Reporting Deferred Compensation on Tax Return: A Guide for Employees and Contractors

Reporting deferred compensation on your tax return can be a complex process, but understanding the basics can help you navigate it with ease. According to the IRS, deferred compensation is considered taxable income and must be reported on your tax return.

As an employee or contractor, it's essential to know that deferred compensation is not considered income until it's actually received. This means you won't have to pay taxes on it until the funds are distributed.

To report deferred compensation on your tax return, you'll need to include it in your income, just like any other taxable income. This includes deferred compensation from sources such as 457 plans, 409A plans, and non-qualified deferred compensation plans.

Deferred compensation is a plan that allows employees to delay receiving a portion of the compensation earned in one tax year to a future tax year.

This type of compensation is not considered taxable income for employees until they receive the deferred payment in a future tax year.

Deferred compensation plans are typically offered to key employees or high-earning employees in an organization, and employers should detail the conditions under which employees can access their deferred funds.

Employers must follow specific rules for deferred compensation to avoid penalties with the IRS.

Deferred compensation is taxable, but the taxes are applied at a later date. The IRS Form 1040 tax return has been revised in the past few years, and distributions from NQDC plans are now reported as part of income on Line 1a.

You will be taxed on the compensation when you actually receive it, which should be sometime after you retire, unless you meet the rules for another triggering event that is allowed under the plan. The payment of the deferred compensation will be reported on a Form W-2 even if you are no longer an employee at the time.

The Social Security and Medicare tax (FICA on your W-2) is paid on compensation when it is earned, even if you opt to defer it. This can be a good thing because of the Social Security wage cap, which can exempt a portion of your total compensation from FICA tax.

Employers are subject to different withholding requirements and regulations depending on how the deferred compensation plan is structured. For example, employers can't withhold income tax until the employee receives their compensation, but FICA and FUTA taxes must be withheld and paid when employees defer income.

Deferred compensation is taxed, but the taxes are applied at a later date. This can make filling out tax forms tricky, but employers need to ensure their taxes are filed correctly or they may face an IRS audit and penalties.

Employers can't withhold income tax until the employee receives their compensation, but FICA and FUTA taxes must be withheld and paid when employees defer income.

You'll be taxed on the compensation when you actually receive it, which should be sometime after you retire, unless you meet the rules for another triggering event. The payment of the deferred compensation will be reported on a Form W-2 even if you're no longer an employee at the time.

The rate of return on your deferrals is fixed by the terms of the plan, and it may match the rate of return on the S&P 500 Index. You'll also be taxed on the earnings you get on your deferrals when they're paid to you.

If your plan violates Section 409A, you'll report the penalty and interest on Schedule 2 of your IRS Form 1040 tax return: Line 17h, "Income you received from a nonqualified deferred compensation plan that fails to meet the requirements of section 409A."

The total on Schedule 2 is then entered on Line 23 ("Other taxes") of Form 1040.

Deferring compensation can be a smart move, especially when it comes to FICA taxes. The Social Security and Medicare tax is paid on compensation when it's earned, regardless of whether you opt to defer it.

The Social Security wage cap can actually work in your favor. For the 2024 tax year, earnings subject to the Social Security portion of FICA are capped at $168,600.

You can save a significant amount of money on FICA taxes by deferring compensation. In this example, $36,400 of total compensation for the year is not subject to the FICA tax.

The FICA tax exemption increases over time, so you may save even more in the future. For the 2025 tax year, earnings subject to the Social Security portion of FICA are capped at $176,100.

No FICA tax will be deducted when the deferred compensation is paid out, which is a huge perk. This means you get to keep even more of your hard-earned money.

You report deferred compensation on your tax return, specifically on Form 1040, as part of your income on Line 1a. This includes distributions from nonqualified deferred compensation plans, as well as salary income.

If your company's NQDC plan violates Section 409A, you'll report the penalty and interest on Schedule 2 of your Form 1040 tax return, specifically on Line 17h. This is a separate calculation from your regular income.

The income that's subject to this additional tax will appear on your Form W-2 or on the revised Form 1099-MISC and new Form 1099-NEC, depending on your employment status.

Non-qualified deferred compensation plans are a type of benefit offered to select employees, typically those in upper management or highly compensated positions. These plans are in addition to traditional qualified deferred compensation plans, such as 401(k)s.

The amount an employee chooses to defer reduces their taxable income, but the deferred amount is not taxed until they receive the funds, usually in retirement. This can provide a significant tax benefit, but it's essential to understand the terms of the plan before participating.

The IRS recognizes several types of deferred compensation Section 409A plans, including Excess Benefit Plans, Salary Reduction Arrangements, Supplemental Executive Retirement Plans (SERPs), and Bonus Deferral Plans.

Here are some key characteristics of each type of plan:

Non-qualified deferred compensation plans can be complex, so it's crucial to carefully understand the terms before participating. If you're offered one of these plans, take the time to review the details and ask questions to ensure you're making an informed decision.

When reporting deferred compensation to employees or contractors, it's essential to understand the tax implications. Deferred compensation is taxable, but taxes are applied at a later date.

You'll need to ensure you're withholding the correct taxes, which can be tricky. Employers are subject to different withholding requirements and regulations depending on how the deferred compensation plan is structured.

FICA and FUTA taxes must be withheld and paid when employees defer income, but income tax withholding is only required once the employee receives their compensation. This means you'll need to carefully consider the plan's structure to avoid IRS penalties.

Non-qualified deferred compensation plans, in particular, can be more complicated than traditional retirement plans. Employees offered these plans should carefully understand the terms before taking part.

The amount an employee chooses to defer reduces their taxable income, and the amount deferred is not taxed until they receive the funds.

Compliance and Regulations are crucial when reporting deferred compensation on your tax return. The IRS requires you to report deferred compensation on your tax return, including amounts earned in the current year.

The IRS considers deferred compensation to be taxable income, regardless of when it's actually paid out. You'll need to report it on your tax return, even if you don't receive the payment until a later year.

The tax rules for deferred compensation are outlined in the Tax Code, specifically in section 409A. This section provides guidance on the reporting requirements for deferred compensation.

You'll need to report deferred compensation on Form W-2 or Form 1099, depending on the type of compensation you received.

When you start receiving pension payments, you'll need to consider how much tax to withhold. A payer must withhold as if the recipient were a married person with three allowances unless the recipient provides an exemption certificate (Form NC-4P) reflecting a different filing status or number of allowances.

To report and pay the withheld tax, a pension payer must register with the Department of Revenue by completing Form AS/RP1 and mailing it to the Business Registration Unit in Raleigh, North Carolina. This will assign an account identification number and provide forms for paying the State tax withheld.

You'll need to pay the tax withheld from pensions separately, but if you also withhold tax from wages, you can choose to report the two types of withholding together. However, if you initially report withholding from pensions separately, you can later choose to report them together by notifying the Business Registration Unit and closing the separate withholding account.

If you're required to withhold State tax from a pension payment, you must register with the Department of Revenue by completing Form AS/RP1.

This form needs to be mailed to the N.C. Department of Revenue, Business Registration Unit, P.O. Box 25000, Raleigh, North Carolina 27640-0100.

You'll be assigned an account identification number and receive forms for paying the State tax withheld.

The payer will initially be classified as a quarterly filer, but the filing frequency may change after the first year depending on the amount of tax withheld during the first year.

If you withhold tax from pensions and also withhold tax from wages, you must report the withholding from pensions with the wage withholding unless you choose to report the withholding from pensions separately.

For those payers that don't choose to report the two types of withholding separately, the payment of tax withheld from pensions is due at the time the withholding from wages is due.

If you choose to report the two types of withholding together, you should report the combined withholding under the account number for reporting wages.

You'll need to complete the Out of Business Notification for the separate pension withholding account and file it with the Department to close the separate withholding account.

If you initially report the two types of withholding at the same time, you can choose to begin reporting the withholding on pensions separately by notifying the Business Registration Unit.

In either case, you must file separate annual reconciliations for the year in which the choice is changed.

The penalties and interest on both types of withholding will be based on the due date of the withholding from wages if you don't report the two types of withholding separately.

For a periodic payment, the payer must withhold as if the recipient were a married person with three allowances unless the recipient provides an exemption certificate.

The exemption certificate, Form NC-4P, is used by a North Carolina resident to report the correct filing status, number of allowances, and any additional amount they want withheld from the pension payment.

Four percent of a nonperiodic distribution must be withheld. This includes an eligible rollover distribution, as defined in Code section 3405(c)(3).

State law differs from federal law with respect to eligible rollover distributions, imposing the same rate of withholding on all nonperiodic distributions.

Qualified plans, such as 401(k)s, provide investors with a tax-advantaged retirement account. The money is invested and grows over time.

These plans can be moved from employer to employer, making them a great option for those who change jobs frequently.

The Internal Revenue Service (IRS) considers qualified plans to be tax-deferred, meaning you won't pay taxes on the money until you withdraw it.

Qualified plans are typically offered to employees by their employers, and the contributions are made on a pre-tax basis.

Here's a summary of the key differences between qualified and non-qualified plans:

The IRS provides guidance on non-qualified deferred compensation plans in Publication 5528, which notes that these plans are subject to certain rules and restrictions.