The IRS recently issued Notice 2007-89 regarding federal income tax reporting and withholding requirements for deferred compensation under Section 409A of the Internal Revenue Code. The tax burden for deferred compensation arrangements failing to comply with Section 409A generally falls on workers. However, the obligation to generally report deferrals and to report and withhold on amounts subject to the tax consequences of Section 409A falls on employers.
Just as it did for years 2005 and 2006, the IRS will not require employers to report amounts deferred under a nonqualified plan for 2007 (Box 12, Code Y on Form W-2, and Box 15a of Form 1099). However, as with 2005 and 2006, employers will be required to report amounts subject to Section 409A’s tax consequences both as wages (or nonemployee compensation) and as “Code Z” (Box 12, Form W-2) or “Box 15b” (Form 1099) amounts for 2007. Employers also must withhold federal income taxes on such amounts with respect to employees. The IRS did clarify that such amounts should be treated as supplemental wages. The guidance includes methods for determining such amounts, including with respect to defined contribution accounts, defined benefit accounts and stock rights, and for situations where assets set aside to pay deferred compensation are put in off-shore or triggered-restriction trusts. The guidance also discusses reporting and tax responsibilities of workers subject to the tax consequences of Section 409A.
Many employers breathed a sigh of relief with the recent extension of Section 409A good faith compliance through the end of 2008. However, the extension does not alleviate the possibility that some employers may have arrangements that failed to comply with Section 409A in recent years (2005 through 2007) for which they were required to report and withhold taxes. Penalties associated with reporting and tax withholding failures are yet another reason for employers to be familiar with 409A, identify arrangements potentially subject to 409A and ascertain compliance with 409A.