Question

Under a nonqualified deferred compensation arrangement, when are amounts taxable to the service provider and when does an accrual basis employer get the deduction?

Answer 1

Nonqualified deferred compensation (NQDC) is a general term that includes plans that provide equity compensation, plans that provide additional retirement benefits and plans that provide mid-term and long-term incentive payments.  

A nonqualified deferred compensation (NQDC) plan is a broad, general description for any arrangement under which the employer or the employee can defer taxation of compensation that is earned in one year so that it becomes included in taxable compensation in a later year (because payment occurs more than 2 ½ months after the year in which the benefit is earned). The NQDC rules apply to employees and other “service providers”, such as a director or a partner providing service to a partnership; for simplicity this discussion uses the term “employee” rather than “service provider”.

Before offering a NQDC plan, an employer must determine the company’s overall business strategy, and how NQDC obligations work with the company’s overall compensation philosophy. In general, NQDC plans fall into five categories:

1. Salary reduction arrangements (sometimes with employer matching contributions)
2. Deferred bonus plans
3. Supplemental executive retirement plans
4. Supplements to normal compensation
5. “Excess benefit plans”, which solely provide benefits to employees, due to benefit limitations under the employer's qualified plan