Employers are responsible for monitoring whether a nonqualified deferred compensation plan fails under Internal Revenue Code Section 409A, a speaker said May 7 at the 2013 American Payroll Association Congress in Grapevine, Texas.

NQDC plans are those plans that do not meet the tax code requirements for a qualified retirement plan and that provide for the deferral of compensation, including employee and employer contributions and any earnings from the contributions, said James Medlock, director of education and training for the American Payroll Association.

Employment agreements, severance plans and agreements, supplemental employee retirement plans, bonus and incentive plans, reimbursement plans, and certain stock option plans could be NQDC plans, Medlock said.

Often, the plans are set up for highly compensated employees, such as executives, to set aside more money than a qualified plan would allow, he said.

An employee has a legally binding right under an NQDC plan to receive the compensation; however, there can be a risk of forfeiture, such as a minimum period of service by the employee, Medlock said.

To receive the tax benefits of deferral, NQDC plans must comply with Section 409A, which puts significant restrictions on NQDC plans, he said.

If an NQDC plan does not meet Section 409A's requirements, then the deferred income could be included in the employee's taxable income that year, even though employee does not receive the money in that year, Medlock said.

The deferred income is included in Form W-2, Box 1, and is subject to supplemental wage withholding, an additional tax of 20 percent of the amount, and interest, Medlock said.

According Internal Revenue Service Notice 2008-113, correctable plan failures include failures to defer, excess deferrals, incorrect distributions, and incorrect exercise prices of otherwise excluded stock rights.

Although IRS provided guidance to employers that lets them correct unintentional plan failures, the corrections must be made within the tax year that the failure occurred, Medlock said.

By letting employers correct the failures within the tax year in which they occurred, the IRS encourages employers to be diligent in monitoring the compliance of NQDC plans, he said.

An employer can determine if the plan fails by examining if it meets Section 409A restrictions and if it operates according to the plan description, Medlock said.

Closely monitoring NQDC plans can ensure that plan failures are quickly corrected and that tax penalties for unintended failures are prevented, he said.

Often, an employer's compliance officer is the employee best suited to conduct this monitoring; however, independent audits also can be of assistance, Medlock said.

By Allison M. Gatrone