Deferred Compensation Plan (Business)
Deferred compensation plans provide options for highly compensated individuals to defer receipt of some compensation until a later time.
Commonly referred to as non-qualified deferred compensation plan, NQDC plan and supplemental executive retirement plan.
Do I Qualify for the Deferred Compensation Plan (Business)?
To qualify for benefits from a deferred compensation plan, the business must be able to make contributions to an employee account and include those payments as gross income for the employee.
2022 Deferred Compensation Plan (Business) Details
A non-qualified deferred compensation (NQDC) plan is an elective or non-elective plan, agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee or independent contractor compensation in the future. NQDC plans provide employers and employees with different tax benefits than the qualified plans that meet all the requirements listed in IRC § 401(a). Under a non-qualified plan, employers generally only deduct expenses for tax purposes when income is recognized by the employee or service provider. The primary tax benefit that distinguishes qualified plans from NQDCs is the current-year deductibility of employer contributions to qualified plans. However, NQDCs offer advantages when it comes to flexibility in timing and amounts of contributions.
NQDC plans typically fall into four categories. 1) Salary Reduction Arrangements allow employees to defer receipt of some portion of salary that would otherwise be included in current compensation. 2) Bonus Deferral Plans resemble salary reduction arrangements, except they enable participants to defer receipt of bonuses. 3) Top-Hat Plans (aka Supplemental Executive Retirement Plans or SERPs) are NQDC plans maintained primarily for a select group of management or highly compensated employees. These plans are usually some form of additional compensation that the employer agrees to pay the employee in the future, not a deferral of salary that the employer would otherwise pay to the employee in the current year. 4) Excess Benefit Plans are NQDC plans that provide benefits solely to employees whose benefits under the employer's qualified plan are limited by the tax law.
NQDC plans can be either funded or unfunded, but most are intended to be unfunded because of the tax advantages unfunded plans afford participants. An unfunded arrangement is one where the employee has only an unsecured promise from the employer to pay the deferred compensation benefits in the future. The employer may simply keep track of the benefit in a bookkeeping account, or it may voluntarily choose to invest amounts intended to help fulfill its promise to pay the employee. The employer may even transfer amounts to a trust that remains a part of the employer's general assets with the intention of using those assets to fund the future payments to the employee. These arrangements are still considered “unfunded” because the employer is not required under the law to hold that money for the employee’s benefit, and the assets would be subject to the claims of the employer's creditors if the employer becomes insolvent. For the employee to get the benefit of income tax deferral, it is important that the amounts are not set aside from the employer's creditors for the exclusive benefit of the employee. If the assets are segregated in a manner that protects them for the employee’s exclusive benefit, the employee may have currently includible compensation.
NQDC plans may be formal or informal, but they must be in writing. While many plans are set forth in extensive detail, some are referenced by nothing more than a few provisions contained in an employment contract.
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• Reduces employee’s current taxable income.
• Third party financial advisor will need to be involved in this transaction.
• Any assets used to fund the obligation would be unprotected from creditors in the event of insolvency.
Assumptions When Taking the Deferred Compensation Plan (Business)
• None noted.
Requirements to Claim the Deferred Compensation Plan (Business)
• Written plan must be completed. Any assets intended to fund the future obligation cannot be protected from the employer’s creditors for the exclusive benefit of the employee.
Business Entities That Can Claim the Deferred Compensation Plan (Business)
• Schedule C
• Schedule F
• S Corporation
• C Corporation
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.