to an amount
previously taken into account (within the meaning of paragraph (d)(1)
of this section), but only if the income reflects a rate of return that
does not exceed either the rate of return on a predetermined actual
investment (as determined in accordance with paragraph (d)(2)(i)(B) of
this section) or, if the income does not reflect the rate of return on
a predetermined actual investment (as so determined), a reasonable rate
of interest (as
[[Page 4555]]
determined in accordance with paragraph (d)(2)(i)(C) of this section).
(B) Rules relating to actual investment--(1) In general. For
purposes of this paragraph (d)(2)(i), the rate of return on a
predetermined actual investment for any period means the rate of total
return (including increases or decreases in fair market value) that
would apply if the account balance were, during the applicable period,
actually invested in one or more investments that are identified in
accordance with the plan before the beginning of the period. For this
purpose, an account balance plan can determine income based on the rate
of return of a predetermined actual investment regardless of whether
assets associated with the plan or the employer are actually invested
therein and regardless of whether that investment is generally
available to the public. For example, an account balance plan could
provide that income on the account balance is determined based on an
employee's prospective election among various investment alternatives
that are available under the employer's section 401(k) plan, even if
one of those investment alternatives is not generally available to the
public. In addition, an actual investment includes an investment
identified by reference to any stock index with respect to which there
are positions traded on a national securities exchange described in
section 1256(g)(7)(A).
(2) Certain rates of return not based on predetermined actual
investment. A rate of return will not be treated as the rate of return
on a predetermined actual investment within the meaning of this
paragraph (d)(2)(i)(B) if the rate of return (to any extent or under
any conditions) is based on the greater of the rate of return of two or
more actual investments, is based on the greater of the rate of return
on an actual investment and a rate of interest (whether or not the rate
of interest would otherwise be reasonable under paragraph (d)(2)(i)(C)
of this section), or is based on the rate of return on an actual
investment that is not predetermined. For example, if a plan bases the
rate of return on the greater of the rate of return on a predetermined
actual investment (such as the value of the employer's stock), and a 0
percent interest rate (i.e., without regard to decreases in the value
of that investment), the plan is using a rate of return that is not a
rate of return on a predetermined actual investment within the meaning
of this paragraph (d)(2)(i)(B).
(C) Rules relating to reasonable interest rates--(1) In general. If
income for a period is credited to an account balance plan on a basis
other than the rate of return on a predetermined actual investment (as
determined in accordance with paragraph (d)(2)(i)(B) of this section),
then, except as otherwise provided in this paragraph (d)(2)(i)(C), the
determination of whether the income for the period is based on a
reasonable rate of interest will be made at the time the amount
deferred is required to be taken into account and annually thereafter.
(2) Fixed rates permitted. If, with respect to an amount deferred
for a period, an account balance plan provides for a fixed rate of
interest to be credited, and the rate is to be reset under the plan at
a specified future date that is not later than the end of the fifth
calendar year that begins after the beginning of the period, the rate
is reasonable at the beginning of the period, and the rate is not
changed before the reset date, then the rate will be treated as
reasonable in all future periods before the reset date.
(ii) Nonaccount balance plans. For purposes of the nonduplication
rule of paragraph (a)(2)(iii) of this section, in the case of a
nonaccount balance plan, the income attributable to the amount taken
into account means the increase, due solely to the passage of time, in
the present value of the future payments to which the employee has
obtained a legally binding right, the present value of which
constituted the amount taken into account (determined as of the date
such amount was taken into account), but only if the amount taken into
account was determined using reasonable actuarial assumptions and
methods. Thus, for each year, there will be an increase (determined
using the same interest rate used to determine the amount taken into
account) resulting from the shortening of the discount period before
the future payments are made, plus, if applicable, an increase in the
present value resulting from the employee's survivorship during the
year. As a result, if the amount deferred for a period is determined
using a reasonable interest rate and other reasonable actuarial
assumptions and methods, and the amount is taken into account when
required under paragraph (e) of this section, then, under the
nonduplication rule of paragraph (a)(2)(iii) of this section, none of
the future payments attributable to that amount will be subject to FICA
tax when paid.
(iii) Unreasonable rates of return--(A) Account balance plans. This
paragraph (d)(2)(iii)(A) applies to an account balance plan under which
the income credited is based on neither a predetermined actual
investment, within the meaning of paragraph (d)(2)(i)(B) of this
section, nor a rate of interest that is reasonable, within the meaning
of paragraph (d)(2)(i)(C) of this section, as determined by the
Commissioner. In that event, the employer must calculate the amount
that would be credited as income under a reasonable rate of interest,
determine the excess (if any) of the amount credited under the plan
over the income that would be credited using the reasonable rate of
interest, and take that excess into account as an additional amount
deferred in the year the income is credited. If the employer fails to
calculate the amount that would be credited as income under a
reasonable rate of interest and to take the excess into account as an
additional amount deferred in the year the income is credited, or the
employer otherwise fails to take the full amount deferred into account,
then the excess of the income credited under the plan over the income
that would be credited using AFR will be treated as an amount deferred
in the year the income is credited. For purposes of this section, AFR
means the mid-term applicable federal rate (as defined pursuant to
section 1274(d)) for January 1 of the calendar year, compounded
annually. In addition, pursuant to paragraph (d)(1)(ii) of this
section, the excess over the income that would result from the
application of AFR and any income attributable to that excess are
subject to the general timing rule of paragraph (a)(1) of this section.
(B) Nonaccount balance plans. If any actuarial assumption or method
used to determine the amount taken into account under a nonaccount
balance plan is not reasonable, as determined by the Commissioner, then
the income attributable to the amount taken into account is limited to
the income that would result from the application of the AFR and, if
applicable, the applicable mortality table under section
417(e)(3)(A)(ii)(I) (the 417(e) mortality table), both determined as of
the January 1 of the calendar year in which the amount was taken into
account. In addition, paragraph (d)(1)(ii)(B) of this section applies
and, in calculating the fraction described in paragraph (d)(1)(ii)(B)
of this section (at the date specified in paragraph (d)(1)(ii)(B) of
this section), the numerator is the amount taken into account plus
income (as limited under this paragraph (d)(2)(iii)(B)), and the
present value in the denominator is determined using the AFR, the
417(e) mortality table, and reasonable assumptions as to cost of
living, each determined as of the time
[[Page 4556]]
the amount deferred was required to be taken into account.
(3) Examples. This paragraph (d) is illustrated by the following
examples:
Example 1. (i) In 2001, Employer M establishes a nonqualified
deferred compensation plan for Employee A under which all benefits
are 100 percent vested. In 2002, Employee A has $200,000 of current
annual compensation from Employer M that is subject to FICA tax. The
amount deferred under the plan on behalf of Employee A for 2002 is
$20,000. Thus, Employee A has total wages for FICA tax purposes of
$220,000. Because Employee A has other wages that exceed the OASDI
wage base for 2002, no additional OASDI tax is due as a result of
the $20,000 amount deferred. Because there is no wage base
limitation for the HI portion of FICA, additional HI tax liability
results from the $20,000 amount deferred. However, Employer M fails
to pay the additional HI tax.
(ii) Under paragraph (d)(1)(i) of this section, an amount
deferred is considered taken into account as wages for FICA tax
purposes as of the date it is included in computing FICA wages, but
only if any additional FICA tax liability that results from
inclusion of the amount deferred is actually paid. Because the HI
tax resulting from the $20,000 amount deferred was not paid, that
amount deferred was not taken into account within the meaning of
paragraph (d)(1) of this section. Thus, pursuant to paragraph
(d)(1)(ii) of this section, benefit payments attributable to the
$20,000 amount deferred will be included as wages in accordance with
the general timing rule of paragraph (a)(1) of this section and will
be subject to the HI portion of FICA tax when actually or
constructively paid (and the OASDI portion of FICA tax to the extent
Employee A's wages do not exceed the OASDI wage base limitation).
Example 2. (i) The facts are the same as in Example 1, except
that Employer M takes all actions necessary to correct its failure
to pay the additional tax before the applicable period of
limitations expires for 2002 (including payment of any applicable
interest and penalties).
(ii) Because the HI tax resulting from the $20,000 amount
deferred is paid, that amount deferred is considered taken into
account for 2002. Thus, in accordance with paragraph (a)(2)(iii) of
this section, neither the amount deferred nor the income
attributable to the amount taken into account will be treated as
wages for FICA tax purposes at any time thereafter.
Example 3. (i) Employer N establishes a nonqualified deferred
compensation plan under which all benefits are 100 percent vested.
Under the plan, an employee's account is credited with a
contribution equal to 10 percent of salary on December 31 of each
year. The employee's account balance also is increased each December
31 by interest on the total amounts credited to the employee's
account as of the preceding December 31. The interest rate specified
in the plan results in income credits that are not based on the rate
of return on a predetermined actual investment within the meaning of
paragraph (d)(2)(i)(B) of this section, and that are greater than
the income that would result from application of a reasonable rate
of interest within the meaning of paragraph (d)(2)(i)(C) of this
section. Employer N fails to take into account an additional amount
for the excess of the income credited under the plan over a
reasonable rate of interest.
(ii) Pursuant to paragraph (d)(2)(iii)(A) of this section, the
income credits in excess of the income that would be credited using
the AFR are considered additional amounts deferred in the year
credited.
Example 4. (i) The facts are the same as in Example 3, except
that the annual increase is based on Moody's Average Corporate Bond
Yield.
(ii) Because this index reflects a reasonable rate of interest,
the income credited under the plan is considered income attributable
to the amount taken into account within the meaning of paragraph
(d)(2)(i) of this section.
Example 5. (i) The facts are the same as in Example 3, except
that the annual increase (or decrease) is based on the rate of total
return on Employer N's publicly traded common stock.
(ii) Because the income credited under the plan does not exceed
the actual rate of return on a predetermined actual investment, the
income credited is considered income attributable to the amount
taken into account within the meaning of paragraph (d)(2)(i) of this
section.
Example 6. (i) The facts are the same as in Example 3, except
that the annual rate of increase or decrease is equal to the greater
of the rate of total return on a specified aggressive growth mutual
fund or the rate of return on a specified income-oriented mutual
fund. Employer N fails to take into account an additional amount for
the excess of the income credited under the plan over a reasonable
rate of interest.
(ii) Because the rate of increase or decrease is based on the
greater of two rates of returns, the increase is not based on the
return on a predetermined actual investment within the meaning of
paragraph (d)(2)(i)(B) of this section. Thus, if the rate of return
credited under the plan (i.e., the greater of the rates of return of
the two mutual funds) exceeds the income that would be credited
using the AFR, the excess is not considered income attributable to
the amount taken into account within the meaning of paragraph
(d)(2)(i) of this section and, pursuant to paragraph (d)(2)(iii)(A)
of this section, is considered an additional amount deferred.
Example 7. (i) The facts are the same as in Example 6, except
that the annual increase or decrease with respect to 50 percent of
the employee's account is equal to the rate of total return on the
specified aggressive growth mutual fund and the annual increase or
decrease with respect to the other 50 percent of the employee's
account is equal to the increase or decrease in the Standard &
Poor's 500 Index.
(ii) Because the increase or decrease attributable to any
portion of the employee's account is based on the return on a
predetermined actual investment, the entire increase or decrease is
considered income attributable to the amount taken into account
within the meaning of paragraph (d)(2)(i) of this section.
Example 8. (i) The facts are the same as in Example 3, except
that, pursuant to the terms of the plan, before the beginning of
each year, the board of directors of Employer N designates a
specific investment on which the following year's annual increase or
decrease will be based. The board is authorized to switch
investments more frequently on a prospective basis. Before the
beginning of 2004, the board designates Company A stock as the
investment for 2004. Before the beginning of 2005, the board
designates Company B stock as the investment for 2005. At the end of
2005, the board determines that the return on Company B stock was
lower than expected and changes its designation for 2005 to the rate
of return on Company C stock, which had a higher return during 2005.
Employer N fails to take into account an additional amount for the
excess of the income credited under the plan over a reasonable rate
of interest.
(ii) The annual increase or decrease for 2004 is based on the
return of a predetermined actual investment. Although the annual
increase or decrease for 2005 is based on an actual investment, the
actual investment is not predetermined since it was not designated
before the beginning of 2005. Pursuant to paragraph (d)(2)(iii)(A)
of this section, the excess of the income credited under the plan
over the income determined using AFR is an additional amount
deferred for 2005.
Example 9. (i) Employer O establishes a nonqualified deferred
compensation plan for Employee B. Under the plan, if Employee B
survives until age 65, he has a fully vested right to receive a lump
sum payment at that age, equal to the product of 10 percent per year
of service and Employee B's highest average annual compensation for
any 3-year period, but no benefits are payable in the event Employee
B dies prior to age 65. As permitted under paragraph (e)(5) of this
section, any amount deferred under the plan for the calendar year is
taken into account as wages as of the last day of the year. As of
December 31, 2002, Employee B has 25 years of service and Employee
B's high 3-year average compensation is $100,000 (the average for
the years 2000 through 2002). As of December 31, 2002, Employee B
has a legally binding right to receive a payment at age 65 of
$250,000 (10 percent x 25 years x $100,000). As of December 31,
2003, Employee B is age 63, has 26 years of service, and has high 3-
year average compensation of $104,000. As of December 31, 2003,
Employee B has a legally binding right to receive a payment at age
65 of $270,400 (10 percent x 26 years x $104,000). Thus, during
2003, Employee B has earned a legally binding right to an additional
payment at age 65 of $20,400 ($270,400-$250,000). The assumptions
that Employer O uses to determine the amount deferred for 2003 are a
7 percent interest rate and the GAM 83 (male) mortality table,
which, solely for purposes of this example, are assumed to be
reasonable actuarial assumptions. The amount deferred for 2003 is
the present value, as of December 31, 2003, of the $20,400 payment,
which is $17,353. Employer O takes this amount into account by
including it in Employee B's FICA wages for 2003 and paying the
additional FICA tax.
[[Page 4557]]
(ii) Under paragraph (d)(2)(ii) of this section, the income
attributable to the amount that was taken into account is the
increase in the present value of the future payment due solely to
the passage of time, because the amount deferred was determined
using reasonable actuarial assumptions and methods. As of the
payment date at age 65, the present value of the future payment
earned during 2003 is $20,400. The entire difference between the
$20,400 and the $17,353 amount deferred ($3,047) is the increase in
the present value of the future payment due solely to the passage of
time, and thus constitutes income attributable to the amount taken
into account. Because the amount deferred was taken into account,
the entire payment of $20,400 represents either an amount deferred
that was previously taken into account ($17,353) or income
attributable to that amount ($3,047). Accordingly, pursuant to the
nonduplication rule of paragraph (a)(2)(iii) of this section, none
of the payment is included in wages.
Example 10. (i) The facts are the same as in Example 9, except
that, instead of providing a lump sum equal to 10 percent of average
compensation per year of service, the plan provides Employee B with
a fully vested right to receive a life annuity, payable monthly
beginning at age 65, equal to the product of 2 percent for each year
of service and Employee B's highest average annual compensation for
any 3-year period. The plan also provides that, if Employee B dies
before age 65, the present value of the future payments will be paid
to his or her beneficiary. As of December 31, 2002, Employee B has a
legally binding right to receive lifetime payments of $50,000 (2
percent x 25 years x $100,000) per year. As of December 31,
2003, Employee B has a legally binding right to receive lifetime
payments of $54,080 (2 percent x 26 years x $104,000) per year.
Thus, during 2003, Employee B has earned a legally binding right to
additional lifetime payments of $4,080 ($54,080-$50,000) per year
beginning at age 65. The amount deferred for 2003 is $32,935, which
is the present value, as of December 31, 2003, of these additional
payments, determined using the same actuarial assumptions and
methods used in Example 9, except that there is no discount for the
probability of death prior to age 65. Employer O takes this amount
into account by including it in Employee B's FICA wages for 2003 and
paying the additional FICA tax.
(ii) Under paragraph (d)(2)(ii) of this section, the income
attributable to the amount that was taken into account is the
increase in the present value of the future payments due solely to
the passage of time, because the amount deferred was determined
using reasonable actuarial assumptions and methods. Because the
amount deferred was taken into account, each annual payment of
$4,080 attributable to the amount deferred in 2003 represents either
an amount deferred that was previously taken into account or income
attributable to that amount. Accordingly, pursuant to the
nonduplication rule of paragraph (a)(2)(iii) of this section, none
of the payments are included in wages.
Example 11. (i) The facts are the same as in Example 10, except
that no amount is taken into account for 2003 because Employer O
fails to pay the additional FICA tax.
(ii) Under paragraph (d)(1)(ii)(A) of this section, if an amount
deferred for a period is not taken into account, then the benefit
payments attributable to that amount deferred are included as wages
in accordance with the general timing rule of paragraph (a)(1) of
this section. In this case, assuming that the amounts deferred in
other periods were taken into account, $4,080 of each year's total
benefit payments will be included in wages when actually or
constructively paid, in accordance with the general timing rule.
Example 12. (i) Employer P establishes an account balance plan
on January 1, 2002, under which all benefits are 100 percent vested.
The plan provides that amounts deferred will be credited annually
with interest beginning in 2002 at a rate that is greater than a
reasonable rate of interest. Employer P treats the excess over the
applicable interest rate in section 417(e) as an additional amount
deferred for 2002 and in each year thereafter, and takes the
additional amount into account by including it in FICA wages and
paying the additional FICA tax for the year.
(ii) Under the nonduplication rule in paragraph (a)(2)(iii) of
this section, the benefits paid under the plan will be excluded from
wages for FICA tax purposes.
Example 13. (i) The facts are the same as in Example 9, except
that, in determining the amount deferred, Employer O uses a 15
percent interest rate, which, solely for purposes of this example,
is assumed not to be a reasonable interest rate. Employer O
determines that the amount deferred for 2003 is the present value,
as of December 31, 2003, of the $20,400 payment, which is $15,023.
Employer O includes $15,023 in wages and pays any resulting FICA
tax. Solely for purposes of this example, it is assumed that the AFR
as of January 1, 2003, is 7 percent.
(ii) Under paragraph (d)(2)(iii)(B) of this section, if any
actuarial assumption or method is not reasonable, then the income
attributable to the amount taken into account is limited to the
income that would result from application of the AFR and, if
applicable, the 417(e) mortality table. Because the 15 percent
interest rate is unreasonable, the income attributable to the amount
taken into account is limited to the income that would result from
using a 7 percent interest rate and, in this case, an increase for
survivorship using the 417(e) mortality table. Under these
assumptions, the income attributable to the $15,023 amount taken
into account for 2003 is $1,199 in 2004 and $1,313 in 2005. Under
paragraph (d)(1)(ii) of this section, the sum of these amounts
($17,535) is excluded from Employee B's wages pursuant to the
nonduplication rule of paragraph (a)(2)(iii) of this section, and
the balance of the payment ($2,865) is subject to the general timing
rule of paragraph (a)(1) of this section and, thus, is included in
Employee B's wages when actually or constructively paid.
(iii) The same result can be reached by multiplying the
attributable benefit payments by a fraction, the numerator of which
is the amount taken into account, and the denominator of which is
the amount deferred that would have been taken into account at the
same time had the amount deferred been calculated using the AFR and
the 417(e) mortality table. These assumptions are determined as of
January 1 of the calendar year in which the amount was taken into
account. In this Example 13, the fraction would be $15,023 divided
by $17,478, which equals .85954. The $20,400 payment is multiplied
by this fraction to determine the amount of the payment that is
excluded from wages pursuant to the nonduplication rule of paragraph
(a)(2)(iii) of this section. Thus, $17,535 ($20,400 x .85954) is
excluded from wages and the balance ($2,865) is subject to FICA tax
when actually or constructively paid.
Example 14. (i) The facts are the same as Example 10, except
that Employer O calculates the amount deferred for 2003 as $18,252
and takes that amount into account by including that amount in wages
and paying any resulting FICA tax. The assumptions that Employer O
uses to determine the amount deferred are a 15 percent interest rate
and, for the period after commencement of benefit payments, the GAM
83 (male) mortality table. The 15 percent interest rate is assumed,
solely for purposes of this example, not to be a reasonable
actuarial assumption. Solely for purposes of this example, it is
assumed that the AFR as of January 1, 2003, is 7 percent.
(ii) Under paragraph (d)(2)(iii)(B) of this section, if any
actuarial assumption or method used is not reasonable, then the
income attributable to the amount taken into account is limited to
the income that would result from application of the AFR and, if
applicable, the 417(e) mortality table. Because the 15 percent
interest rate is not reasonable, the income attributable to the
amount taken into account is equal to the income that would result
from using a 7 percent interest rate and the amount taken into
account is treated as if it represented a portion of the amount
deferred for purposes of applying paragraph (d)(1)(ii)(B) of this
section. Under these assumptions, the income attributable to the
$18,252 amount taken into account for 2003 is $1,278 in 2004 and
$1,367 in 2005. Under paragraph (d)(1)(ii)(B) of this section, the
portion of each benefit payment attributable to the amount deferred
that is excluded from wages pursuant to the nonduplication rule of
paragraph (a)(2)(iii) of this section is determined at benefit
commencement by multiplying each benefit payment by a fraction, the
numerator of which is the amount taken into account (plus income
attributable to that amount) and the denominator of which is the
present value of future benefit payments attributable to the amount
deferred. Because the interest rate assumption is not reasonable,
not only is the income limited to the application of the AFR, but
the present value in the denominator must be determined using the
AFR and (if applicable) the 417(e) mortality table. In this case,
the present value is $40,283 and thus the fraction is $20,897
divided by $40,283, or .51875. Thus, $2,116 (.51875 x $4,080) of
each year's benefit payment is excluded from
[[Page 4558]]
wages and the balance of each year's payment ($1,964) is subject to
the general timing rule of paragraph (a)(1) of this section and is
included in wages when actually or constructively paid.
(iii) The same result can be reached by multiplying the
attributable benefit payments by a fraction the numerator of which
is the amount taken into account, and the denominator of which is
the amount deferred that would have been taken into account at the
same time had the amount deferred been calculated using the AFR and
the 417(e) mortality table. These assumptions are determined as of
January 1 of the calendar year in which the amount was taken into
account. In this Example 14, the fraction would be $18,252 divided
by $35,185, which equals .51875. The $4,080 annual payment is
multiplied by this fraction to determine the amount of the payment
that is excluded from wages pursuant to the nonduplication rule of
paragraph (a)(2)(iii) of this section. Thus, $2,116 ($4,080 x
.51875) is excluded from wages and the balance ($1,964) is subject
to FICA tax when actually or constructively paid.
(e) Time amounts deferred are required to be taken into account--
(1) In general. Except as otherwise provided in this paragraph (e), an
amount deferred under a nonqualified deferred compensation plan must be
taken into account as wages for FICA tax purposes as of the later of
the date on which services creating the right to the amount deferred
are performed (within the meaning of paragraph (e)(2) of this section)
or the date on which the right to the amount deferred is no longer
subject to a substantial risk of forfeiture (within the meaning of
paragraph (e)(3) of this section). However, in no event may any amount
deferred under a nonqualified deferred compensation plan be taken into
account as wages for FICA tax purposes prior to the establishment of
the plan providing for the amount deferred (or, if later, the plan
amendment providing for the amount deferred). Therefore, if an amount
is deferred pursuant to the terms of a legally binding agreement that
is not put in writing until after the amount would otherwise be taken
into account under this paragraph (e)(1), the amount deferred
(including any attributable income) must be taken into account as wages
for FICA tax purposes as of the date the material terms of the plan are
put in writing.
(2) Services creating the right to an amount deferred. For purposes
of this section, services creating the right to an amount deferred
under a nonqualified deferred compensation plan are considered to be
performed as of the date on which, under the terms of the plan and all
the facts and circumstances, the employee has performed all of the
services necessary to obtain a legally binding right (as described in
paragraph (b)(3)(i) of this section) to the amount deferred.
(3) Substantial risk of forfeiture. For purposes of this section,
the determination of whether a substantial risk of forfeiture exists
must be made in accordance with the principles of section 83 and the
regulations thereunder.
(4) Amount deferred that is not reasonably ascertainable under a
nonaccount balance plan--(i) In general--(A) Date required to be taken
into account. Notwithstanding any other provision of this paragraph
(e), an amount deferred under a nonaccount balance plan is not required
to be taken into account as wages under the special timing rule of
paragraph (a)(2) of this section until the first date on which all of
the amount deferred is reasonably ascertainable (the resolution date).
In this case, the amount required to be taken into account as of the
resolution date is determined in accordance with paragraph (c)(2) of
this section.
(B) Definition of reasonably ascertainable. For purposes of this
paragraph (e)(4), an amount deferred is considered reasonably
ascertainable on the first date on which the amount, form, and
commencement date of the benefit payments attributable to the amount
deferred are known, and the only actuarial or other assumptions
regarding future events or circumstances needed to determine the amount
deferred are interest and mortality. For this purpose, the form and
commencement date of the benefit payments attributable to the amount
deferred are treated as known if the requirements of paragraph
(c)(2)(iii)(B) of this section (under which payments are treated as
being made in the normal form of benefit commencing at normal
commencement date) are satisfied. In addition, an amount deferred does
not fail to be reasonably ascertainable on a date merely because the
exact amount of the benefit payable cannot readily be calculated on
that date or merely because the exact amount of the benefit payable
depends on future changes in the cost of living. If the exact amount of
the benefit payable depends on future changes in the cost of living,
the amount deferred must be determined using a reasonable assumption as
to the future changes in the cost of living. For example, the amount of
a benefit is treated as known even if the exact amount of the benefit
payable cannot be determined until future changes in the cost of living
are reflected in the section 415 limitation on benefits payable under a
qualified retirement plan.
(ii) Earlier inclusion permitted--(A) In general. With respect to
an amount deferred that is not reasonably ascertainable, an employer
may choose to take an amount into account at any date or dates (an
early inclusion date or dates) before the resolution date (but not
before the date described in paragraph (e)(1) of this section with
respect to the amount deferred). Thus, for example, with respect to an
amount deferred under a nonaccount balance plan that is not reasonably
ascertainable because the plan permits employees to receive their
benefits in more than one form or commencing at more than one date (and
the requirements of paragraph (c)(2)(iii) of this section are not
satisfied), an employer may choose to take an amount into account on
the date otherwise described in paragraph (e)(1) of this section before
the form and commencement date are selected (based on assumptions as to
the form and commencement date for the benefit payments) or may choose
to wait until the form and commencement date of the benefit payments
are selected. An employer that chooses to take an amount into account
at an early inclusion date under this paragraph (e)(4)(ii) for an
employee under a plan is not required until the resolution date to
identify the period to which the amount taken into account relates.
(B) True-up at resolution date. If, with respect to an amount
deferred for a period, an employer chooses to take an amount into
account as of an early inclusion date in accordance with this paragraph
(e)(4)(ii) and the benefit payments attributable to the amount deferred
exceed the benefit payments that are actuarially equivalent to the
amount taken into account at the early inclusion date (payable in the
same form and using the same commencement date as the benefit payments
attributable to the amount deferred), then the present value of the
difference in the benefits, determined in accordance with paragraph
(c)(2) of this section, must be taken into account as of the resolution
date.
(C) Actuarial assumptions. For purposes of determining the benefits
that are actuarially equivalent to the amount taken into account as of
an early inclusion date, the amount taken into account is converted to
an actuarially equivalent benefit payable in the same form and
commencing on the same date as the actual benefit payments attributable
to the amount deferred using an interest rate, and, if applicable,
mortality and cost-of-living assumptions, that were reasonable as of
the early inclusion date. Thus, with respect to an amount deferred for
a
[[Page 4559]]
period, the amount required to be taken into account as of the
resolution date is the present value (determined using an interest
rate, and, if applicable, mortality and cost-of-living assumptions,
that are reasonable as of the resolution date) of the excess, if any,
of the future benefit payments attributable to the amount deferred over
the future benefits payable in the same form and commencing on the same
date that are actuarially equivalent to the portion of the amount
deferred that was taken into account as of the early inclusion date
(where actuarial equivalence is determined using an interest rate, and,
if applicable, mortality and cost-of-living assumptions, that were
reasonable as of the early inclusion date).
(D) Allocation rules for amounts deferred over more than one
period--(1) General rule. The rules of this paragraph (e)(4)(ii)(D)
apply for purposes of determining whether an amount has been included
under this paragraph (e)(4) before the earliest date permitted under
paragraph (e)(1) of this section.
(2) Future compensation increases. Increases in an employee's
compensation after the early inclusion date must be disregarded.
(3) Early retirement subsidies. An early retirement subsidy that
the employee ultimately receives may be taken into account at an early
inclusion date if the employee would have a legally binding right to
the subsidy at the early inclusion date but for any condition that the
employee continue to render services. Accordingly, an employer may take
into account at an early inclusion date any early retirement subsidy
that the employee ultimately receives to the extent that elimination or
reduction of that subsidy would violate section 411(d)(6)(B)(i) if that
section applied to the plan.
(4) Allocation with respect to offsets. In any case in which a
series of amounts are deferred over more than one period, the amounts
deferred are not reasonably ascertainable until a single resolution
date and the benefit payments attributable to the entire series are
determined under a formula that provides a gross benefit that in the
aggregate is subject to an objective reduction for future events under
the terms of the plan, such as an offset for the aggregate benefits
payable under a plan qualified under section 401(a), the attribution of
benefit payments to the amount deferred in each period is determined
under the rules of this paragraph (e)(4)(ii)(D)(4). In a case described
in the preceding sentence, the benefit payments made as a result of the
series of amounts deferred may be treated as attributable to the amount
deferred as of the earliest period in which the employee obtained a
legally binding right to a benefit under the plan equal to the excess,
if any, of the amount of the gross benefit attributable to that period
(determined at the resolution date), over the amount of the reduction
determined as of the end of that period. Thus, for example, if an
employee obtains a legally binding right in each of several years to
benefit payments from a nonqualified deferred compensation plan that
provides for a specified gross benefit for the years to be offset by
the benefits payable under a qualified plan, the amount deferred in the
first year may be treated as equal to the gross benefit for the year,
reduced by the offset applicable at the end of the year (even if the
offset increases after the end of the year).
(E) Treatment of benefits paid before the resolution date. If a
benefit payment is attributable to an amount deferred that is not
reasonably ascertainable at the time of payment (or is paid before the
date selected under paragraph (e)(5) of this section), and the employer
has previously taken an amount into account with respect to the amount
deferred under the early inclusion rule of this paragraph (e)(4), then,
in lieu of the pro rata rule provided in paragraph (d)(1)(ii)(B) of
this section, a first-in-first-out rule applies in determining the
portion of the benefit payment attributable to the amount taken into
account. Under this first-in-first-out rule, the benefit payment is
compared to the sum of the amount taken into account at the early
inclusion date and the income attributable to that amount. If the
benefit payment equals or exceeds the amount taken into account at the
early inclusion date and the income attributable to that amount as of
the date of the benefit payment, the benefit payment is included as
wages under the general timing rule of paragraph (a)(1) of this section
to the extent of any excess, and the amount taken into account at the
early inclusion date (and income attributable to that amount) is
disregarded thereafter with respect to the amount deferred. If the
amount taken into account at the early inclusion date and the income
attributable to that amount as of the date of the benefit payment
exceeds the benefit payment, the benefit payment is not included as
wages under the general timing rule of paragraph (a)(1) of this section
and, in determining the amount that must be taken into account
thereafter with respect to the amount deferred, the amount taken into
account at the early inclusion date, plus attributable income as of the
date of the benefit payment, is reduced by the amount of the benefit
payment, and only the excess plus future income attributable to the
excess (credited using assumptions that were reasonable on the early
inclusion date) is taken into consideration. If amounts have been taken
into account at more than one early inclusion date, this paragraph
(e)(4)(ii)(E) applies on a first-in-first-out basis, beginning with the
amount taken into account at the earliest early inclusion date
(including income attributable thereto).
(5) Rule of administrative convenience. For purposes of this
section, an employer may treat an amount deferred as required to be
taken into account under this paragraph (e) on any date that is later
than, but within the same calendar year as, the actual date on which
the amount deferred is otherwise required to be taken into account
under this paragraph (e). For example, if services creating the right
to an amount deferred are considered performed under paragraph (e)(2)
of this section periodically throughout a year, the employer may
nevertheless treat the services creating the right to that amount
deferred as performed on December 31 of that year. If an employer uses
the rule of administrative convenience described in this paragraph
(e)(5), any determination of whether the income attributable to an
amount deferred under an account balance plan is based on a reasonable
rate of interest or whether the actuarial assumptions used to determine
the present value of an amount deferred in a nonaccount balance plan
are reasonable will be made as of the date the employer selects to take
the amount into account.
(6) Portions of an amount deferred required to be taken into
account on more than one date. If different portions of an amount
deferred are required to be taken into account under paragraph (e)(1)
of this section on more than one date (e.g., on account of a graded
vesting schedule), then each such portion is considered a separate
amount deferred for purposes of this section.
(7) Examples. This paragraph (e) is illustrated by the following
examples:
Example 1. (i) Employer M establishes a nonqualified deferred
compensation plan for Employee A on November 1, 2005. Under the
plan, which is an account balance plan, Employee A obtains a legally
binding right on the last day of each calendar year (if Employee A
is employed on that date) to be credited with a principal amount
equal to 5 percent of compensation for the year. In addition, a
reasonable rate of interest is credited quarterly. Employee A's
account balance is nonforfeitable and is payable upon Employee A's
termination of employment. For 2006, the principal amount credited
to
[[Page 4560]]
Employee A under the plan (which, in this case, is also the amount
deferred within the meaning of paragraph (c) of this section) is
$25,000.
(ii) Under paragraph (e)(2) of this section, the services
creating the right to the $25,000 amount deferred are considered
performed as of December 31, 2006, the date on which Employee A has
performed all of the services necessary to obtain a legally binding
right to the amount deferred. Thus, in accordance with paragraph
(e)(1) of this section, the $25,000 amount deferred must be taken
into account as of December 31, 2006, which is the later of the date
on which services creating the right to the amount deferred are
performed or the date on which the right to the amount deferred is
no longer subject to a substantial risk of forfeiture.
Example 2. (i) The facts are the same as in Example 1, except
that the principal amount credited under the plan on the last day of
each year (and attributable interest) is forfeited if the employee
terminates employment within five years of that date.
(ii) Under paragraph (e)(3) of this section, the determination
of whether the right to an amount deferred is subject to a
substantial risk of forfeiture is made in accordance with the
principles of section 83. Under Sec. 1.83-3(c) of this chapter, a
substantial risk of forfeiture generally exists where rights in
property that are transferred are conditioned, directly or
indirectly, upon the future performance of substantial services.
Because Employee A's right to receive the $25,000 principal amount
(and attributable interest) is conditioned on the performance of
services for five years, a substantial risk of forfeiture exists
with respect to that amount deferred until December 31, 2011.
(iii) December 31, 2011, is the later of the date on which
services creating the right to the amount deferred are performed or
the date on which the right to the amount deferred is no longer
subject to a substantial risk of forfeiture. Thus, in accordance
with paragraph (e)(1) of this section, the amount deferred (which,
pursuant to paragraph (c)(1) of this section, is equal to the
$25,000 principal amount credited to Employee A's account on
December 31, 2006, plus the interest credited with respect to that
principal amount through December 31, 2011) must be taken into
account as of December 31, 2011.
Example 3. (i) The facts are the same as in Example 2, except
that the principal amount credited under the plan on the last day of
each year (and attributable interest) becomes nonforfeitable
according to a graded vesting schedule under which 20 percent is
vested as of December 31, 2007; 40 percent is vested as of December
31, 2008; 60 percent is vested as of December 31, 2009; 80 percent
is vested as of December 31, 2010; and 100 percent is vested as of
December 31, 2011. Because these dates are later than the date on
which the services creating the right to the amount deferred are
considered performed (December 31, 2006), the amount deferred is
required to be taken into account as of these dates that fall in
five different years.
(ii) Paragraph (e)(6) of this section provides that, if
different portions of an amount deferred are required to be taken
into account under paragraph (e)(1) of this section on more than one
date, then each such portion is considered a separate amount
deferred for purposes of this section. Thus, $5,000 of the principal
amount, plus interest credited through December 31, 2007, is taken
into account as an amount deferred on December 31, 2007; $5,000 of
the principal amount, plus interest credited through December 31,
2008, is taken into account as a separate amount deferred on
December 31, 2008; etc.
Example 4. (i) On November 21, 2001, Employer N establishes a
nonqualified deferred compensation plan under which all benefits are
100 percent vested. The plan provides for Employee B (who is age 45)
to receive a lump sum benefit of $500,000 at age 65. This benefit
will be forfeited if Employee B dies before age 65.
(ii) Because the amount, form, and commencement date of the
benefit are known, and the only assumptions needed to determine the
amount deferred are interest and mortality, the amount deferred is
reasonably ascertainable within the meaning of paragraph (e)(4)(i)
of this section on November 21, 2001.
Example 5. (i) The facts are the same as in Example 4, except
that plan provides that the lump sum will be paid at the later of
age 65 or termination of employment and provides that the $500,000
payable to Employee B is increased by 5 percent per year for each
year that payment is deferred beyond age 65.
(ii) Because the commencement date of the benefit payment is
contingent on when Employee B terminates employment, the
commencement date of the benefit payment is not known. Thus, the
amount deferred is not reasonably ascertainable within the meaning
of paragraph (e)(4)(i) of this section, unless the plan satisfies
the requirements of paragraph (c)(2)(iii)(B) of this section.
Because the fixed 5 percent factor may not be reasonable at the time
benefit payments commence (i.e., 5 percent might be higher or lower
than a reasonable interest rate when payments commence), the plan
fails to satisfy paragraph (c)(2)(iii)(B) of this section and
accordingly the amount deferred is not reasonably ascertainable
until termination of employment.
Example 6. (i) The facts are the same as in Example 4, except
that the $500,000 is payable to Employee B at the later of age 55 or
termination of employment.
(ii) Because the commencement date of the benefit payment is
contingent on when Employee B terminates employment, the
commencement date of the benefit payment is not known. Thus, the
amount deferred is not reasonably ascertainable until termination of
employment.
Example 7. (i) The facts are the same as in Example 4, except
that Employee B may elect to take the benefit in the form of a life
annuity of $50,000 per year (commencing at age 65).
(ii) Because the plan permits employees to elect to receive
benefits in more than one form and the alternative forms may not
have the same value when Employee B makes his election, the plan
fails to satisfy the requirements of paragraph (c)(2)(iii)(B) of
this section until a form of benefit is selected. Thus, the amount
deferred is not reasonably ascertainable until then.
Example 8. (i) Employer O establishes a nonqualified deferred
compensation plan. The plan is a supplemental executive retirement
plan (SERP) that provides Employee C with a fully vested right to
receive a pension, in the form of a life annuity payable monthly,
beginning at age 65, equal to the excess of 3 percent of Employee
C's final 3-year average pay for each year of participation up to 15
years, over the amount payable to Employee C from Employer O's
qualified pension plan. The amount payable under the qualified
pension plan is a life annuity payable monthly, beginning at age 65,
equal to 1.5 percent of final 3-year average pay for each year of
employment, excluding pay in excess of the section 401(a)(17)
compensation limit. No benefits are payable under the SERP if
Employee C dies before age 65. Employee C becomes a participant in
the SERP on January 1, 2001, at age 44. The amount deferred under
the SERP for any year is not reasonably ascertainable prior to
termination of employment because the amount of the benefit is not
known and the determination of the amount deferred requires
assumptions other than interest and mortality (e.g., an assumption
as to Employee C's average pay for the final three years of
employment). As permitted by paragraph (e)(4)(i) of this section,
Employer O chooses not to take any amount into account for any year
before the resolution date. Employee C terminates employment on
December 31, 2018 when he is age 62.
(ii) As of the date Employee C terminates employment, the amount
of the benefit is known and the only actuarial or other assumptions
needed to determine the amount deferred are an interest rate
assumption and a mortality assumption. At that time, the amount
deferred in each past year becomes reasonably ascertainable, and
Employer O is able to determine that during 2001 Employee C earned a
legally binding right to a life annuity of $4,000 per year beginning
in 2021 when Employee C is age 65. Employer O determines the present
value of Employee C's future benefit payments under the SERP as of
this resolution date (December 31, 2018), using a 7 percent interest
rate and the UP-84 mortality table, which, solely for purposes of
this example, are assumed to be reasonable actuarial assumptions for
December 31, 2018. The special timing rule will be satisfied if the
resulting present value, $26,950, is taken into account on that date
in accordance with paragraph (d)(1) of this section.
Example 9. (i) The facts are the same as in Example 8, except
that the plan provides that Employee C may choose to receive early
retirement benefits on an unreduced basis at any time after age 60
if Employee C has completed 15 years of service by that date.
(ii) As of the date Employee C terminates employment, the amount
of the benefit is known and the only actuarial or other assumptions
needed to determine the amount deferred are an interest rate
assumption and a mortality assumption. At that time, the amount
deferred in each past year becomes reasonably ascertainable, and
Employer O is able to determine that during 2001 Employee C earned a
legally binding right to a life annuity of $4,000 per year beginning
on
[[Page 4561]]
December 31, 2018 when Employee C is age 62. Employer O determines
the present value of Employee C's future benefit payments under the
SERP as of this resolution date (December 31, 2018), using a 7
percent interest rate and the UP-84 mortality table, which, solely
for purposes of this example, are assumed to be reasonable actuarial
assumptions for December 31, 2018. The special timing rule will be
satisfied if the resulting present value, $37,576, is taken into
account on that date in accordance with paragraph (d)(1) of this
section.
Example 10. (i) The facts are the same as in Example 9, except
that, as permitted under paragraph (e)(4)(ii) of this section,
Employer O chooses to take an amount into account before the amount
deferred for 2001 is reasonably ascertainable. The amount that
Employer O takes into account on December 31, 2001, is $13,043 (the
present value of a life annuity of $4,000 per year, payable at age
62, using a 6 percent interest rate and the UP-84 mortality table).
Employer O does not take any other amount into account before the
resolution date.
(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,
Employer O must determine any additional amount required to be taken
into account in 2018. If the $4,000 payable in the form of a life
annuity beginning at age 62 exceeds the life annuity which is
actuarially equivalent to the $13,043 previously taken into account,
the present value of the excess must be taken into account. In this
Example 10, the $13,043 previously taken into account is actuarially
equivalent to a $4,000 annuity commencing at age 62 using a 6
percent interest rate and the UP-84 mortality table ( which, solely
for purposes of this example, are assumed to be reasonable actuarial
assumptions for December 31, 2001). Accordingly, no additional
amount need be taken into account in 2018, regardless of any changes
in market rates of interest between 2001 and 2018.
Example 11. (i) The facts are the same as in Example 9, except
that, as permitted under paragraph (e)(4)(ii) of this section,
Employer O chooses to take an amount into account before the amount
deferred for 2001 is reasonably ascertainable. The amount that
Employer O takes into account on December 31, 2001, is $9,569 (the
present value of a life annuity of $4,000 per year, payable at age
65, using a 6 percent interest rate and the UP-84 mortality table).
Employer O does not take any other amount into account before the
resolution date.
(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,
Employer O must determine any additional amount required to be taken
into account in 2018. If the $4,000 payable in the form of a life
annuity beginning in 2018 at age 62 exceeds the life annuity which
is actuarially equivalent to the $9,569 previously taken into
account, the present value of the excess must be taken into account.
In this case, the $9,569 previously taken into account is
actuarially equivalent to a $2,935 annuity commencing at age 62
using a 6 percent interest rate and the UP-84 mortality table
(which, solely for purposes of this example, are assumed to be
reasonable actuarial assumptions for December 31, 2001).
Accordingly, an additional amount needs to be taken into account in
2018 equal to the present value of the excess of the $4,000 annual
stream of benefit payments to which Employee C obtained a legally
binding right during 2001 over the $2,935 annual stream of benefit
payments which is actuarially equivalent to the amount previously
taken into account. This present value (i.e., the present value of a
life annuity equal to $4,000 minus $2,935, or $1,065 annually) is
determined by Employer O to be $10,005 as of the resolution date
using a 7 percent interest rate and the UP-84 mortality table
(which, solely for purposes of this example, are assumed to be
reasonable actuarial assumptions for December 31, 2018).
Example 12. (i) The facts are the same as in Example 9, except
that the amount that Employer O takes into account on December 31,
2001, is $15,834 (the present value of $4,000, payable at age 60,
using a 6 percent interest rate and the UP-84 mortality table).
Employer O does not take any other amount into account before the
resolution date.
(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,
Employer O must determine any additional amount required to be taken
into account in 2018. If the $4,000 payable in the form of a life
annuity beginning at age 62 exceeds the life annuity which is
actuarially equivalent to the $15,834 previously taken into account,
the present value of the excess must be taken into account. In this
case, the $15,834 previously taken into account is actuarially
equivalent to a $4,856 annuity commencing at age 62 using a 6
percent interest rate and the UP-84 mortality table (which, solely
for purposes of this example, are assumed to be reasonable actuarial
assumptions for December 31, 2001). Because the life annuity of
$4,856 per year (which is equivalent to the amount taken into
account at the early inclusion date) exceeds the $4,000 annuity
attributable to the amount deferred in 2001, no additional amount is
required to be taken into account for that amount deferred as of the
resolution date. Employer O may claim a refund or credit for the
overpayment of FICA tax with respect to amounts taken into account
prior to the resolution date to the extent permitted by sections
6402, 6413, and 6511.
Example 13. (i) The facts are the same as in Example 12, except
that Employee C became a participant in the SERP on January 1, 2000.
In addition, Employer O determines in 2018 that during 2000 Employee
C earned a legally binding right to a life annuity of $1,500 per
year beginning on December 31, 2018.
(ii) Employer O may allocate the $15,834 previously taken into
account among any amounts deferred on or before the early inclusion
date. At the resolution date, Employer O will have to take into
account the present value of an annuity equal to the excess of the
life annuity attributable to the amounts deferred for 2000 and 2001
over a life annuity of $4,856 per year.
Example 14. (i) In 2003, Employer P establishes a nonqualified
deferred compensation plan for Employee D. The plan provides that,
in consideration of Employee D's services to be performed on Project
X in 2004, Employee D will have a nonforfeitable right to receive 1
percent per year of Employer P's net profits associated with Project
X for each of the immediately succeeding three years. No services
beyond 2004 are required. The 1 percent of net profits payable each
year will be paid on March 31 of the immediately succeeding year.
One percent of net profits associated with Project X is $750,000 in
2005, $400,000 in 2006, and $90,000 in 2007. Employee D receives
$750,000 on March 31, 2006, $400,000 on March 31, 2007, and $90,000
on March 31, 2008.
(ii) Because the services creating the right to all of the
amount deferred are performed in 2004, the benefit payments based on
the 2005, 2006, and 2007 net profits are all attributable to the
amount deferred in 2004. However, because the present value of
Employee D's future benefit is contingent on future profits, the
determination of the amount deferred requires the use of assumptions
other than interest, mortality, and cost of living. Thus, all of the
amount deferred in 2004 will not be reasonably ascertainable within
the meaning of paragraph (e)(4)(i) of this section until December
31, 2007 (which is the resolution date). Employer P does not choose
to take any amount into account prior to the amount deferred
becoming reasonably ascertainable.
(iii) However, paragraph (d)(1)(ii)(A) of this section provides
that a benefit payment attributable to an amount deferred under a
nonqualified deferred compensation plan must be included as wages
when actually or constructively paid if the amount deferred has not
been taken into account as wages under the special timing rule of
paragraph (a)(2) of this section. Thus, the benefit payments in 2006
and 2007 must be included as wages when paid.
(iv) As of December 31, 2007, all of the amount deferred under
the plan becomes reasonably ascertainable because the amount of the
benefit payable attributable to the amount deferred is treated as
known under paragraph (e)(4)(i)(B) of this section, and the only
assumption needed to determine the present value of the future
benefits is interest. However, since Employer P was required to
treat the payments in 2006 and 2007 as wages when paid under the
general timing rule of paragraph (a)(1) of this section, only the
present value of the payment to be made in 2008 is required to be
taken into account as of the resolution date (December 31, 2007)
under the special timing rule of paragraph (a)(2) of this section.
Using an interest rate of 10 percent per year (which, solely for
purposes of this Example 14, is assumed to be reasonable), Employer
P determines that on December 31, 2007, the present value of the
future benefits is $87,881, and Employer P includes that additional
amount in wages for 2007. (Note that Employer P can choose to use
the lag method of withholding described in paragraph (f)(3) of this
section, which allows the resolution date amount to be taken into
account no later than March 31, 2008, provided that the amount
deferred is increased by interest using the AFR for January of
2008.)
Example 15. (i) The facts are the same as in Example 14, except
that Employer P
[[Page 4562]]
chooses the early inclusion option permitted by paragraph (e)(4)(ii)
of this section to take $1,000,000 into account on December 31,
2004, before the amount deferred for 2004 is reasonably
ascertainable.
(ii) Pursuant to paragraph (e)(4)(ii)(E) of this section, in
applying the nonduplication rule of paragraph (a)(2)(iii) of this
section, a first-in-first-out rule applies in determining the
benefit payments that are attributable to amounts previously taken
into account. Using the 10 percent interest rate, Employer P
determines that the $750,000 benefit payment on March 31, 2006, and
the March 31, 2007, benefit payment of $400,000 are less than the
$1,000,000 taken into account at the early inclusion date, plus
attributable income, and, therefore, are not included in wages when
paid.
(iii) Under paragraph (e)(4)(ii)(E) of this section, if an
employer chooses to take an amount into account before the
resolution date, the amount taken into account (plus income
attributable to that amount) is disregarded to the extent the amount
is attributed to benefit payments made before the resolution date.
Thus, Employer P must reduce the $1,000,000 taken into account in
2004 (plus income attributable to that amount) based upon the two
benefit payments ($750,000 and $400,000) that were excluded from
wages. Using an interest rate of 10 percent, Employer P determines
that the amount taken into account in 2004 plus interest to the
resolution date and reduced based upon the two benefit payments is
$15,228 and the additional amount that is required to be taken into
account as of December 31, 2007, is $72,653 ($87,881-$15,228).
Example 16. (i) Employee E obtains a fully vested, legally
binding right during 2002, 2003, and 2004 to payments from a
nonqualified deferred compensation plan of Employer Q under which
the benefits are based on a formula that includes an actuarial
offset by the account balance under a qualified defined contribution
plan of Employer Q as of December 31, 2004. The payments from the
nonqualified deferred compensation plan are to commence on December
31, 2005. At the resolution date for the amounts earned during 2002,
2003, and 2004, which is December 31, 2004, Employee E has a legally
binding right to a net annual benefit of $100,000 payable for life
to commence on December 31, 2005. On the resolution date, Employer Q
determines that on December 31, 2002, Employee E had a legally
binding right to receive $100,000 annually for life beginning on
December 31, 2005 (as a result of the gross benefit under the
nonqualified plan being $120,000 annually for life, and the offset
being $20,000 annually for life, as of December 31, 2002). On
December 31, 2003, Employee E had a legally binding right to receive
$95,000 annually for life beginning on December 31, 2005 (as a
result of the gross benefit under the nonqualified plan being
$135,000 annually for life, and the offset being $40,000 annually
for life, as of December 31, 2003). On December 31, 2004, Employee E
had a legally binding right to receive $100,000 annually for life
beginning on December 31, 2005 (as a result of the gross benefit
under the nonqualified plan being $145,000 annually for life, and
the offset being $45,000 annually for life, as of December 31,
2004).
(ii) In this case, pursuant to paragraph (e)(4)(ii)(D)(4) of
this section, Employer Q can attribute the entire $100,000 life
annuity to the amount deferred for 2002, even though Employee E's
benefit under the nonqualified deferred compensation plan is reduced
to $95,000 in 2003.
Example 17. (i) In 2010, Employee F performs services for which
she earns a right to 10 percent of the proceeds from the sale of a
motion picture. In 2011, Employee F performs services for which she
earns a right to 10 percent of the proceeds from the sale of another
motion picture. These proceeds are calculated by subtracting the
total advertising expenses for both movies. Payment is to be made in
the year following the date on which both pictures have been sold,
but not later than 2018. At the end of 2010, the advertising
expenses for both pictures totaled $300,000. The first motion
picture is sold for $10,000,000 in 2014. The second motion picture
is sold for $17,000,000 in 2017. At the end of 2017, the advertising
expenses totaled $1,700,000. In 2018, Employee F is paid $2,530,000
(10 percent of the sum of $10,000,000 and $17,000,000 minus
$1,700,000).
(ii) Pursuant to paragraph (e)(4)(ii)(D)(4) of this section,
$970,000 (10 percent of the excess of the gross proceeds from the
sale of the first motion picture at the resolution date in 2017 over
the advertising expenses incurred at the end of 2010) of the payment
made in 2018 can be attributed to the amount deferred in 2010 (and
with the remaining payment of $1,560,000 to be attributed to the
amount deferred in 2011).
(f) Withholding--(1) In general. Unless an employer applies an
alternative method described in paragraph (f)(2) or (3) of this
section, an amount deferred under a nonqualified deferred compensation
plan for any employee is treated, for purposes of withholding and
depositing FICA tax, as wages paid by the employer and received by the
employee at the time it is taken into account in accordance with
paragraph (e) of this section. However, paragraphs (f)(2) and (3) of
this section provide alternative methods which may be used with respect
to an amount deferred for an employee. An employer is not required to
be consistent in applying the alternatives described in this paragraph
(f) with respect to different employees or amounts deferred.
(2) Estimated method--(i) In general. Under the alternative method
provided in this paragraph (f)(2), the employer may make a reasonable
estimate of the amount deferred on the date on which the amount is
taken into account in accordance with paragraph (e) of this section and
take that estimated amount into account as wages paid by the employer
and received by the employee on that date (the estimate date), for
purposes of withholding and depositing FICA tax.
(ii) Underestimate of the amount deferred--(A) General rule. If the
employer underestimates the amount deferred (as determined after
calculating the actual amount deferred that should have been taken into
account as of the date on which the amount was taken into account in
accordance with paragraph (e) of this section, using an interest rate
and other actuarial assumptions that are reasonable as of that date),
the employer may treat the shortfall as wages paid as of the estimate
date or as of any date that is no later than three months after the
estimate date. In either case, the shortfall does not include the
income credited to the amount deferred after the amount is taken into
account in accordance with paragraph (e) of this section.
(B) Shortfall is treated as wages paid on a date after the estimate
date. If the employer chooses to treat the shortfall as wages paid on a
date that is no later than three months after the estimate date, the
employer must take that shortfall into account as wages paid by the
employer and received by the employee on that date, for purposes of
withholding and depositing FICA tax.
(C) Shortfall is treated as wages paid on the estimate date. If the
employer chooses to treat the shortfall as wages paid as of the
estimate date, the shortfall is treated as an error for purposes of
withholding and depositing FICA tax. Appropriate adjustments may be
made in accordance with section 6205(a) and the regulations thereunder;
however, for purposes of Sec. 31.6205-1(b), the error need not be
treated as ascertained before the date that is three months after the
estimate date.
(D) Reporting. The employer must report the shortfall as wages on
Form 941, Employer's Quarterly Federal Tax Return (and, if applicable,
Form 941c, Supporting Statement to Correct Information) and Form W-2,
Wage and Tax Statement (or, if applicable, Form W-2c, Corrected Wage
and Tax Statement) in accordance with its treatment of the shortfall
under paragraph (f)(2)(ii) (B) or (C) of this section.
(iii) Overestimate of the amount deferred. If the employer
overestimates the amount deferred (as determined after calculating the
actual amount deferred that should have been taken into account as of
the date on which the amount was taken into account in accordance with
paragraph (e) of this section, using an interest rate and actuarial
assumptions that are reasonable as of that date) and deposits
[[Page 4563]]
more than the amount required, the employer may claim a refund or
credit in accordance with sections 6402, 6413, and 6511. A Form 941c,
or an equivalent statement, must accompany each claim for refund. In
addition, Form W-2 or, if applicable, Form W-2c must also reflect the
actual amount deferred that should have been taken into account.
(3) Lag method. Under the alternative method provided in this
paragraph (f)(3), an amount deferred, plus interest, may be treated as
wages paid by the employer and received by the employee, for purposes
of withholding and depositing FICA tax, on any date that is no later
than three months after the date the amount is required to be taken
into account in accordance with paragraph (e) of this section. For
purposes of this paragraph (f)(3), the amount deferred must be
increased by interest through the date on which the wages are treated
as paid, at a rate that is not less than AFR. If the employer withholds
and deposits FICA tax in accordance with this paragraph (f)(3), the
employer will be treated as having taken into account the amount
deferred plus income to the date on which the wages are treated as
paid.
(4) Examples. This paragraph (f) is illustrated by the following
examples:
Example 1. (i) Employer M maintains a nonqualified deferred
compensation plan that is an account balance plan. The plan provides
for annual bonuses based on current year profits to be deferred
until termination of employment. Employer M's profits for 2003, and
thus the amount deferred, is reasonably ascertainable, but Employer
M calculates the amount deferred on March 3, 2004, when the relevant
data is available.
(ii) In accordance with the alternative method described in
paragraph (f)(2) of this section, Employer M makes a reasonable
estimate that the amount deferred that must be taken into account as
of December 31, 2003, for Employee A is $20,000, and withholds and
deposits FICA tax on that amount as if it were wages paid by
Employer M and received by Employee A on that date. In January of
2004, Employer M files and furnishes Form W-2 for Employee A
including the $20,000 in FICA wages. On March 3, 2004, Employer M
determines that the actual amount deferred that should have been
taken into account on December 31, 2003, was $22,000.
(iii) In accordance with the alternative method described in
paragraph (f)(2)(ii) of this section, Employer M may treat the
additional $2,000 as wages paid to and received by Employee A on
December 31, 2003, the estimate date. Employer M may treat the
$2,000 shortfall as an error ascertained on March 3, 2004, and
withhold and deposit FICA tax on that amount. Form W-2c for Employee
A for 2003 must include the $2,000 shortfall in FICA wages. Employer
M must also correct the information on Form 941 for the last quarter
of 2003, reporting the adjustment on Form 941 for the first quarter
of 2004, accompanied by Form 941c for the last quarter of 2003.
(iv) Instead, Employer M may treat the $2,000 shortfall as wages
paid on March 31, 2004, and withhold and deposit FICA tax on that
amount as if it were wages paid by Employer M and received by
Employee A on that date. Form W-2 for Employee A for 2004 and Form
941 for the first quarter of 2004 must include the $2,000 shortfall
in FICA wages.
Example 2. (i) The facts are the same as in Example 1, except
that on March 3, 2004, Employer M determines that the actual amount
deferred that should have been taken into account on December 31,
2003, was $19,000.
(ii) Under paragraph (f)(2)(iii) of this section, Employer M
may, in accordance with sections 6402, 6413, and 6511, claim a
refund or credit for the overpayment of tax resulting from the
overestimate. In addition, Employer M must file and furnish a Form
W-2c for Employee A and must correct the information on Form 941 for
the last quarter of 2003.
Example 3. (i) The facts are the same as in Example 1, except
that Employer M does not make a reasonable estimate of the amount
deferred that must be taken into account as of December 31, 2003.
Instead, Employer M withholds and deposits FICA tax on the amount
deferred plus interest on that amount using AFR (for January 2004)
as if it were wages paid by Employer M and received by Employee A on
March 15, 2004.
(ii) Under the alternative method described in paragraph (f)(3)
of this section, the amount taken into account on March 15, 2004
(including the interest), will be treated as FICA wages paid to and
received by Employee A on March 15, 2004.
Example 4. (i) The facts are the same as in Example 1, except
that an amount is also deferred for Employee B which is required to
be taken into account on October 15, 2003, and Employer M chooses to
use the lag method in paragraph (f)(3) of this section in order to
provide time to calculate the amount deferred.
(ii) Employer M may use any date not later than January 15,
2004, to take the amount deferred into account (provided that the
amount deferred includes interest, at AFR for January 1, 2003,
through December 31, 2003, and at AFR for January 1, 2004, through
January 15, 2004).
(g) Effective date and transition rules--(1) General effective
date. Except for paragraphs (g)(2) through (4) of this section, this
section is applicable on and after January 1, 2000. Thus, paragraphs
(a) through (f) of this section apply to amounts deferred on or after
January 1, 2000; to amounts deferred before January 1, 2000, which
cease to be subject to a substantial risk of forfeiture on or after
January 1, 2000, or for which a resolution date occurs on or after
January 1, 2000; and to benefits actually or constructively paid on or
after January 1, 2000.
(2) Reasonable, good faith interpretation for amounts deferred and
benefits paid before January 1, 2000--(i) In general. For periods
before January 1, 2000 (including amounts deferred before January 1,
2000, and any benefits actually or constructively paid before January
1, 2000, that are attributable to those amounts deferred), an employer
may rely on a reasonable, good faith interpretation of section
3121(v)(2), taking into account pre-existing guidance. An employer will
be deemed to have determined FICA tax liability and satisfied FICA
withholding requirements in accordance with a reasonable, good faith
interpretation of section 3121(v)(2) if the employer has complied with
paragraphs (a) through (f) of this section. For purposes of paragraphs
(g)(2) through (4) of this section, and subject to paragraphs
(g)(2)(ii) and (iii) of this section, whether an employer that has not
complied with paragraphs (a) through (f) of this section has determined
FICA tax liability and satisfied FICA withholding requirements in
accordance with a reasonable, good faith interpretation of section
3121(v)(2) will be determined based on the relevant facts and
circumstances, including consistency of treatment by the employer and
the extent to which the employer has resolved unclear issues in its
favor.
(ii) Plan must be established or adopted. If an amount is deferred
under a plan before January 1, 2000, and benefit payments attributable
to that amount are actually or constructively paid on or after January
1, 2000, then in no event will an employer's treatment of the amount
deferred be considered to be in accordance with a reasonable, good
faith interpretation of section 3121(v)(2) if the employer treats that
amount as taken into account as wages for FICA tax purposes prior to
the establishment of the plan (within the meaning of paragraph (b)(2)
of this section) providing for the deferred compensation (or, if later,
the establishment of the plan as amended to provide for the deferred
compensation, as provided in paragraph (b)(2)(ii) of this section). If
an amount is deferred under a plan before January 1, 2000, and benefit
payments attributable to that amount are actually or constructively
paid before January 1, 2000, then in no event will the employer's
treatment of that amount deferred be considered to be in accordance
with a reasonable, good faith interpretation of section 3121(v)(2) if
the employer treats that amount as taken into account as wages for FICA
tax purposes prior to the adoption of the plan providing for the
deferred
[[Page 4564]]
compensation (or, if later, the adoption of the plan amendment
providing the deferred compensation). For example, awards, bonuses,
raises, incentive payments, and other similar amounts granted under a
plan as compensation for past services may not be taken into account
under section 3121(v)(2) prior to the establishment (or, if applicable,
the adoption) of the plan.
(iii) Certain changes in position for stock options, stock
appreciation rights, and other stock value rights not reasonable, good
faith interpretation. In the case of a stock option, stock appreciation
right, or other stock value right (as defined in paragraph (b)(4)(ii)
of this section) that is exercised before January 1, 2000, an employer
that treats the exercise as not subject to FICA tax as a result of the
nonduplication rule of section 3121(v)(2)(B) is not acting in
accordance with a reasonable, good faith interpretation of section
3121(v)(2) if the employer has not treated that grant and all earlier
grants as subject to section 3121(v)(2) by reporting the current value
of such options and rights as FICA wages on Form 941 filed for the
quarter during which each grant was made (or, if later, for the quarter
during which each grant ceased to be subject to a substantial risk of
forfeiture).
(3) Optional adjustments to conform with this section for pre-
effective-date open periods--(i) General rule. If an employer
determined FICA tax liability with respect to section 3121(v)(2) in any
period ending before January 1, 2000, for which the applicable period
of limitations has not expired on January 1, 2000 (pre-effective-date
open periods), in a manner that was not in accordance with this
section, the employer may adjust its FICA tax determination for that
period to conform to this section. Thus, if an amount deferred was
taken into account in a pre-effective-date open period when it was not
required to be taken into account (e.g., an amount taken into account
before it became reasonably ascertainable), the employer may claim a
refund or credit for any FICA tax paid on that amount to the extent
permitted by sections 6402, 6413, and 6511.
(ii) Consistency required. In the case of a plan that is not a
nonqualified deferred compensation plan (within the meaning of
paragraph (b)(1) of this section), if any payment was actually or
constructively paid to an employee under the plan in a pre-effective-
date open period and that payment was not included in FICA wages by
reason of the employer's treatment of the plan as a nonqualified
deferred compensation plan, then the employer may claim a refund or
credit for FICA tax paid on amounts treated as amounts deferred under
the plan (in accordance with the employer's treatment of the plan as a
nonqualified deferred compensation plan) for that employee for pre-
effective-date open periods only to the extent that the FICA tax paid
on all amounts treated as amounts deferred for the employee in all pre-
effective-date open periods under the plan exceeds the FICA tax that
would have been due on the benefits actually or constructively paid to
the employee in those periods under the plan if those benefits were
included in FICA wages when paid. If any benefit payments attributable
to amounts deferred after December 31, 1993, were actually or
constructively paid to an employee under a nonqualified deferred
compensation plan (within the meaning of paragraph (b)(1) of this
section) in a pre-effective-date open period, but these payments were
treated as subject to FICA tax because the employer treated the plan as
not being a nonqualified deferred compensation plan, then the employer
may claim a refund or credit for the FICA tax paid on those benefit
payments only to the extent that the FICA tax paid on those benefit
payments exceeds the FICA tax that would have been due on the amounts
deferred to which those benefit payments are attributable if those
amounts deferred had been taken into account when they would have been
required to have been taken into account under this section (if this
section had been in effect then).
(iii) Reporting. Any employer that adjusts its FICA tax
determination in accordance with paragraphs (g)(3)(i) and (ii) of this
section must make appropriate adjustments on Form 941 and Form 941c for
the affected periods, and, in addition, must file and furnish Form W-2,
or, if applicable, Form W-2c, for any affected employee so that the
Social Security Administration may correctly post the amount deferred
to the employee's earnings record. The adjustments may be made in
accordance with section 6205(a) and the regulations thereunder;
however, for purposes of Sec. 31.6205-1(b), the error is not required
to be treated as ascertained before March 31, 2000.
(4) Application of reasonable, good faith standard--(i) Plans that
are not subject to section 3121(v)(2). If a plan is not a nonqualified
deferred compensation plan within the meaning of paragraph (b)(1) of
this section, but, for a period ending prior to January 1, 2000, and,
pursuant to a reasonable, good faith interpretation of section
3121(v)(2), an amount under the plan was taken into account (within the
meaning of paragraph (d)(1) of this section) as an amount deferred
under a nonqualified deferred compensation plan, then, pursuant to
paragraph (g)(2) of this section, the following rules shall apply--
(A) With respect to benefit payments actually or constructively
paid before January 1, 2000, that are attributable to amounts
previously taken into account under the plan, no additional FICA tax
will be due;
(B) On or after January 1, 2000, benefit payments under the plan
must be taken into account as wages when actually or constructively
paid in accordance with paragraph (a)(1) of this section; and
(C) To the extent permitted by paragraph (g)(3) of this section,
the employer may claim a refund or credit for FICA tax actually paid on
amounts taken into account prior to January 1, 2000.
(ii) Plans that are subject to section 3121(v)(2) for which the
amount deferred has not been fully taken into account--(A) In general.
The rules of paragraphs (g)(4)(ii)(B) through (E) of this section apply
if a plan is a nonqualified deferred compensation plan (within the
meaning of paragraph (b)(1) of this section) and, with respect to an
amount deferred under the plan for an employee prior to January 1,
2000, the employer, in accordance with a reasonable, good faith
interpretation of section 3121(v)(2), either took into account an
amount that is less than the amount that would have been required to be
taken into account if paragraphs (a) through (f) of this section had
been in effect for that period or took no amount into account. Thus,
paragraphs (g)(4)(ii)(B) through (E) of this section apply both to an
employer that treated the plan as if it were not a nonqualified
deferred compensation plan within the meaning of section 3121(v)(2) (by
withholding and paying FICA tax due on benefits actually or
constructively paid under the plan during that period, if any) and to
an employer that treated the plan as a nonqualified deferred
compensation plan within the meaning of section 3121(v)(2).
(B) No additional tax required. Pursuant to paragraph (g)(2) of
this section, no additional FICA tax will be due for any period ending
prior to January 1, 2000.
(C) General timing rule applicable. In accordance with paragraph
(d)(1)(ii) of this section, except as provided in paragraphs (g)(4)(ii)
(D) and (E), the general timing rule described in paragraph (a)(1) of
this section applies to benefits actually or constructively paid on or
after January 1, 2000, attributable to an amount deferred in a period
before January 1, 2000, to the
[[Page 4565]]
extent the amount taken into account was less than the amount that
would have been required to be taken into account if paragraphs (a)
through (f) of this section had been in effect before January 1, 2000.
(D) Special rule for amounts deferred before 1994. The difference
between the amount that was taken into account in any period ending
prior to January 1, 1994, and the amount that would have been required
or permitted to be taken into account in that period if paragraphs (a)
through (f) of this section had been in effect is treated as if it had
been taken into account within the meaning of paragraph (d)(1) of this
section. For example, in the case of an amount deferred before 1994
that was not reasonably ascertainable (and which was not subject to a
substantial risk of forfeiture), the employer is treated as if it had
anticipated the actual amount, form, and commencement date for the
benefit payments attributable to the amount deferred and had taken the
amount deferred into account at an early inclusion date before 1994
using a method permitted under this section. Thus, with respect to such
an amount deferred, the employer is not required to take any additional
amount into account when the amount deferred becomes reasonably
ascertainable, and no additional FICA tax will be due when the benefit
payments attributable to the amount deferred are actually or
constructively paid.
(E) Special rule for amounts required to be taken into account in
1994 or 1995. In the case of an amount deferred that would have been
required to be taken into account in 1994 or 1995 if paragraphs (a)
through (f) of this section had been in effect, an employer will be
treated as taking the amount deferred into account under paragraph
(d)(1) of this section to the extent the employer takes the amount into
account by treating it as wages paid by the employer and received by
the employee as of any date prior to April 1, 2000.
(iii) Plans that are subject to section 3121(v)(2) for which more
than the amount deferred has been taken into account. If a plan is a
nonqualified deferred compensation plan (within the meaning of
paragraph (b)(1) of this section) and an amount was taken into account
under the plan for an employee before January 1, 2000, in accordance
with a reasonable, good faith interpretation of section 3121(v)(2), but
that amount could not have been taken into account before January 1,
2000, if paragraphs (a) through (f) of this section had been in effect
then, the following rules apply--
(A) The determination of the amount deferred for any period
beginning on or after January 1, 2000, must be made in accordance with
paragraph (c) of this section, and the time when amounts deferred under
the plan are required to be taken into account must be determined in
accordance with paragraph (e) of this section, without regard to any
such amount that was taken into account for any period ending before
January 1, 2000; and
(B) To the extent permitted by sections 6402, 6413, and 6511, the
employer may claim a refund or credit for an overpayment of tax caused
by the overinclusion of wages that occurred before January 1, 2000.
(5) Examples. This paragraph (g) is illustrated by the following
examples:
Example 1. (i) In 1996, Employer M establishes a nonqualified
deferred compensation plan that is a nonaccount balance plan for
Employee A. All benefits under the plan are 100 percent vested. In
order to determine the amount deferred on behalf of Employee A under
the plan for 1996 and 1997, Employer M must make assumptions as to
the date on which Employee A will retire and the form of benefit
Employee A will elect, in addition to interest, mortality, and cost-
of-living assumptions. Based on assumptions made with respect to all
of these contingencies, Employer M determines that the amount
deferred for 1996 is $50,000 and the amount deferred for 1997 is
$55,000. In 1996 and 1997, Employee A's total wages (without regard
to the amounts deferred) exceed the OASDI wage bases. Employer M
withholds and deposits HI tax on the $50,000 and $55,000 amounts.
Employee A does not retire before January 1, 2000. Employer M
chooses under paragraph (g)(3) of this section to apply this section
to 1996 and 1997 before the January 1, 2000, general effective date.
(ii) Under this section, the amounts deferred in 1996 and 1997
are not reasonably ascertainable (within the meaning of paragraph
(e)(4)(i) of this section) before January 1, 2000. Thus, as long as
the applicable period of limitations has not expired for the periods
in 1996 and 1997, Employer M may, to the extent permitted under
paragraph (g)(3) of this section, apply for a refund or credit for
the HI tax paid on the amounts deferred for 1996 and 1997 and, in
accordance with paragraph (e)(4) of this section, take into account
the amounts deferred when they become reasonably ascertainable.
Example 2. (i) Employer N adopts a plan on January 1, 1994, that
covers Employee B, who has 10 years of service as of that date. The
plan provides that, in consideration of Employee B's outstanding
services over the past 10 years, Employee B will be paid a $500,000
lump sum distribution upon termination of employment at any time. On
January 15, 1996, Employee B terminates employment with Employer N.
Employer N determines, based on a reasonable, good faith
interpretation of section 3121(v)(2), that the plan is a
nonqualified deferred compensation plan under that section. Employer
N treats the $500,000 as having been taken into account as an amount
deferred in 1993 and earlier years.
(ii) Under paragraph (g)(2)(ii) of this section, if all amounts
are deferred and all benefits are paid under a plan before January
1, 2000, then in no event will an employer's treatment of amounts
deferred under the plan be considered to be in accordance with a
reasonable, good faith interpretation of section 3121(v)(2) if the
employer treats these amounts as taken into account as wages for
FICA tax purposes prior to the adoption of the plan. Accordingly,
Employer N's treatment is not in accordance with a reasonable, good
faith interpretation of section 3121(v)(2) because Employer N
treated amounts as taken into account in years before the adoption
of the plan. As a result, the payment made to Employee B in 1996 was
subject to both the OASDI and HI portions of FICA tax when paid.
Example 3. (i) Employer O adopts a bonus plan on December 1,
1993, that becomes effective and legally binding on January 1, 1994.
Under the plan, which is not set forth in writing, a specified bonus
amount (which is 100 percent vested) is credited to Employee C's
account each December 31. A reasonable rate of interest on Employee
C's account balance is credited quarterly. Employee C's account
balance will begin to be paid in equal annual installments over 10
years beginning on January 1, 2000. Employer O determines, based on
a reasonable, good faith interpretation of section 3121(v)(2), that
the bonus plan is a nonqualified deferred compensation plan under
that section and, therefore, treats the amounts credited from
January 1, 1994, through December 31, 1999, as amounts deferred and,
in accordance with a reasonable, good faith interpretation of
section 3121(v)(2), takes those amounts deferred into account as
wages for FICA tax purposes as of those dates. The bonus plan is set
forth in writing on May 1, 1999, and, thus, is treated as
established as of January 1, 1994.
(ii) Under paragraph (g)(2)(ii) of this section, if an amount is
deferred before January 1, 2000, and the attributable benefit is
paid on or after January 1, 2000, then in no event will an
employer's treatment of the amount deferred under a plan be
considered to be in accordance with a reasonable, good faith
interpretation of section 3121(v)(2) if the employer treats the
amount deferred as taken into account as wages for FICA tax purposes
prior to the establishment of the plan (within the meaning of
paragraph (b)(2) of this section). Because the bonus plan is treated
as established on January 1, 1994 (pursuant to the transition rule
for unwritten plans in paragraph (b)(2)(iii) of this section), and
because Employer O, in accordance with a reasonable, good faith
interpretation of section 3121(v)(2), took amounts deferred into
account in 1994 through 1999, the amounts paid to Employee C
attributable to those amounts deferred will not be subject to FICA
tax when paid.
Example 4. (i) In 1985, Employer P establishes a compensation
arrangement for Employee D that provides for a lump sum
[[Page 4566]]
payment to be made after termination of employment but the
arrangement is not a nonqualified deferred compensation plan (within
the meaning of paragraph (b)(1) of this section). However, prior to
January 1, 2000, and in accordance with a reasonable, good faith
interpretation of section 3121(v)(2), Employer P treats the
arrangement as a nonqualified deferred compensation plan under
section 3121(v)(2). Employer P determines that Employee D's total
wages (without regard to the amount deferred) for each year from
1985 through 1993 exceed the applicable OASDI and HI wage bases for
each of those years and, consequently, there is no FICA tax
liability with respect to the amounts deferred for those years. In
1994, Employee D's total wages (without regard to the amount
deferred) exceed the OASDI wage base. However, because there is no
limit on the HI wage base, the amount deferred for 1994 results in
additional HI tax liability of $290, which is timely paid by
Employer P.
(ii) Employee D terminates employment with Employer P in 1995
and receives a plan payment of $50,000. In that year, Employee D
also receives wages of $60,000 from Employer P. In accordance with
its treatment of the plan as a nonqualified deferred compensation
plan under section 3121(v)(2), Employer P does not treat the $50,000
payment in 1995 as wages for FICA tax purposes in that year.
(iii) Because amounts under a plan were taken into account
(within the meaning of paragraph (d)(1) of this section) as amounts
deferred under a nonqualified deferred compensation plan pursuant to
a reasonable, good faith interpretation of section 3121(v)(2)(A),
but that plan is not a nonqualified deferred compensation plan
within the meaning of paragraph (b)(1) of this section, the
transition rules provided in paragraph (g)(4)(i) of this section
apply. Thus, no additional FICA tax will be due on the benefits paid
in 1995.
(iv) Because $290 of HI tax was paid on the amount deferred in
1994, Employer P is entitled to a refund or credit for that amount
to the extent permitted under sections 6402, 6413, and 6511--but
only to the extent that $290 exceeds the FICA tax that would have
been due on the $50,000 payment in 1995 if that payment had been
subject to FICA tax when paid (i.e., if paragraphs (a) through (f)
of this section had been effective for those years). In 1995,
Employee D had other wages of $60,000. Thus, only $1,200 (the
$61,200 OASDI wage base, less the $60,000 of other wages) of the
$50,000 payment would have been subject to OASDI; the full $50,000
would have been subject to HI. This would have resulted in $148.80
of OASDI tax ($1,200 x 12.4 percent) and $1,450 of HI tax ($50,000 x
2.9 percent). Employer P is not entitled to a refund or credit under
the consistency rule of paragraph (g)(3)(ii) because the $290 of HI
tax paid in 1994 is less than the total $1,598.80 of FICA tax
liability that would have resulted if this section had applied for
1995.
(v) However, if the benefit payment is instead actually or
constructively paid on or after January 1, 2000, the benefit payment
must be taken into account as wages when actually or constructively
paid in accordance with the general timing rule of paragraph (a)(1)
of this section (and paragraph (g)(4)(i)(B) of this section).
Example 5. (i) In 1985, Employer Q establishes a compensation
arrangement for Employee E that is a nonqualified deferred
compensation plan within the meaning of paragraph (b)(1) of this
section. However, prior to January 1, 2000, Employer Q determines,
based on a reasonable, good faith interpretation of section
3121(v)(2), that the arrangement is not a nonqualified deferred
compensation plan within the meaning of that section. Thus, when
Employee E retires at the end of 1996 and benefit payments under the
arrangement begin in 1997, Employer Q withholds and deposits FICA
tax on the amounts paid to Employee E. Payments under the
arrangement continue on or after January 1, 2000. Employer Q does
not choose (under paragraph (g)(3) of this section) to adjust its
FICA tax determination for a pre-effective-date open period by
treating this section as in effect for all amounts deferred and
benefits actually or constructively paid for any such period. The
periods in 1994 and 1995 are not pre-effective-date open periods for
Employer Q.
(ii) Under paragraph (g)(4)(ii) of this section, for purposes of
determining whether benefits actually or constructively paid on or
after January 1, 2000, were previously taken into account for
purposes of applying the nonduplication rule of section
3121(v)(2)(B), any amount that would have been required to have been
taken into account before 1994 will be treated as if it had been
taken into account within the meaning of paragraph (d)(1) of this
section. Under the nonduplication rule, benefit payments
attributable to an amount that has been so treated as taken into
account is not treated as wages for FICA tax purposes at any later
time (such as upon payment).
(iii) Because Employer Q does not adjust its FICA tax
determination by treating this section as in effect for all amounts
deferred for periods ending after December 31, 1993, any benefit
payments attributable to amounts deferred in periods ending after
December 31, 1993, will be included in wages when actually or
constructively paid in accordance with the general timing rule of
paragraph (a)(1) of this section.
Example 6. (i) The facts are the same as in Example 5, except
that Employer Q chooses (in accordance with paragraph (g)(3) of this
section) to adjust its FICA tax determination for all pre-effective-
date open periods by treating this section as in effect for all
amounts deferred for those periods. In addition, Employer Q chooses
(in accordance with paragraph (g)(4)(ii)(E) of this section) to take
the amounts deferred for 1994 and 1995 into account by treating
these amounts as FICA wages paid and received by Employee E on
January 15, 2000.
(ii) In accordance with the nonduplication rule of paragraph
(a)(2)(iii) of this section, because all amounts deferred for
Employee E under the plan were taken into account (or treated as
taken into account), any benefit payments made to Employee E under
the plan will not be included as FICA wages when actually or
constructively paid.
Example 7. (i) The facts are the same as in Example 5, except
that Employer Q does not withhold and deposit the FICA tax due on
benefits actually or constructively paid before January 1, 2000.
(ii) Because Employer Q did not withhold and deposit the FICA
tax due on benefits actually or constructively paid before January
1, 2000, Employer Q did not determine FICA tax liability and satisfy
FICA tax withholding requirements in accordance with a reasonable,
good faith interpretation of section 3121(v)(2). Thus, the
transition rules provided in paragraphs (g)(3) and (4) of this
section do not apply. As a result, any amount that would have been
required to have been taken into account under this section before
1994 is not treated as if it had been so taken into account under
paragraph (g)(4)(ii)(D) of this section, and benefit payments
attributable to amounts deferred before January 1, 2000, are treated
as FICA wages when actually or constructively paid in accordance
with the general timing rule of paragraph (a)(1) of this section.
Example 8. (i) In 1993, Employer R establishes a nonqualified
deferred compensation plan for Employee F under which Employee F
will have a fully vested right to receive a lump sum payment in 2000
equal to 50 percent of Employee F's highest rate of salary. On
December 31, 1993, Employee F's highest salary is $1 million. In
accordance with a reasonable, good faith interpretation of section
3121(v)(2), Employer R determines that, for 1993, there is an amount
deferred that must be taken into account as wages for FICA tax
purposes. Based Employer R's estimate that Employee F's highest
salary will be $3 million in 2000, Employer R determines that the
amount deferred is equal to the present value in 1993 of $1.5
million payable in 2000. However, because Employee F has other wages
in 1993 that exceed the applicable OASDI and HI wage bases for that
year, no additional FICA tax is paid as a result of that amount
deferred being taken into account for 1993. In addition, Employer R
takes no amounts into account under the plan after 1993 for Employee
F. Under paragraphs (e)(1) and (4)(ii)(D)(2) of this section, the
largest amount that could have been taken into account in 1993 is
the present value of a lump sum payment of $500,000, payable in
2000, because that is the maximum amount to which Employee R has a
legally binding right as of December 31, 1993. Employee F's highest
salary is, in fact, $3 million in 2000 and Employee F receives $1.5
million under the plan on December 31, 2000.
(ii) In accordance with paragraphs (g)(1) and (4)(iii)(A) of
this section, the determination of the amount deferred under the
plan for any period beginning on or after January 1, 2000, and the
time when that amount deferred is required to be taken into account
must be determined in accordance with this section. In addition,
these determinations must be made without regard to any amount
deferred that was taken into account for any period ending before
January 1, 2000, that could not be taken into account before January
1, 2000, if paragraphs (a) through (f) of this section had been in
effect. Because no FICA tax was actually paid on
[[Page 4567]]
that $1 million in 1993, no overpayment of tax was caused by the
overinclusion of wages in 1993 and, thus, Employer R is not entitled
to a refund or credit (even assuming that the period of limitations
has been kept open for periods in 1993). In addition, because the
difference between the present value of the $1.5 million payment and
the present value of a $500,000 payment was not taken into account
for periods beginning on or after January 1, 1994, $1 million must
be included in FICA wages under the general timing rule when paid.
Sec. 31.3121(v)(2)-2 Effective dates and transition rules.
(a) General statutory effective date. Except as otherwise provided
in paragraphs (b) through (e) of this section, section 3121(v)(2) and
the amendments made to section 3121(a)(2), (a)(3), and (a)(13) by the
Social Security Amendments of 1983 (Pub. L. 98-21, 97 Stat. 65), as
amended by section 2662(f)(2) of the Deficit Reduction Act of 1984
(Pub. L. 98-369, 98 Stat. 494), apply to amounts deferred and benefits
paid after December 31, 1983.
(b) Definitions. For purposes of Sec. 31.3121(v)(2)-1 and this
section, the following definitions apply:
(1) FICA. FICA means the Federal Insurance Contributions Act (26
U.S.C. 3101 et seq.).
(2) 457(a) plan. A 457(a) plan means an eligible deferred
compensation plan of a State or local government or of a tax-exempt
organization to which section 457(a) applies.
(3) Gap agreement. Gap agreement means an agreement adopted after
March 24, 1983, and on or before December 31, 1983, between an
individual and a nonqualified deferred compensation plan within the
meaning of Sec. 31.3121(v)(2)-1(b). Such an agreement does not fail to
be a gap agreement merely because the terms of the plan are changed
after December 31,1983.
(4) Individual party to a gap agreement. Individual party to a gap
agreement means an individual who was eligible to participate in a gap
agreement on December 31, 1983, under the terms of the agreement on
that date. An individual will be treated as an individual party to a
gap agreement even if the individual has not accrued any benefits under
the plan by December 31, 1983, and regardless of whether the individual
has taken any specific action to become a party to the agreement.
However, an individual who becomes eligible to participate in a gap
agreement after December 31, 1983, is not an individual party to a gap
agreement.
(5) Individual party to a March 24, 1983 agreement. Individual
party to a March 24, 1983 agreement means an individual who was
eligible to participate in a March 24, 1983 agreement under the terms
of the agreement on March 24, 1983. An individual will be treated as an
individual party to a March 24, 1983 agreement even if the individual
has not accrued any benefits under the plan by March 24, 1983, and
regardless of whether the individual has taken any specific action to
become a party to the agreement. However, an individual who becomes
eligible to participate in a March 24, 1983 agreement after March 24,
1983, is not an individual party to a March 24, 1983 agreement.
(6) March 24, 1983 agreement. March 24, 1983 agreement means an
agreement in existence on March 24, 1983, between an individual and a
nonqualified deferred compensation plan within the meaning of
Sec. 31.3121(v)(2)-1(b). Such an agreement does not fail to be a March
24, 1983 agreement merely because the terms of the plan are changed
after March 24, 1983. In addition, for purposes of this paragraph
(b)(6) only, any plan (or agreement) that provides for payments that
qualify for one of the retirement payment exclusions is treated as a
nonqualified deferred compensation plan. For example,
Sec. 31.3121(v)(2)-1(b)(4)(v) provides that certain benefits
established in connection with impending termination do not result from
the deferral of compensation and thus are not considered deferred under
a nonqualified deferred compensation plan. However, a plan that
provides such benefits and that was in existence on March 24, 1983, is
treated as a nonqualified deferred compensation plan for purposes of
this paragraph (b) to the extent it provides benefits that would have
satisfied one of the retirement payment exclusions.
(7) Retirement payment exclusions. Retirement payment exclusions
are the exclusions from wages (for FICA tax purposes) for retirement
payments under section 3121(a)(2)(A), (a)(3), and (a)(13)(A)(iii), as
in effect on April 19, 1983 (the day before enactment of the Social
Security Amendments of 1983).
(8) Transition benefits. Transition benefits are payments made
after December 31, 1983, attributable to services rendered before
January 1, 1984. For this purpose, transition benefits are determined
without regard to any changes made in the terms of the plan after March
24, 1983, in the case of a March 24, 1983 agreement or after December
31, 1983, in the case of a gap agreement.
(c) Transition rules--(1) In general. Except as provided in
paragraph (c)(2) or (3) of this section, the general statutory
effective date described in paragraph (a) of this section applies to
benefit payments after December 31, 1983. Thus, except as provided in
paragraph (c)(2) or (3) of this section, section 3121(v)(2) applies,
and the retirement payment exclusions do not apply, to benefit payments
made after December 31, 1983, even if the benefit payments are made
under a March 24, 1983 agreement or a gap agreement.
(2) Transition benefits under a March 24, 1983 agreement. With
respect to an individual party to a March 24, 1983 agreement,
transition benefits paid under that March 24, 1983 agreement (except
for those paid under a 457(a) plan) are not subject to the special
timing rule of section 3121(v)(2) and are subject to section 3121(a) as
in effect on April 19, 1983. Thus, transition benefits under a March
24, 1983 agreement (except for those under a 457(a) plan) to an
individual party to a March 24, 1983 agreement are excluded from wages
(for FICA tax purposes) only if they qualify for any of the retirement
payment exclusions (or any other exclusion provided under section
3121(a) as in effect on April 19, 1983).
(3) Transition benefits under a gap agreement. With respect to an
individual party to a gap agreement, the payor of transition benefits
under the gap agreement must choose to either--
(i) Take the transition benefits into account as wages when paid;
or
(ii) Take the amount deferred (within the meaning of
Sec. 31.3121(v)(2)-1(c)) with respect to the transition benefits into
account as wages under section 3121(v)(2) (as if section 3121(v)(2) had
applied before its general statutory effective date).
(d) Determining transition benefit portion. For purposes of
determining the portion of total benefits under a nonqualified deferred
compensation plan that represents transition benefits, if, under the
terms of the plan, benefit payments are not attributed to specific
years of service, the employer may use any reasonable method. For
example, if a plan provides that the employee will receive benefits
equal to 2 percent of high 3-year average compensation multiplied by
years of service, and the employee retires after 25 years of service, 9
of which are before 1984, the employer may determine that 9/25 of the
total benefit payments to be received beginning in 2000 are transition
benefits attributable to services performed before 1984.
(e) Order of payment. If an employer determines, in accordance with
paragraph (d) of this section, that a portion of the total benefits
under a
[[Page 4568]]
nonqualified deferred compensation plan constitutes transition
benefits, then, for purposes of determining the portion of each benefit
payment that constitutes transition benefits, the employer must treat
each benefit payment as consisting of transition benefits in the same
proportion as the transition benefits that have not been paid (as of
January 1, 2000) bear to total benefits that have not been paid (as of
January 1, 2000), unless such allocation is inconsistent with the terms
of the plan. However, for a benefit payment made before January 1,
2000, the employer may use any reasonable allocation method to
determine the portion of a payment that consists of transition
benefits, provided that the allocation method is consistent with the
terms of the plan.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 3. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 4. In Sec. 602.101, paragraph (c) is amended by adding the
following entry in the table in numerical order to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current
OMB
CFR part or section where identified and described control
No.
------------------------------------------------------------------------
* * * * *
31.3121(v)(2)-1............................................. 1545-1643
* * * * *
------------------------------------------------------------------------
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: December 23, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 99-1663 Filed 1-28-99; 8:45 am]
BILLING CODE 4830-01-P
