In short, NQDC plans that are not in compliance are potentially subject to this treatment:
- Inclusion in income
- Additional 20% federal income tax
- Interest as if the amounts had not been deferred at the Federal Underpayment Rate plus 1%
Bad stuff, huh? Unlike virtually everything else in the Tax Code, to the extent that there is a failure to comply (whether it is the fault of the employer or employee), the employee pays these taxes.
How do you have a failure to comply (not an exhaustive list)?
- Plan must be in writing.
- Written plan must be compliant with 409A.
- Each participant must make a bona fide initial deferral election
- Generally before deferring, they must specify in writing when and in what form they will take their distribution.
- Changes to the initial deferral election require a 5-year pushback, and must be made at least one year before the scheduled distribution.
- Plan must be operated in compliance with the written document
- Plan must be operated in compliance with 409A
Guidance on the correction programs can be found in Notice 2010-6 to correct documentary failures and Notice 2008-113 to correct operational errors .
These notices are long and complex. Many organizations have found that they don't have the expertise to follow this process in-house. Do you need help?
Nothing in this post is to be construed as legal, tax, or accounting advice. These can only be obtained from qualified counsel.