myNQDC | NQDC Taxation

1. What taxation applies at the time I defer salary and/or a bonus under a nonqualified deferred compensation plan?

Ordinary income tax
Social Security tax up to the yearly maximum and Medicare (payroll taxes)
Capital gains tax plus Social Security up to the yearly maximum and Medicare
Ordinary income tax plus Social Security up to the yearly maximum and Medicare

2. When do you usually owe ordinary income taxes on salary and/or a bonus put into a nonqualified deferred compensation plan?

At the time of distribution
At the time of deferral, with no additional taxes owed at distribution
When the amounts are distributed, but only for the increase in the amount over what you deferred
At the time of deferral, if you make an election to be taxed on its value 30 days after the start of the year in which you defer income

3. What is the tax treatment of a company match or contribution made through the NQDC plan?

Company matches are exempt from taxation
Ordinary income tax and FICA tax (Social Security and Medicare) at the time of distribution
Payroll tax (FICA, which is Social Security and Medicare) at the time of vesting but no ordinary income until the time of distribution
Only ordinary income tax when the match or contribution has vested

4. Will I owe additional payroll taxes (Social Security and Medicare tax) on the interest or investment earnings credited to my NQDC account when it is distributed?

Yes, on the increase in value on the amount deferred
No, assuming that it was paid when the income was deferred or when it vested, and that any credited interest was based on a reasonable rate or on actual investment returns
Not the interest, but only on the investment earnings
Yes on the full value of the account, with credit for the amounts paid at the time of deferral

5. When I get my distributions from the NQDC plan, are the taxes I owe based on the value of the amount I initially deferred or on the value of the distribution I receive?

The value at distribution, unless you had to pay taxes up front because the money was held in a secular trust
The value when you receive the distribution, but only if paid out as a lump sum
The value at the time of deferral if you make an election within one year of deferral
The value at the time you receive the distribution if you make an election within one year of deferral

6. When I defer income as an employee, and when I later receive the distributions, what tax form do I receive that reports all these?

IRS Form 1099-NQDC
IRS Schedule D
IRS Schedule NQDC
IRS Form W-2

7. Why is Section 409A of the tax code so important to understanding nonqualified deferred compensation?

It provides almost all the restrictions and limits on nonqualified deferred compensation plans
The tax treatment of NQDC changes if your company and its plan do not follow the 409A rules
You will personally face tax penalties if the rules are not met
All of the above

8. Beyond immediate taxation on the deferred amount, what penalty applies to you if your company's NQDC plan does not follow the rules of Section 409A?

An eventual surtax of 10% when you receive the distributions
An immediate tax of 10% on the compensation deferred
An eventual surtax of 20% when you receive the distributions, along with interest on the amount deferred at the IRS underpayment rate plus 1%
An immediate tax of 20% on the compensation deferred, along with interest at the IRS tax underpayment rate plus 1%

9. Under the rules of Section 409A, what is the maximum amount of work you can continue to perform for your company after a separation of service (i.e. termination of employment) without potentially triggering penalties?

50% of the average level of service performed during the five years before termination
20% of the average level of service performed during the five years before termination
50% of the average level of service performed during the 36 months before termination
20% of the average level of service performed during the 36 months before termination

10. Are the tax rules the same for outside directors or consultants as for regular employees?

Yes, the tax and reporting rules are the same as for employees
Outside directors cannot participate in nonqualified deferred compensation, but consultants can if they formally worked for the company
The taxes can be deferred on the Social Security and Medicare, but not the income
The deferrals and distributions are taxed under similar rules, but the tax-reporting rules are different

11. When I am receiving Social Security payments in retirement, will NQDC distributions cause my Social Security benefits to be taxed?

Income from NQDC plans is not considered in the calculation for determining whether your Social Security payments are taxable
Only when the amount distributed in any year exceeds the average of your salary during the last five years of your job
NQDC income is no different than any other income in the calculation for determining whether your Social Security will be taxed
Only when the Social Security benefits exceed 35% of the distribution amount from your NQDC plan

12. Will I owe taxes in the state I used to work in when I now live in a state with no income tax?

It depends on the type of plan your company uses, or the length of time during which you will receive distributions in retirement
No, unless you elected at the time of deferral to pay taxes in the state you live in at the time of retirement
Yes, if the state you now live in had no income tax at the time you deferred the income
The tax rate for the state you lived in at the time you earned the income will always apply

13. Can you roll over NQDC distributions into an IRA and keep the tax-deferred status?

Never, unless the distributions are made in company stock
Never, even if the distributions are made in company stock
Yes, the tax treatment is similar to that of a 401(k) plan
Yes, but the amount you can roll over is limited to $5,000 per year

14. Can NQDC distributions fund living expenses before the mandatory age of IRA and 401(k) withdrawals while letting me delay Social Security payments?

Only if the rules of IRC Section 409A on accelerated distributions are not met
Never
Yes
This depends on the state where you live

15. After death, are NQDC distributions still included in your estate for tax purposes if the plan is set up to pay them in a lump sum to a beneficiary when you die?

The NQDC distributions will always be included in your estate for tax purposes upon your death, regardless of a beneficiary designation
If the plan will never pay distributions to you, only to your beneficiary upon your death, the income will probably be excluded from your estate for tax purposes
As long as the rules of Section 409A are met, NQDC distributions are automatically excluded from your estate for tax purposes
You cannot name a beneficiary for NQDC distributions, which can be paid only to you

NQDC Taxation Quiz