How to calculate amounts includable under 409A
Tax Facts | National Underwriter Company
The Internal Revenue Service has issued proposed regulations regarding the calculation of amounts that are includible in income under Code section 409A and the additional taxes that are imposed with respect to service providers participating in certain nonqualified deferred compensation plans. Final regulations regarding 409A were issued in April 2007, but those regulations largely covered requirements to comply with 409A.
Section 409A generally provides that if at any time during a taxable year a nonqualified deferred compensation plan fails to meet its requirements, or is not operated in accordance with the requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years is includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Therefore, to calculate the amount includible in income upon a failure to meet the requirements of section 409A, the first step is to determine the total amount deferred under the plan for the service provider's taxable year and all preceding taxable years. The second step is to calculate the portion of the total amount deferred for the taxable year, if any, that is either subject to a substantial risk of forfeiture or has been included in income in a previous taxable year. The last step is to subtract the amount determined in the second step from the amount determined in the first step. The excess of the amount determined in step one over the amount determined in step two is the amount includible in income and subject to additional income taxes for the year as a result of the plan's failure to comply with section 409A.
In general, under the proposed regulations, the amount deferred under a deferred compensation plan for a taxable year and all preceding taxable years would be referred to as the total amount deferred for a taxable year and would be determined as of the last day of the taxable year. For calendar year taxpayers the relevant calculation date would be December 31. For example, if a service provider has a calendar year taxable year, and if the service provider's account balance under a plan is $105,000 as of July 1, but is only $100,000 as of December 31 of the same year, due solely to deemed investment losses (with no payments made under the plan during the year), the total amount deferred under the plan for that taxable year would be $100,000. Similarly, the total amount deferred for a taxable year would not necessarily be the greatest total amount deferred for any previous year, even if no amount has been paid under the plan. For example, if a service provider has a calendar year taxable year, and if the service provider's account balance under a plan as of December 31, 2010 is $105,000, as of December 31, 2011 is $100,000, and as of December 31, 2012 is $95,000, and if those decreases are due solely to deemed investment losses (and no payments were made under the plan in 2011 or 2012), then the total amount deferred for 2011 would be $100,000 and the total amount deferred for 2012 would be $95,000.
To reasonably reflect the effect of payments made during a taxable year, the proposed regulations provide that the sum of all payments of amounts deferred under a plan during a taxable year, including all payments that are substitutes for an amount deferred, are added to the amounts deferred outstanding as of the last day of the taxable year to calculate the total amount deferred for the taxable year. To lower the administrative burden of the calculation, the proposed regulations provide that the addition of these payments to the total amount deferred for the taxable year will not be increased by any interest or other amount to reflect the time value of money. The total amount deferred for a taxable year includes all payments, regardless of whether the service recipient made some or all of the payments in accordance with the requirements of section 409A. For example, if during a taxable year an employee receives a single sum payment of the entire amount deferred under a plan, the employee would have a total amount deferred under the plan for the taxable year equal to the amount paid.
The regulations are proposed to be effective for taxable years beginning on or after the issuance of final regulations. Taxpayers may rely on the proposed regulations only to the extent provided in future guidance.
Prop. Treas. Reg. §1.409A-4.
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