The Tax Court recently ruled that nonqualified deferred compensation is deductible only in the year in which an employee includes it in income. Ken Berry explains why the court sided with the IRS and how the rules apply.
Foul on the play! In a new case, Hoops, LP, TC Memo 2022-9, 2/23/22, the former owner of a professional basketball team tried to deduct nonqualified deferred compensation that was owed to two of their players. But the Tax Court determined that taking a current deduction was a violation of the rules.
First, here’s some background information. A nonqualified deferred compensation plan is an arrangement that is usually set up to supplement a qualified retirement plan like a 401(k) plan. It is often an attractive recruiting tool for employers.
For starters, the plan is exempt from most reporting requirements and strict ERISA rules, so it can discriminate in favor of highly-compensated employees (HCEs). In addition, it is not subject to the required minimum distribution (RMD) rules for qualified plans. As a result, such plans can appeal to employees currently in the prime of their careers.
Also, if the employer is experiencing cash flow problems, payments are postponed until a time when it is more feasible. And the plan can reward HCEs for meeting specific performance standards—either individually or for the overall operation—while providing vesting over time or upon the occurrence of certain events stated in the agreement.
As long as the plan is unfunded—in other words, amounts aren’t set aside and specifically earmarked for this purpose—the employee doesn‘t owe tax until a future date—usually at retirement. But this also defers the employer’s deduction until the time the employee recognizes income.
Register for free to continue reading
It’s 100% free and provides unlimited access to the latest accounting news, advice and insight every day. As well as access to this exclusive article, you can:
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...