On January 5, the IRS issued guidance on new code section 409A that establishes the rules and required reporting for nonqualified deferred compensation plans (IRS Notice 2005-1). The notice, in question and answer format, is available on the IRS web site www.irs.gov. The new code section was signed into law as part of the American Jobs Creation Act of 2004 (Act).

The IRS considers all amounts deferred under a nonqualified deferred compensation plan to be currently reportable in taxable income in 2005 unless there is a substantial risk of forfeiture and not previously included in income. This includes amounts that were deferred in prior years if there has been a substantial change in the deferral agreement after October 3, 2004.

The notice also clarifies that a deferred compensation agreement is not limited to employees, but may also apply to arrangements between an employer and independent contractors or partner to partnership arrangements.

The Act requires that all deferrals under a nonqualified arrangement be separately reported on Form 1099-MISC or Form W-2, whether or not included in earnings for that year. If the aggregate amount of the deferral is $600 or less, no reporting is required.

Total employee deferrals are reported by an employer in Box 12 of Form W-2 with new Code Y. For non-employees, the total deferred amount is reported in Box 15a of Form 1099-MISC. The Act requires that deferrals reported as income for an employee be considered wages subject to federal income tax withholding. The same rules for FICA taxes apply to these distributions as to other benefit distributions.

If you currently have any nonqualified plans or want to learn more about them to see if they might be a good tool to help you secure and retain good employees, go to the IRS web site at www.irs.gov and search for IRS code section 409A or use the keyword "deferred compensation."