On November 30, 2006, the IRS issued Notice 2006–100 (the “Notice”). The Notice provides guidance related to reporting and wage withholding requirements for non-qualified deferred compensation arrangements under Section 409A of the Internal Revenue Code (the “Code”). The reporting and wage withholding requirements are for calendar years 2005 and 2006 and apply to deferred compensation subject to, and amounts includible in income under, Code section 409A. The Notice does not apply to the rules governing FICA taxation of nonqualified deferred compensation. IRS Notice 2005–94 is superseded and Notice 2005–1 is modified by the Notice. The following is a synopsis of the material provisions of the Notice as it relates to the employer.
Employer Withholding and Reporting Requirements
Employers and other payers are not required to report deferrals of non-qualified deferred compensation that are subject to Code section 409A if such amounts are not taxable in calendar years 2005 and 2006. However, any amounts that an employee includes as gross income under Code section 409A in calendar years 2005 and 2006 must be withheld upon and reported by the employer or other payer, as outlined below.
In particular, Section 3401(a) of the Code defines the “wages” upon which an employer is required to withhold income taxes. “Wages” under the Code includes any amounts includable in gross income under Code section 409A. Therefore, an employer must treat amounts includable in gross income under Code section 409A as wages for income tax withholding purposes.
If an employee has received other wages from the employer during calendar years 2005 and 2006, the amounts includable in gross income under Code section 409A are considered supplemental wages for determining the appropriate amount the employer must withhold. Therefore, for calendar years 2005 and 2006, if the total amount of an employee’s supplemental wages exceeds $1,000,000, taking into account the amount includible under Code section 409A, then the amounts includible in income under Code section 409A shall be subject to a 35% withholding rate. If the total amount is less than $1,000,000, then the amounts includible in income under Code section 409A generally shall be subject to a 25% withholding rate.
Failure to Withhold by Employer
If the employer has not withheld from the employee wages required to be withheld, or did not withhold a sufficient amount as required under the Notice, the employer must do one of the following:
- Between December 31, 2006, and February 1, 2007, withhold or recover from the employee the amount of under-withholding and report as wages for the quarter ending December 31, 2006, the amounts that were imputed Code section 409A income. These amounts would be reported on Form 941 and in box 1 of the employee’s W-2 for calendar year 2006; or
- Pay the income tax withholding liability on behalf of the employee and report the gross amount of wages and income tax liability for the quarter ending December 31, 2006. The reporting must include all amounts that were includible as income under Code section 409A.
An employer must report these amounts as wages on the following IRS forms:
- Form 941: Employer’s Quarterly Federal Tax Return, Line 2
- Form W-2: Box 1 and Box 12, using Code Z.
The Employer must report as wages for the quarter ending December 31, 2006, the amounts that were imputed Code section 409A income. If the employer pays the income tax withholding liability on behalf of the employee, the employer must report the gross amount of wages and income tax liability for the quarter ending December 31, 2006. The reporting must include all amounts that were includible as income under Code section 409A.
Any employer who relied on IRS Notice 2005–94 for tax reporting for calendar year 2005, which suspended reporting requirements for amounts included in income under Code section 409A, is now required to file an original or amended information return and provide an original or amended statement to the employee for calendar year 2005. These reports will specify any amounts previously unreported that were includible in gross income to the employee. An employer’s failure to furnish these statements to the IRS and to the employee may result in penalties to the employer under Sections 6721 and 6722 of the Code. An employer must furnish these statements to the appropriate party by the applicable deadlines for filing such information for calendar year 2006 (February 28, 2007, for the original or corrected information return and January 31, 2007, for the payee statement). If, on the other hand, an employer did report the appropriate amounts included in income under Code section 409A, they would not need to do so again for these amounts.
Compliance Prevents Further Withholding and Reporting
An employer or other payer who complies with the requirements of the Notice will not be liable for additional income tax withholding or penalties, or be required to file subsequent amended information returns as a result of future published guidance. However, if it is later determined that the employer or other payer did not apply the rules of the Notice, any recalculation of these amounts will result in additional liability under Section 3403 of the Code (an employer’s liability for the payment of underwithholding).
Calculation of Amounts Includible in Income under Code Section 409A
In GeneralAmounts includable in gross income by an employee under Code section 409A, whether constructively or actually received by such employee, are considered a payment of wages by the employer for purposes of withholding and reporting such income. The timing of withholding and reporting depends on whether the amounts includible in gross income are constructively or actually received. There are corrective actions available for the failure of an employer to withhold on amounts that are neither constructively nor actually received.
If amounts are includible in an employee’s gross income and subject to Code section 409A, the amounts includible are calculated as follows:
- Account Balance and Nonaccount Balance PlansThe amounts deferred as of December 31, 2006, equal any amounts that would be treated as a deferral under Code section 3121(v). For account balance plans, the amount deferred includes any investment credits or debits credited to the applicable amounts. Note that if only a portion of a non-qualified deferred compensation plan qualifies as an account balance plan, certain bifurcation rules will apply.
- Stock RightsThe amount includible in income as of December 31, 2006, is the amount that the employee would be required to include in income if the stock right (i.e. non-qualified stock option or stock appreciation right) was exercised on December 31, 2006. Specifically, this amount equals the fair market value of the underlying stock on December 31, 2006, less the sum of the exercise price and any amount the employee would have paid for such stock right (i.e. the exercise price of an option).
Other Deferred Amounts
The Notice provides that for any other deferred amounts not specifically addressed, an amount deferred as of December 31, 2006, must be determined under a reasonable good faith standard.