TAX BREAK

The Times, They Are A-Changin’ – The New Deferred Compensation Rules By Amy Erlbacher-Anderson (Continued)

 

 

No subsequent election to delay timing or change the form of payment is allowed unless the new election will not take effect for 12 months, defers the payment for at least 5 years after a distribution would have been made, and is made at least 12 months before the first payment date. Again, there is an exception for certain payment elections made before the end of 2005. 

 

Distributions – time and form of payment must be set by the plan or elected by the participant at the time of deferral and can only occur upon death, disability, separation from service (plus 6 months for key employees of a public company), a specified time or under a fixed schedule, a change in control of the employer, or an unforeseeable emergency. Both the term “change in control” and “unforeseeable emergency” are specifically defined by the IRS for this purpose. 

 

Accelerated distributions are generally forbidden, including changing a form of benefit from installments to a lump sum and “haircut” provisions. However, the IRS has allowed certain exceptions to this rule, including distributions under a domestic relations order, withholding for or paying employment taxes under narrow circumstances, and distributing a small account balance ($10,000). 

 

Reporting and Withholding – deferrals made during 2005 and following years must be reported on the participant’s Form W-2 for year of the deferral, regardless of whether the amounts are currently includible in the participant’s income. The IRS has designated a new code (Code Y) for this purpose. In addition, when taxable payments are made from the plan, the amounts must again be reported on Form W-2 (using new Code Z) and federal income tax withheld. 

 

If deferrals are made by a non-employee participant (i.e. – independent contractors or directors), a Form 1099-MISC would be used. 

 

Funding - the use of offshore trusts and trusts that are not funded until the employer’s financial stability changes are forbidden. 

 

Penalties – amounts deferred after 2004 that violate the new rules are: 1) immediately taxable to the participant, 2) subject to an interest penalty (the underpayment rate plus 1% to 5% currently) and 3) an additional 20% penalty tax. 

 

Conclusion

 

If you sponsor a plan covered by the new rules, you should become familiar with the Act and IRS guidance as soon as possible. Although amendments are not due until December 31, 2005, the Act applies to your plans today and failure to follow the new rules could result in a hefty penalty for your employees. 

 

 

 

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