The IRS has released an updated Audit Techniques Guide (ATG), Nonqualified Deferred Compensation, for examiners. Among other things, the ATG addresses when deferred amounts are includible in an employee’s gross income, when they are deductible by the employer, and when they must be taken into account for employment tax purposes. The ATG also includes audit strategies, such as questions to ask during an audit and which company personnel to interview.
Nonqualified deferrals of compensation made after December 31, 2004, are subject to Code Sec. 409A, which provides that amounts deferred under an NQDC plan (generally, other than a retirement-type plan that is not taxed until withdrawal) and that are not subject to a substantial risk of forfeiture must be included in the service provider’s gross income, unless the plan meets certain requirements with regard to deferral elections and distributions. Failure to meet these requirements could result in immediate taxation and penalties.
The ATG notes that a nonqualified deferred compensation (NQDC) plan examination should focus on when the deferred amounts are includible in the employee’s gross income and when those amounts are deductible by the employer. For these purposes, the ATG outlines the doctrines of constructive receipt (for unfunded plans) and economic benefit (for funded plans).
The ATG instructs examiners that cash basis taxpayers must include gains, profits, and income in gross income for the taxable year in which they are actually or constructively received. Constructive receipt generally means the recipient had control of the receipt of the deferred amounts and that such control was not subject to substantial limitations or restrictions.
The ATG offers IRS agents tips for examining constructive receipt and economic benefit issues, including a list of documents to consult, questions to ask, and company personnel to interview.
Examiners should review, among other things: plan documents, employment agreements, deferral election forms, or other communications between the employer and the employee.
The ATG also underscores that employers are required to withhold income taxes from NQDC amounts at the time the amounts are actually or constructively received by the employee.