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Bulletin No. 1996–12

March 18, 1996

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

Code relate to when amounts deferred or paid from

certain nonqualified deferred compensation plans are

taken into account as ‘‘wages’’ for FICA purposes.

T.D. 8653, page 4.

Final regulations under sections 446 and 1221 of the

Code relate to the character and timing of gain or loss

from certain hedging transactions entered into by

members of a consolidated group.

ADMINISTRATIVE

T.D. 8655, page 9.

Final and temporary regulations under section 7805 of

the Code are declared obsolete as part of the

President’s Regulatory Reinvention Initiative.

Notice 96–14, page 11.

T.D. 8650, 1996–10 I.R.B. 5, relating to the disallowance of deductions for employee remuneration in

excess of $1,000,000, is corrected.

EMPLOYMENT TAX

Announcement 96–13, page 33.

Test of Employment Tax Early Referral Procedures for

Appeals. This announcement describes the method by

which a taxpayer requests early referral of one or more

unagreed employment tax issues from the District to

Appeals.

EE–55–95, page 12.

Proposed regulations under section 3306(r) of the Code

relate to when amounts deferred or paid from certain

nonqualified deferred compensation plans are taken

into account as ‘‘wages’’ for FUTA purposes.

Announcement 96–14, page 35.

A list is given of organizations now classified as private

foundations.

EE–142–87, page 13.

Proposed regulations under section 3121(v)(2) of the

Finding Lists begin on page 39.

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Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of

view.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining officers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great courtesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

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Introduction

The Internal Revenue Bulletin is the authoritative

instrument of the Commissioner of Internal Revenue for

announcing official rulings and procedures of the

Internal Revenue Service and for publishing Treasury

Decisions, Executive Orders, Tax Conventions, legislation, court decisions, and other items of general

interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription basis. Bulletin contents of a permanent nature are

consolidated semiannually into Cumulative Bulletins,

which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin

all substantive rulings necessary to promote a uniform

application of the tax laws, including all rulings that

supersede, revoke, modify, or amend any of those

previously published in the Bulletin. All published

rulings apply retroactively unless otherwise indicated.

Procedures relating solely to matters of internal

management are not published; however, statements of

internal practices and procedures that affect the rights

and duties of taxpayers are published.

Revenue rulings represent the conclusions of the

Service on the application of the law to the pivotal facts

stated in the revenue ruling. In those based on

positions taken in rulings to taxpayers or technical

advice to Service field offices, identifying details and

information of a confidential nature are deleted to

prevent unwarranted invasions of privacy and to comply

with statutory requirements.

Rulings and procedures reported in the Bulletin do not

have the force and effect of Treasury Department

Regulations, but they may be used as precedents.

Unpublished rulings will not be relied on, used, or cited

as precedents by Service personnel in the disposition of

other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be

considered, and Service personnel and others concerned are cautioned against reaching the same

conclusions in other cases unless the facts and

circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on

provisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows:

Subpart A, Tax Conventions, and Subpart B, Legislation

and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellanous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and

Subparts. Also included in this part are Bank Secrecy

Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary

(Enforcement).

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly

and semiannual basis, and are published in the first

Bulletin of the succeeding quarterly and semi-annual

period, respectively.

The Bulletin Index-Digest System, a research and

reference service supplementing the Bulletin, may be

obtained from the Superintendent of Documents on a

subscription basis. It consists of four Services: Service

No. 1, Income Tax; Service No. 2, Estate and Gift

Taxes; Service No. 3, Employment Taxes; Service No.

4, Excise Taxes. Each Service consists of a basic

volume and a cumulative supplement that provides (1)

finding lists of items published in the Bulletin, (2)

digests of revenue rulings, revenue procedures, and

other published items, and (3) indexes of Public Laws,

Treasury Decisions, and Tax Conventions.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 446.—General Rule for

Methods of Accounting

26 CFR 1.446–4: Hedging transactions

T.D. 8653

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Hedging Transactions by Members of

a Consolidated Group

AGENCY: Internal Revenue Service,

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to the character and timing of gain or loss from

certain hedging transactions entered

into by members of a consolidated

group. These regulations apply when

one member of the group hedges its

own risk, hedges the risk of another

member, or enters into a risk-shifting

transaction with another member. The

regulations are needed to provide appropriate rules for these transactions.

The regulations provide guidance for

corporations that are members of consolidated groups.

DATES: These regulations are effective

February 7, 1996.

For dates of applicability of these

regulations, see §1.446–4(e)(9)(iv) and

§1.1221–2(g)(4), (5), and (6).

FOR FURTHER INFORMATION

CONTACT: Jo Lynn Ricks of the

Office of the Assistant Chief Counsel

(Financial Institutions and Products),

telephone (202) 622-3920 (not a tollfree number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under

control number 1545–1480. Some re-

sponses to these collections of information are mandatory, and others are

required to obtain the benefit of the

separate-entity election or of applying

single-entity treatment in taxable years

prior to the general effective date of

the regulations.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid control number.

The estimated annual burden per

respondent or recordkeeper varies from

1.0 to 40.0 hours, depending on individual circumstances, with an estimated

average of 5 hours.

Comments concerning the accuracy

of this burden estimate and suggestions

for reducing this burden should be sent

to the Internal Revenue Service, Attn:

IRS Reports Clearance Officer, T:FP,

Washington, DC 20224, and to the

Office of Management and Budget,

Attn: Desk Officer for the Department

of the Treasury, Office of Information

and Regulatory Affairs, Washington,

DC 20503.

Books or records relating to this

collection of information must be retained as long as their contents may

become material in the administration

of any Internal Revenue law. Generally, tax returns and tax return information are confidential, as required by 26

U.S.C. 6103.

Background

On July 18, 1994, the IRS published

in the Federal Register (59 FR 36394)

a notice of proposed rulemaking (FI–

34–94 [1994–2 C.B. 863]) relating to

the character and timing of gain or loss

from certain risk-shifting transactions

entered into by members of a consolidated group. Comments were received

on the proposed regulations, and a

public hearing was held on October 18,

1994. Most commentators believe that

the proposed regulations provide a

sensible and flexible set of rules to deal

with hedging operations by the members of a consolidated group of

corporations.

The most significant comment on the

regulations relates to their effective

date. Almost all of the commentators

requested a transition rule permitting

consolidated groups to elect to apply

the proposed character rules retroactively. The final regulations adopt this

suggestion, generally allowing consolidated groups to elect to apply the

single-entity approach of the proposed

regulations to all open years. Section

1.1221–2, concerning the character of

hedging transactions, was made retroactive for all open years to permit the

IRS to resolve fairly and consistently

controversies involving transactions

that were entered into prior to the

publication date of those regulations. It

is appropriate that these regulations, as

an integral part of §1.1221–2, also

apply retroactively. To prevent any

adverse consequences, however, retroactivity is elective.

The proposed regulations, with new

effective date provisions, are adopted

as final regulations. The new provisions, and several comments that were

not adopted, are discussed below.

Explanation of provisions

Character regulations

The final regulations retain the

single-entity approach of the proposed

regulations. That is, they treat the risk

of one member of the group as the risk

of the other members, as if all the

members were divisions of a single

corporation. Thus, a member of a consolidated group that hedges the risk of

another member by entering into a

transaction with a third party may

receive ordinary gain or loss treatment

on that transaction if the transaction

otherwise qualifies as a hedging

transaction.

Under this single-entity approach,

intercompany transactions are neither

hedging transactions nor hedged items.

Because they are treated as transactions

between divisions of a single corporation, intercompany transactions do not

reduce the risk of that single corporation and, therefore, fail to qualify as

hedging transactions.

Some commentators requested that

the IRS extend the single-entity approach to apply the hedging rules to a

taxpayer’s transactions that hedge the

risk of a related party that is not a

member of the taxpayer’s consolidated

group. The IRS and Treasury, however,

do not believe that this approach is

appropriate where the parties file dif-

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ferent tax returns. Accordingly, the

final regulations do not adopt this

suggestion.

The final regulations also retain the

separate-entity election of the proposed

regulations, permitting a consolidated

group to treat its members as separate

entities when applying the hedging

rules. The election is made by attaching

a statement to the group’s federal

income tax return.

For a group that elects separateentity treatment, an intercompany transaction is treated as a hedging transaction if and only if: (1) it would qualify

as a hedging transaction if entered into

with an unrelated party; and (2) it is

entered into with a member that, under

its method of accounting, marks its

position in the intercompany transaction to market. If these requirements

are satisfied, the member with respect

to which it is an intercompany hedging

transaction must account for its position in the transaction under §1.446–4,

and, if that member properly identifies

the transaction as a hedging transaction, each member treats the gain or

loss from its position in the transaction

as ordinary.

In response to comments, the final

regulations clarify that, even when

these two requirements are met, these

regulations supplant only the character

and timing rules of §1.1502–13. Other

aspects of the transaction, such as the

source of the gain or loss, are unaffected by these regulations and thus

may be governed by §1.1502–13.

As noted above, commentators

pointed out that taxpayers frequently

enter into transactions to transfer their

business risk to related parties that do

not qualify as members of a consolidated group. Some commentators argued that, even if risk reduction in

these circumstances is not analyzed

using a single-entity perspective, the

relationship between the parties to the

risk transfer justifies a rule under

which the party receiving the risk has

ordinary gain or loss on its position in

the transaction. That is, they wanted to

apply one part of the separate-entity

rules to taxpayers that are not part of

the same consolidated group.

The IRS and Treasury, however, do

not believe that additional, special

character rules are appropriate for riskshifting transactions outside the context

of a consolidated group. Accordingly,

the final regulations do not adopt these

comments.

The final regulations expand upon

the effective date provision of the

proposed regulations. The final regulations generally apply to transactions

entered into on or after March 8, 1996.

In response to comments, the final

regulations permit a consolidated group

to apply the single-entity approach of

the regulations retroactively. The group

may elect to begin to apply the singleentity approach for all transactions

entered into in any taxable year (the

election year) beginning prior to March

8, 1996. The election may be made,

however, only if the election year and

each subsequent taxable year are still

open for assessment under section 6501

on July 1, 1996, or such earlier date as

the Commissioner may allow. Once

made, the single-entity election applies

to all transactions entered into in the

election year and in all subsequent

consolidated return years until the date

as of which the group makes a

separate-entity election. The Service

will publish guidance on the manner,

and the time, for making the singleentity election.

Further, the regulations also permit a

consolidated group to apply the

separate-entity approach to all transactions entered into in taxable years

subject to the election. The taxpayer

may choose, as the first year under the

election, any taxable year beginning on

or after July 12, 1995. This ability to

apply the election to taxable years

beginning before March 8, 1996, allows a consolidated group to apply the

separate-entity approach to all intercompany transactions that are subject

to new §1.1502–13 (which is effective

for taxable years beginning on or after

July 12, 1995). Thus, by electing

separate-entity treatment for all transactions entered into in a taxable year

beginning on or after July 12, 1995, a

consolidated group can determine the

character and timing of its intercompany hedging transactions under

§1.446–4 and §1.1221–2, rather than

under §1.1502–13.

If the group makes the single-entity

election or elects to apply the separateentity approach retroactively, special

identification rules apply.

First, the members of the group are

required to identify transactions that

were entered into prior to March 8,

1996, that are still in existence on that

date, and that become hedging transactions as a result of one of these

elections. The members are also re-

quired to identify the hedged item for

these transactions.

Second, the final regulations extend

the time period for making the additional identifications that are referred to

in the preceding paragraph.

Third, if the taxpayer’s consolidated

group has elected the single-entity

approach, the regulations nullify all

hedge identifications under §1.1221–2(e)(i) that had been made for intercompany transactions. In this situation, the

regulations determine the character of

each intercompany transaction as if it

had never been identified as a hedging

transaction. Thus, the character and

timing of the intercompany transaction

are determined under the otherwise

applicable regulations, and the transaction is not subject to the ordinary-gain,

capital-loss rule that generally applies

to transactions that are incorrectly

identified as hedging transactions. The

identification may, however, serve to

identify the hedged item.

In order to ensure that consolidated

groups do not improperly use hindsight

in making these identifications, the

regulations provide a consistency requirement. Under this requirement, the

group members must treat similar or

identical transactions consistently

within the same year and from year to

year. If a member of the consolidated

group fails to identify a hedging

transaction as a hedging transaction,

but has identified similar or identical

hedging transactions in the same or a

subsequent year, then, for purposes of

§1.1221–2(f)(2)(iii), the member entering into the transaction is treated as

having no reasonable grounds for treating the transaction as other than a

hedging transaction. Thus, the member

is generally subject to the ordinarygain, capital-loss rules for taxpayers

who fail to identify transactions as

hedging transactions.

Timing regulations

The final regulations clarify the

general rule that was provided in the

proposed regulations for the timing of

the gain or loss from hedging transactions that are entered into by members

of a consolidated group. Under the

final regulations, a member of a consolidated group must account for its

hedging transactions as if all the

members were separate divisions of a

single corporation (the single-entity

approach). Thus, the timing of the

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income, deduction, gain, or loss on the

hedging transaction must match the

timing of the income, deduction, gain,

or loss from the item, items, or

aggregate risk being hedged. These

regulations make clear that a member

must account for all of its hedging

transactions, not just those that hedge

the risk of another member, under the

single-entity approach.

Since all of the members are treated

as divisions of a single corporation,

intercompany transactions are neither

hedging transactions nor hedged items.

Thus, under the single-entity approach,

the timing of the gain or loss from

intercompany transactions is not determined under the rules of §1.446–4.

The final regulations also clarify the

rule in the proposed regulations on

accounting for the gain or loss on

hedging transactions by members of a

group that has made a separate-entity

election. If a group makes the separateentity election, the members do not

account for their hedging transactions

(including their intercompany hedging

transactions) as if they were divisions

of a single corporation. Rather, each

member accounts for its hedging transactions on a member-by-member basis.

For example, if an intercompany transaction is treated as a hedging transaction, the gain or loss on the transaction

is accounted for under the rules of

§1.446–4 rather than under the timing

rules of the intercompany transaction

regulations, §1.1503–13. As was stated

above, even when a separate-entity

election is in place, §§1.1221–2 and

1.446–4 affect only the timing and

character of intercompany hedging

transactions. Other aspects of the intercompany hedging transaction remain

subject to the rules of §1.1502–13.

These final timing regulations are

effective for transactions entered into

on or after March 8, 1996.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It is hereby

certified that these regulations do not

have a significant economic impact on

a substantial number of small entities.

This certification is based on the fact

that these regulations will primarily

affect affiliated groups of corporations

that have elected to file consolidated

returns, which tend to be larger businesses. The regulations do not significantly alter the reporting or recordkeeping duties of small entities. Therefore,

a Regulatory Flexibility Analysis under

the Regulatory Flexibility Act (5

U.S.C. chapter 6) is not required.

Pursuant to section 7805(f) of the

Internal Revenue Code, the notice of

proposed rulemaking preceding these

regulations was submitted to the Small

Business Administration for comment

on its impact on small business.

Drafting Information

The principal author of these regulations is Jo Lynn Ricks, Office of

Assistant Chief Counsel (Financial Institutions and Products), IRS. However,

other personnel from the IRS and

Treasury Department participated in

their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and

602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by removing the

entry for §1.1221–2 and by adding

entries in numerical order to read as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.446–4 also issued under 26

U.S.C. 1502. * * *

Section 1.1221–2 also issued under

26 U.S.C. 1502 and 6001. * * *

Par. 2. Section 1.446–4 is amended

by adding the text of paragraph (e)(9)

to read as follows:

§1.446–4 Hedging Transactions.

(e) * * *

(9) Hedging by members of a consolidated group—(i) General rule:

single-entity approach. In general, a

member of a consolidated group must

account for its hedging transactions as

if all of the members were separate

divisions of a single corporation. Thus,

the timing of the income, deduction,

gain, or loss on a hedging transaction

must match the timing of income,

deduction, gain, or loss from the item

or items being hedged. Because all of

the members are treated as if they were

divisions of a single corporation, intercompany transactions are neither hedging transactions nor hedged items for

these purposes.

(ii) Separate-entity election. If a

consolidated group makes an election

under §1.1221–2(d)(2), then paragraph

(e)(9)(i) of this section does not apply.

Thus, in that case, each member of the

consolidated group must account for its

hedging transactions in a manner that

meets the requirements of paragraph

(b) of this section. For example, the

income, deduction, gain, or loss from

intercompany hedging transactions (as

defined in §1.1221–2(d)(2)(ii)) is taken

into account under the timing rules of

§1.446–4 rather than under the timing

rules of §1.1502–13.

(iii) Definitions. For definitions of

consolidated group, divisions of a

single corporation, intercompany transaction, and member, see section 1502

and the regulations thereunder.

(iv) Effective date. This paragraph

(e)(9) applies to transactions entered

into on or after March 8, 1996.

Par. 3. Section 1.1221–2 is amended

by adding the text of paragraphs (d),

(e)(5), (f)(3), and (g)(4), and by adding

the text and headings of paragraphs

(g)(5) and (6) to read as follows:

§1.1221–2 Hedging Transactions.

(d) Hedging by members of a consolidated group—(1) General rule:

single-entity approach. For purposes of

this section, the risk of one member of

a consolidated group is treated as the

risk of the other members as if all of

the members of the group were divisions of a single corporation. For

example, if any member of a consolidated group hedges the risk of another

member of the group by entering into a

transaction with a third party, that

transaction may potentially qualify as a

hedging transaction. Conversely, intercompany transactions are not hedging

transactions because, when considered

as transactions between divisions of a

single corporation, they do not reduce

the risk of that single corporation.

(2) Separate-entity election. In lieu

of the single-entity approach specified

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in paragraph (d)(1) of this section, a

consolidated group may elect separateentity treatment of its hedging transactions. If a group makes this separateentity election, the following rules

apply.

(i) Risk of one member not risk of

other members. Notwithstanding paragraph (d)(1) of this section, the risk of

one member is not treated as the risk of

other members.

(ii) Intercompany transactions. An

intercompany transaction is a hedging

transaction (an intercompany hedging

transaction) with respect to a member

of a consolidated group if and only if it

meets the following requirements—

(A) The position of the member in

the intercompany transaction would

qualify as a hedging transaction with

respect to the member (taking into

account paragraph (d)(2)(i) of this

section) if the member had entered into

the transaction with an unrelated party;

and

(B) The position of the other member (the marking member) in the

transaction is marked to market under

OPERATING

MEMBER

risk

position

Example 1. Single-entity treatment—(i) General rule. Under paragraph (d)(1) of this section,

O’s risk A is treated as H’s risk, and therefore D

is a hedging transaction with respect to risk A.

Thus, the character of D is determined under the

rules of this section, and the income, deduction,

gain, or loss from D must be accounted for under

a method of accounting that satisfies §1.446–4.

The intercompany transaction B–C is not a

hedging transaction and is taken into account

under §1.1502–13.

(ii) Identification. D must be identified as a

hedging transaction under paragraph (e)(1) of

this section, and A must be identified as the

hedged item under paragraph (e)(2) of this

section. Under paragraph (e)(5) of this section,

the identification of A as the hedged item can be

accomplished by identifying the positions in the

intercompany transaction as hedges or hedged

items, as appropriate. Thus, substantially contemporaneous with entering into D, H may identify

C as the hedged item and O may identify B as a

hedge and A as the hedged item.

Example 2. Separate-entity election; counterparty that does not mark to market. In addition

the marking member’s method of

accounting.

(iii) Treatment of intercompany

hedging transactions. An intercompany

hedging transaction (that is, a transaction that meets the requirements of

paragraphs (d)(2)(ii)(A) and (B) of this

section) is subject to the following

rules—

(A) The character and timing rules

of §1.1502–13 do not apply to the

income, deduction, gain, or loss from

the intercompany hedging transaction;

and

(B) Except as provided in paragraph

(f)(3) of this section, the character of

the marking member’s gain or loss

from the transaction is ordinary.

(iv) Making and revoking the election. Unless the Commissioner otherwise prescribes, the election described

in this paragraph (d)(2) must be made

in a separate statement saying ‘‘[Insert

Name and Employer Identification

Number of Common Parent] HEREBY

ELECTS THE APPLICATION OF

SECTION 1.1221–2(d)(2) (THE

SEPARATE-ENTITY APPROACH).’’

HEDGING

MEMBER

intercompany

transaction

position

The statement must also indicate the

date as of which the election is to be

effective. The election must be signed

by the common parent and filed with

the group’s federal income tax return

for the taxable year that includes the

first date for which the election is to

apply. The election applies to all

transactions entered into on or after the

date so indicated.

(3) Definitions. For definitions of

consolidated group, divisions of a

single corporation, group, intercompany

transactions, and member, see section

1502 and the regulations thereunder.

(4) Examples. The following examples illustrate this paragraph (d):

General Facts. In these examples, O and H are

members of the same consolidated group. O’s

business operations give rise to interest rate risk

‘‘A,’’ which O wishes to hedge. O enters into an

intercompany transaction with H that transfers

the risk to H. O’s position in the intercompany

transaction is ‘‘B,’’ and H’s position in the

transaction is ‘‘C.’’ H enters into position ‘‘D’’

with a third party to reduce the interest rate risk

it has with respect to its position C. D would be

a hedging transaction with respect to risk A if

O’s risk A were H’s risk.

riskshifting

transaction

THIRD

PARTY

position

to the General Facts stated above, assume that

the group makes a separate-entity election under

paragraph (d)(2) of this section. If H does not

mark C to market under its method of accounting, then B is not a hedging transaction, and the

B–C intercompany transaction is taken into account under the rules of section 1502. D is not a

hedging transaction with respect to A, but D may

be a hedging transaction with respect to C if C is

ordinary property or an ordinary obligation and if

the other requirements of paragraph (b) of this

section are met. If D is not part of a hedging

transaction, then D may be part of a straddle for

purposes of section 1092.

Example 3. Separate-entity election; counterparty that marks to market. The facts are the

same as in Example 2 above, except that H

marks C to market under its method of accounting. Also assume that B would be a

hedging transaction with respect to risk A if O

had entered into that transaction with an unrelated party. Thus, for O, the B–C transaction is

an intercompany hedging transaction with respect

to O’s risk A, the character and timing rules of

§1.1502–13 do not apply to the B–C transaction,

and H’s income, deduction, gain, or loss

from C is ordinary. However, other attributes of

the items from the B–C transaction are determined under §1.1502–13. D is a hedging transaction with respect to C if it meets the

requirements of paragraph (b) of this section.

(e) * * *

(5) Identification of hedges involving

members of a consolidated group—(i)

General rule: single-entity approach. A

member of a consolidated group must

satisfy the requirements of this paragraph (e) as if all of the members of

the group were divisions of a single

corporation. Thus, the member entering

into the hedging transaction with a

third party must identify the hedging

transaction under paragraph (e)(1) of

this section. Under paragraph (e)(2) of

this section, that member must also

identify the item, items, or aggregate

risk that is being hedged, even if the

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item, items, or aggregate risk relates

primarily or entirely to other members

of the group. If the members of a

group use intercompany transactions to

transfer risk within the group, the

requirements of paragraph (e)(2) of this

section may be met by identifying the

intercompany transactions, and the

risks hedged by the intercompany

transactions, as hedges or hedged

items, as appropriate. Because identification of the intercompany transaction

as a hedge serves solely to identify the

hedged item, the identification is timely

if made within the period required by

paragraph (e)(2) of this section. For

example, if a member transfers risk in

an intercompany transaction, it may

identify under the rules of this paragraph (e) both its position in that

transaction and the item, items, or

aggregate risk being hedged. The member that hedges the risk outside the

group may identify under the rules of

this paragraph (e) both its position with

the third party and its position in the

intercompany transaction. Paragraph

(d)(4) Example 1 of this section illustrates this identification.

(ii) Rule for consolidated groups

making the separate-entity election. If a

consolidated group makes the separateentity election under paragraph (d)(2)

of this section, each member of the

group must satisfy the requirements of

this paragraph (e) as though it were not

a member of a consolidated group.

(f) * * *

(3) Transactions by members of a

consolidated group—(i) Single-entity

approach. If a consolidated group is

under the general rule of paragraph

(d)(1) of this section (the single-entity

approach), the rules of this paragraph

(f) apply only to transactions that are

not intercompany transactions.

(ii) Separate-entity election. If a

consolidated group has made the election under paragraph (d)(2) of this

section, then, in addition to the rules of

paragraphs (f)(1) and (2) of this section, the following rules apply.

(A) If an intercompany transaction is

identified as a hedging transaction but

does not meet the requirements of

paragraphs (d)(2)(ii)(A) and (B) of this

section, then, notwithstanding any contrary provision in §1.1502–13, each

party to the transaction is subject to the

rules of paragraph (f)(1) of this section

with respect to the transaction as

though it had incorrectly identified its

position in the transaction as a hedging

transaction.

(B) If a transaction meets the requirements of paragraphs (d)(2)(ii)(A)

and (B) of this section but the transaction is not identified as a hedging

transaction, each party to the transaction is subject to the rules of paragraph

(f)(2) of this section. (Because the

transaction is an intercompany hedging

transaction, the character and timing

rules of §1.1502–13 do not apply. See

paragraph (d)(2)(iii)(A) of this section.)

(g) * * *

(4) Effective date and transition

rules for hedges by members of a consolidated group. Paragraphs (d), (e)(5),

and (f)(3) of this section apply to

transactions entered into on or after

March 8, 1996.

(5) Elections to accelerate the effective date of the regulations—(i) Election to apply the single-entity approach

retroactively. A consolidated group

may elect to begin to apply paragraphs

(d)(1) and (3), (e)(5)(i), and (f)(3)(i) of

this section to all transactions entered

into in any taxable year (the election

year) beginning prior to March 8, 1996.

This election must be made in the

manner, and at the time, prescribed by

the Commissioner. A group may make

the election only if the election year,

and each subsequent taxable year, are

still open for assessment under section

6501 on July 1, 1996 (or such earlier

date as the Commissioner may allow).

The election applies to all transactions

entered into in the election year and in

all subsequent consolidated return years

until the date, if any, as of which the

group makes a separate-entity election

under paragraph (d)(2) of this section.

The rules of paragraph (g)(6) of this

section apply to all transactions that

were entered into before March 8,

1996, in taxable years subject to an

election under this paragraph (g)(5)(i).

The election may be revoked only with

the consent of the Commissioner.

(ii) Ability to apply the separateentity approach retroactively. Notwithstanding paragraph (g)(4) of this section, the separate-entity election

described in paragraph (d)(2) of this

section may be made for any taxable

year beginning on or after July 12,

1995. If that election is made for a

taxable year beginning before March 8,

1996, then paragraphs (d)(2) and (3),

(e)(5)(ii), and (f)(3)(ii) of this section

apply to all transactions entered into on

or after the beginning of that taxable

year and while the election is in effect,

and the rules of paragraph (g)(6) of this

section (other than paragraph (g)(6)(i))

apply to all transactions that were

entered into on or after the first day of

the first year for which the election is

made and before March 8, 1996.

(6) Transitional identification rules.

To allow a consolidated group to conform to paragraphs (g)(5)(i) and (ii) of

this section, this paragraph (g)(6) nullifies certain hedge identifications and

permits a member of a consolidated

group to add certain hedge identifications. This paragraph (g)(6) applies

only to the extent provided in paragraph (g)(5) of this section.

(i) Intercompany transactions previously identified. Notwithstanding

paragraph (f)(1)(i) of this section, if,

for purposes of paragraph (e)(1) of this

section, a member identified as a

hedging transaction an intercompany

transaction (or a transaction that would

qualify as an intercompany transaction

under §1.1502–13(b)(1) if the taxable

year in which the transaction was

entered into were described in

§1.1502–13(l)), the character of the

gain on the intercompany transaction is

determined as if it had not been

identified as a hedging transaction. The

identification may, however, serve to

identify the hedged item under paragraph (e)(5)(i) of this section.

(ii) Additional identifications of

hedging transactions. A member of a

consolidated group must identify under

paragraph (e)(5) of this section a

transaction that—

(A) Was entered into before March

8, 1996,

(B) When entered into was not a

hedging transaction (as defined in

paragraph (b) of this section),

election under paragraph (g)(5)(i) or

(ii) of this section, is a hedging

transaction (as defined in paragraph (b)

of this section), and

(D) Remains in existence on March

8, 1996.

(iii) Additional identification of

hedged items. In the case of transactions described in paragraph (g)(6)(ii)

of this section, the hedging member

must identify under paragraph (e)(5) of

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this section the item, items, or aggregate risk being hedged.

(iv) Consistency requirement for

hedge identifications. In identifying

transactions as hedging transactions

under paragraph (g)(6)(ii) of this section, all of the members of the group

must treat similar or identical transactions consistently within the same year

and from year to year. If paragraph

(g)(6)(ii) of this section requires a

member to identify a transaction, and

the member fails to identify a transaction as a hedging transaction, but it or

another member of the group identifies

similar or identical hedging transactions

in the same or a subsequent year, then

for purposes of paragraphs (f)(2)(iii)

and (3) of this section, the member

entering into the transaction is treated

as having no reasonable grounds for

treating the transaction as other than a

hedging transaction.

(v) Extension of time for making

additional identifications. If an identification of a hedging transaction would

not be required but for the rules of

paragraph (g)(6)(ii) of this section, the

identification is timely for purposes of

paragraph (e)(1) of this section if made

before the close of business on May 8,

1996. If an identification of a hedged

item would not be required but for the

rules of paragraph (g)(6)(iii) of this

section, it is timely for purposes of

paragraph (e)(2) of this section if made

before the close of business on the later

of May 8, 1996, or the last day of the

period specified in paragraph (e)(2)(ii)

of this section.

CFR part or section

where identified

and described

Current OMB

control number

1.1221–2(d)(2)(iv) . . . . . . . . 1545–1480

1.1221–2(e)(5) . . . . . . . . . . . 1545–1480

1.1221–2(g)(5)(ii) . . . . . . . . 1545–1480

1.1221–2(g)(6)(ii) . . . . . . . . 1545–1480

1.1221–2(g)(6)(iii) . . . . . . . . 1545–1480

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved December 20, 1995.

Cynthia G. Beerbower,

Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on

January 5, 1996, 8:45 a.m., and published in

the issue of the Federal Register for January 8,

1996, 61 F.R. 517)

Section 7121.—Closing agreements

Par. 4. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 5. In §602.101, paragraph (c) is

amended by adding entries in numerical order to the table to read as

follows:

§602.101 OMB Control numbers.

EFFECTIVE DATE: January 8, 1996.

FOR FURTHER INFORMATION

CONTACT: Philip Bennet, (202) 622–

3926.

SUPPLEMENTARY INFORMATION:

Background

As part of the President’s Regulatory

Reinvention Initiative, the Treasury

Department and the IRS identified

obsolete regulations that relate to prior

law, provide elections for prior years,

or are otherwise outdated due to

changes in the underlying statutory

provisions.

Amendments to the Regulations

Accordingly, under the authority of

26 U.S.C. 7805, 26 CFR parts 1, 20,

23, 24, 25, 27, 33, 38, 301, and 602 are

amended as follows:

PART 1—INCOME TAXES

26 CFR 301.7121–1: Closing agreements.

What is the method by which a taxpayer

requests early referral of one or more unagreed

employment tax issues from the District to

Appeals? See Announcement 96–13, page 33.

Section 7805.—Rules and

Regulations

26 CFR 301.7805–1: Rules and regulations.

PART 602—OMB CONTROL

NUMBERS UNDER THE

PAPERWORK REDUCTION ACT

of the President’s Regulatory Reinvention Initiative.

T.D. 8655

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 20, 23, 24, 25,

27, 33, 38, 301, and 602

Removal of Final and Temporary

Regulations

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Removal of final and temporary regulations.

SUMMARY: This document removes

final and temporary regulations as part

Paragraph 1. Part 1 is amended as

follows:

1. The authority citation for part 1 is

amended by removing the entry for

§1.1303–1.

2. Section 1.32–1 is removed.

3. Section 1.103–12 is removed.

4. Section 1.110–1 is removed.

5. Section 1.114–1 is removed.

6. Section 1.115–1 is removed.

7. Section 1.116–1 is removed.

8. Section 1.116–2 is removed.

9–10. Section 1.367(a)–7T is

removed.

11. The undesignated center heading

preceding §1.383–1A is removed.

12. Section 1.383–1A is removed.

13. Section 1.383–2A is removed.

14–15. Section 1.383–3A is

removed.

16. Section 1.804–1 is removed.

17–18. Section 1.804–2 is removed.

19. Section 1.805–1 is removed.

20. Section 1.805–2 is removed.

21. Section 1.805–3 is removed.

22. Section 1.805–4 is removed.

23. Section 1.805–5 is removed.

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24. Section 1.805–6 is removed.

25–26. Section 1.805–7 is removed.

27. Section 1.805–8 is removed.

28. Section 1.820–1 is removed.

29. Section 1.820–2 is removed.

30. Section 1.820–3 is removed.

31. Section 1.824–1 is removed.

32. Section 1.824–2 is removed.

33. Section 1.824–3 is removed.

34. Section 1.907–0 is amended as

follows:

a. The introductory text is revised to

read as follows:

§1.907–0 Outline of regulation

provisions for section 907.

This section lists the paragraphs

contained in §§1.907(a)–0 through

1.907(f)–1.

43. Section 1.907(c)–3A is removed.

44. Section 1.907(d)–1A is removed.

45. Section 1.907(e)–1A is removed.

46. Section 1.907(f)–1A is removed.

47–48. Section 1.995–7 is removed.

49. The undesignated center heading

‘‘INCOME AVERAGING’’ preceding

§1.1301–0 is removed.

50. Section 1.1301–0 is removed.

51. Section 1.1301–1 is removed.

52. Section 1.1302–1 is removed.

53. Section 1.1302–2 is removed.

54. Section 1.1302–3 is removed.

55–56. Section 1.1303–1 is removed.

57. Section 1.1304–1 is removed.

58. Section 1.1304–2 is removed.

59. Section 1.1304–3 is removed.

60. Section 1.1304–4 is removed.

61. Section 1.1304–5 is removed.

62. Section 1.1304–6 is removed.

b. The undesignated center heading

preceding the entry for §1.907(a)–0 is

removed and the entry for §1.907(e)–1

is removed.

c. The undesignated center heading

preceding the entry for §1.907(a)–0A is

removed.

d. The entry for §1.907(a)–0A is

removed.

e. The entry for §1.907(a)–1A is

removed.

f. The entry for §1.907(b)–1A is

removed.

g. The entry for §1.907(b)–2A is

removed.

h. The entry for §1.907(c)–1A is

removed.

i. The entry for §1.907(c)–2A is

removed.

j. The entry for §1.907(c)–3A is

removed.

k. The entry for §1.907(d)–1A is

removed.

l. The entry for §1.907(e)–1A is

removed.

m. The entry for §1.907(f)–1A is

removed.

35. Section 1.907(e)–1 is removed.

36. The undesignated center heading

preceding §1.907(a)–0A is removed.

37. Section 1.907(a)–0A is removed.

38. Section 1.907(a)–1A is removed.

39. Section 1.907(b)–1A is removed.

40. Section 1.907(b)–2A is removed.

41. Section 1.907(c)–1A is removed.

42. Section 1.907(c)–2A is removed.

PART 20—ESTATE TAX;

ESTATES OF DECEDENTS

DYING AFTER AUGUST 16, 1954

1. Section 301.6676–1 is removed.

2. Section 301.7424–1 is removed.

PART 602—OMB CONTROL

NUMBERS UNDER THE

PAPERWORK REDUCTION ACT

Par. 10. In §602.101, paragraph (c) is

amended by removing the following

entries from the table:

§602.101 OMB Control numbers.

CFR part or section

where identified

and described

Current OMB

control number

1.820–2 . . . . . . . . . . . . . . . . 1545–0128

Par. 2. Section

removed.

20.2035–1

1.824–1 . . . . . . . . . . . . . . . . 1545–1027

1.824–3 . . . . . . . . . . . . . . . . 1545–1027

PART 23—[REMOVED]

Par. 3. Part 23 is removed.

1.1304–1 . . . . . . . . . . . . . . . 1545–0074

1.1304–3 . . . . . . . . . . . . . . . 1545–0074

1.1304–5 . . . . . . . . . . . . . . . 1545–0074

20.2035–1 . . . . . . . . . . . . . . 1545–0015

PART 24—[REMOVED]

Par. 4. Part 24 is removed.

PART 25—GIFT TAX; GIFTS

MADE AFTER DECEMBER 31,

1954

27.642–1 . . . . . . . . . . . . . . . 1545–0020

Par. 5. Section

removed.

25.2517–1

PART 27—[REMOVED]

Par. 6. Part 27 is removed.

38.6302–1 . . . . . . . . . . . . . . 1545–0257

PART 33—[REMOVED]

Par. 7. Part 33 is removed.

PART 38—[REMOVED]

Par. 8. Part 38 is removed.

PART 301—PROCEDURE AND

ADMINISTRATION

Par. 9. Part 301 is amended as

follows:

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved December 18, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on

January 5, 1996, 8:45 a.m., and published in

the issue of the Federal Register for January 8,

1996, 61 F.R. 515)

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Part III. Administrative, Procedural, and Miscellaneous

Notice 96–14

section 162(m) of the Internal Revenue

Code.

Disallowance of Deductions for

Employee Remuneration in Excess of

$1,000,000; Correction

Need for Correction

AGENCY: Internal Revenue Service,

Treasury.

As published, the final regulations

(TD 8650) contain errors that are

misleading and in need of clarification.

ACTION:

regulations.

Correction of Publication

Correction

final

SUMMARY: This document contains

corrections to final regulations (TD

8650) [1996–10 I.R.B. 5] which were

published in the Federal Register on

Wednesday, December 20, 1995 (60

FR 65534), and relates to the disallowance of deductions for employee

remuneration in excess of $1,000,000.

EFFECTIVE DATE: December 20,

1995.

FOR FURTHER INFORMATION

CONTACT: Robert Misner or Charles

T. Deliee at (202) 622-6060 (not a tollfree number).

SUPPLEMENTARY

INFORMATION:

Background

The final regulations that are the

subject of these corrections are under

Accordingly, the publication of the

final regulations (TD 8650), which was

the subject of FR Doc. 95-30869, is

corrected as follows:

§ 1.162–27 [Corrected]

1. On page 65538, column 1,

§ 1.162–27 (c)(3)(ii)(A), line 2, the

language ‘‘3121(a)(1) through section

3121(a)(5)(D)’’ is corrected to read

‘‘3121(a)(5)(A) through section

3121(a)(5)(D)’’.

2. On page 65543, column 2,

§ 1.162–27 (e)(4)(i), the last sentence

is corrected to read as follows:

(e) * * *

(4) * * * (i) * * * The material

terms include the employees eligible to

receive compensation; a description of

the business criteria on which the

performance goal is based; and either

the maximum amount of compensation

that could be paid to any employee or

the formula used to calculate the

amount of compensation to be paid to

the employee if the performance goal is

attained (except that, in the case of a

formula based, in whole or in part, on a

percentage of salary or base pay, the

maximum dollar amount of compensation that could be paid to the employee

must be disclosed).

3. On page 65544, column 3,

§ 1.162–27 (e)(5), second line from the

bottom of the paragraph, the language

‘‘to the increase in the stock of the’’ is

corrected to read ‘‘to the increase in

the value of the stock of the’’.

Cynthia E. Grigsby,

Chief, Regulations Unit,

Assistant Chief Counsel (Corporate).

(Filed by the Office of the Federal Register on

January 5, 1996, 8:45 a.m., and published in

the issue of the Federal Register for February

6, 1996, 61 F.R. 4349)

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Part IV. Items of General Interest

Notice of Proposed Rulemaking

FUTA Taxation of Amounts Under

Employee Benefit Plans

EE–55–95

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains

proposed regulations under section

3306(r)(2) of the Internal Revenue

Code, relating to when amounts deferred under or paid from certain

nonqualified deferred compensation

plans are taken into account as

‘‘wages’’ for purposes of the employment taxes imposed by the Federal

Unemployment Tax Act (FUTA). The

regulations provide guidance to taxpayers who must comply with section

3306(r)(2), which was added to the

Code by section 324 of the Social

Security Amendments of 1983.

DATES: Written comments and requests for a public hearing must be

received by April 24, 1996.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (EE–55–95), Room

5228, Internal Revenue Service, P.O.

Box 7604, Ben Franklin Station, Washington, DC 20044. In the alternative,

submissions may be hand delivered

between the hours of 8 a.m. and 5 p.m.

to CC:DOM:CORP:R (EE–55–95),

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW,

Washington, DC.

FOR FURTHER INFORMATION

CONTACT: David N. Pardys, (202)

622-4606 (not a toll-free number),

concerning the regulations, and Michael Slaughter, (202) 622-7190 (not a

toll-free number), concerning

submissions.

SUPPLEMENTARY INFORMATION:

Regulations (26 CFR part 31) under

section 3306(r)(2) of the Internal Revenue Code of 1986 (the ‘‘Code’’) relating to the employment tax treatment

of amounts deferred under or paid from

certain nonqualified compensation

plans. These amendments are proposed

to reflect the statutory changes made

by section 324 of the Social Security

Amendments of 1983 (the ‘‘1983

Amendments’’), which added section

3306(r)(2) to the Code, and section

2662(f)(2) of the Deficit Reduction Act

of 1984 (DEFRA), which amended section 324 of the 1983 Amendments.

Explanation of Provisions

These proposed regulations provide

guidance under section 3306(r)(2), relating to when amounts deferred under

or paid from certain nonqualified deferred compensation plans are taken

into account as wages for FUTA purposes. These rules are substantially

similar to the rules applicable to the

FICA (Federal Insurance Contributions

Act) tax treatment of such amounts

deferred under section 3121(v)(2).

Thus, these regulations cross-reference

the proposed regulations under section

3121(v)(2).

Special Analyses

It has been determined that this

notice of proposed rulemaking is not a

significant regulatory action as defined

in EO 12866. Therefore, a regulatory

assessment is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) and the Regulatory

Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and,

therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comment

on their impact on small business.

Comments and Requests for a Public

Hearing

Background

This document contains proposed

amendments to the Employment Tax

1996– 24 I.R.B.

Before these proposed regulations

are adopted as final regulations, consideration will be given to any written

comments (a signed original and eight

(8) copies) that are submitted timely to

the IRS. All comments will be available for public inspection and copying.

A public hearing may be scheduled if

requested in writing by any person that

timely submits written comments. If a

public hearing is scheduled, notice of

the date, time, and place for the

hearing will be published in the Federal

Drafting Information

The principal author of these regulations is David N. Pardys, Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations),

IRS. However, other personnel from

the IRS and Treasury Department

participated in their development.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 31 is

proposed to be amended as follows:

PART 31—EMPLOYMENT TAXES

AND COLLECTION OF INCOME

TAX AT SOURCE

Paragraph 1. The authority citation

for part 31 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 31.3306(r)(2)–1 is

added to read as follows:

§ 31.3306(r)(2)–1 Treatment of

amounts deferred under certain

nonqualified deferred compensation

plans.

(a) In general. Section 3306(r)(2)

provides a special timing rule for the

tax imposed by section 3301 with respect to any amount deferred under a

nonqualified deferred compensation

plan. Section 31.3121(v)(2)–11 contains

rules relating to when amounts deferred

under certain nonqualified deferred

compensation plans are wages for

purposes of sections 3121(v)(2), 3101,

1 This section appears as a notice of proposed

rulemaking published elsewhere in this issue of

the Federal Register.

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and 3111. Those rules also apply to the

special timing rule of section

3306(r)(2). For purposes of applying

those rules to section 3306(r)(2) and

this paragraph (a), references in those

rules to the Federal Insurance Contributions Act are considered references to

the Federal Unemployment Tax Act (26

U.S.C. 3301 et seq.), references to

FICA are considered references to

FUTA, references to section 3101 or

3111 are considered references to section 3301, references to section

3121(v)(2) are considered references to

section 3306(r)(2), references to section

3121(a), 3121(a)(5), and 3121(a)(13)

are considered references to sections

3306(b), 3306(b)(5), and 3306(b)(10),

respectively, and references to

§31.3121(a)–2(a) are considered references to §31.3301–4.

(b) Effective dates and transition

rules. Except as otherwise provided,

section 3306(r)(2) applies to remuneration paid after December 31, 1984.

Section 31.3121(v)(2)–2 2 contains

effective date rules for certain remuneration paid after December 31,

1983, for purposes of section

3121(v)(2). Those rules also apply to

section 3306(r)(2). For purposes of

applying those rules to section

3306(r)(2) and this paragraph (b),

references to section 3121(v)(2) are

considered references to section

3306(r)(2), and references to section

3121(a)(2), 3121(a)(3), or 3121(a)(13)

are considered references to section

3306(b)(2), 3306(b)(3), or 3306(b)(10),

respectively. In addition, references to

section 324(d)(1) of the Social Security

Amendments of 1983 are considered

references to section 324(d)(2) of the

Social Security Amendments of 1983,

and references to §31.3121(v)(2)–1 are

considered references to paragraph (a)

of this section. In addition, the rules of

§31.3121(v)(2)–2 shall apply to this

paragraph by—

(1) References to ‘‘December 31,

1983’’ are considered references to

‘‘December 31, 1984’’;

(2) References to ‘‘before 1984’’ are

considered references to ‘‘before

1985’’;

(3) References to ‘‘Federal Insurance Contributions Act’’ are considered

2 This

section appears as a notice of proposed

rulemaking published elsewhere in this issue of

the Federal Register.

references to ‘‘Federal Unemployment

Tax Act’’; and

(4) References to ‘‘FICA’’ are considered references to ‘‘FUTA’’.

chael Slaughter, (202) 622-7190 (not a

toll-free number), concerning submissions.

SUPPLEMENTARY INFORMATION:

Margaret Milner Richardson,

Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on

January 19, 1996, 12:52 p.m., and published in

the issue of the Federal Register for January

25, 1996, 61 F.R. 2214)

Notice of Proposed Rulemaking

FICA Taxation of Amounts Under

Employee Benefit Plans

EE–142–87

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains

proposed regulations under section

3121(v)(2) of the Internal Revenue

Code of 1986, relating to when

amounts deferred under or paid from

certain nonqualified deferred compensation plans are taken into account as

‘‘wages’’ for purposes of the employment taxes imposed by the Federal

Insurance Contributions Act (FICA).

The regulations provide guidance to

taxpayers who must comply with section 3121(v)(2), which was added to

the Code by section 324 of the Social

Security Amendments of 1983.

DATES: Written comments and requests for a public hearing must be

received by April 24, 1996.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (EE–142–87),

Room 5228, Internal Revenue Service,

P.O. Box 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand delivered between the hours of 8 a.m. and 5

p.m. to: CC:DOM:CORP:R (EE–142–

87), Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue,

NW, Washington, DC.

FOR FURTHER INFORMATION

CONTACT: David N. Pardys, (202)

622-4606 (not a toll-free number),

concerning the regulations, and Mi-

Background

This document contains proposed

amendments to the Employment Tax

Regulations (26 CFR part 31) under

section 3121(v)(2) of the Internal Revenue Code of 1986 (the ‘‘Code’’) relating

to the employment tax treatment of

amounts deferred under or paid from

certain nonqualified deferred compensation plans. These amendments are proposed to reflect the statutory changes

made by section 324 of the Social

Security Amendments of 1983 (the

‘‘1983 Amendments’’), which added

section 3121(v)(2) to the Code, and section 2662(f)(2) of the Deficit Reduction

Act of 1984 (DEFRA), which amended

section 324 of the 1983 Amendments.

Explanation of Provisions

Sections 3101 and 3111 of the Code

impose FICA tax on employees and

employers, respectively. FICA tax consists of the Old-Age, Survivors, and

Disability Insurance (OASDI) tax and

the Hospital Insurance (HI) tax, and

generally is computed as a percentage

of wages (as defined in section

3121(a)) with respect to employment.

Subject to specific exceptions, section

3121(a) defines ‘‘wages’’ as all remuneration for employment. Existing

regulations (§31.3121(a)–2(a)) provide

that FICA tax is imposed at the time

the remuneration is actually or constructively paid.

Prior to the 1983 Amendments,

benefits under a nonqualified deferred

compensation plan generally were

wages subject to FICA tax at the time

they were actually or constructively

paid, unless certain retirement-related

exclusions applied. These exceptions

(former section 3121(a)(2)(A), (a)(3),

and (a)(13)(A)(iii)) were repealed by

the 1983 Amendments. Thus, under the

1983 Amendments, which generally

apply to remuneration paid after December 31, 1983, ‘‘retirement’’ payments are no longer excluded from

wages. Instead, the 1983 Amendments

added section 3121(v)(2), which provides a special timing rule for wages

(within the meaning of section 3121(a))

that constitute an amount deferred

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under a nonqualified deferred compensation plan.1

Under section 3121(v)(2)(A), any

‘‘amount deferred’’ under a nonqualified deferred compensation plan

must be taken into account as wages

for FICA purposes as of the later of (1)

when the services are performed, or (2)

when there is no substantial risk of

forfeiture of the rights to such amount.

This special timing rule may result in

imposition of FICA tax before the

benefit payments under the plan begin,

thus accelerating the imposition of

FICA tax on benefits under a nonqualified deferred compensation plan.

Section 3121(v)(2)(B) provides a

special exclusion (the ‘‘nonduplication

rule’’) that prevents double taxation.

Once an amount deferred under a nonqualified deferred compensation plan is

‘‘taken into account’’ as wages under

the special timing rule, the nonduplication rule provides that neither that

amount nor the ‘‘income attributable to

that amount’’ is again treated as FICA

wages. Thus, benefit payments under a

nonqualified deferred compensation

plan are not subject to FICA tax when

actually or constructively paid (i.e.,

under the general timing rule for wage

inclusion) if the benefit payments consist of amounts deferred under the plan

that were previously taken into account

as FICA wages under the special timing rule plus the attributable income.

Conversely, benefits under a nonqualified plan are subject to FICA tax

when actually or constructively paid to

the extent the benefits relate to an

amount deferred that was not previously taken into account under the

special timing rule.

Section 3121(a)(1) imposes a dollar

limit on the annual amount of wages

that is subject to the OASDI portion of

FICA tax. Section 13207 of the Omnibus Budget Reconciliation Act of

1993 repealed the dollar limit on

annual wages subject to the HI portion

of FICA tax, effective for 1994 and

later years.

1 The 1983 Amendments did not amend the

definition of net earnings from self-employment

under section 1402(a) of the Code or the timing

of the tax on self-employment income under

section 1401 of the Code. Accordingly, the

special timing rule under section 3121(v)(2) does

not apply to nonqualified deferred compensation

that constitutes net earnings from selfemployment.

1996– 24 I.R.B.

Overview of Regulations

In contrast to most FICA wages,

nonqualified deferred compensation is

subject to FICA tax not when paid, but

earlier—generally when the related

services are performed. (FICA taxation

is deferred if the compensation is

subject to a substantial risk of forfeiture.) A benefit that was subject to

FICA tax at this earlier date generally

is not subject to tax again when paid to

the participant. Applying these statutory rules often requires difficult valuations of future benefits.

Recognizing the practical administrative problems that can be encountered

by taxpayers in this area, the proposed

regulations are designed to be workable, to minimize complexity, and to

provide appropriate flexibility for taxpayers. For example, the regulations:

● Permit use of any reasonable

assumptions. For the purpose of calculating the present value of a benefit

earned in a given year (an ‘‘amount

deferred’’ under the statute), the regulations do not prescribe specific actuarial assumptions or methods that must

be used. Instead, the regulations simply

allow taxpayers to determine present

value using any reasonable actuarial

assumptions and methods.

● Establish a reasonably ascertainable rule. In some cases, uncertainties

pertaining to future benefits make it

especially difficult to determine the

present value of a benefit (for example,

where a benefit can fluctuate depending

on the varying amount of a qualified

plan benefit). In such cases, under the

regulations, the present value of the

benefit need not be included in FICA

wages (‘‘taken into account’’) until it

becomes reasonably ascertainable.

● Provide flexibility with respect to

withholding. The regulations ease the

administrative burdens of withholding

by permitting payors to delay the

inclusion of any deferred compensation

in wages until the end of the year. In

addition, where amounts deferred cannot be readily calculated by year-end,

the payor may either estimate the

amounts (and make later adjustments

without interest or penalties) or

postpone the inclusion in wages until

the first quarter of the following year.

● Provide reasonable, good faith

transition relief. The regulations

provide transition relief for actions

taken before the effective date of the

regulations based on a reasonable, good

faith interpretation of the statute.

Structure of the Regulations

The regulations generally consist of

three parts. The first part of the

regulations, paragraphs (a) and (b),

describes the special timing rule and

the related nonduplication rule of section 3121(v)(2), defines a nonqualified

deferred compensation plan, and specifies the types of benefits that are

subject to the special timing rule. The

second part of the regulations, paragraphs (c), (d), and (e), describes how

the special timing rule and the nonduplication rule operate. In the remainder of the regulations, paragraph

(f) provides withholding rules, paragraph (g) contains the regulatory effective date and the transition rules, and

§31.3121(v)–2 sets forth the statutory

effective dates.

The most significant items included

in these regulations are discussed

below.

Definition of Nonqualified Deferred

Compensation Plan

In general. Section 3121(v)(2)(C) of

the Code defines a ‘‘nonqualified deferred compensation plan’’ as any plan

or arrangement established and maintained by an employer for one or more

of its employees that provides for the

deferral of compensation, other than a

plan described in section 3121(a)(5)

(such as qualified plans and certain

other plans and arrangements). The

regulations provide that a ‘‘nonqualified deferred compensation plan’’

is a plan that is ‘‘established’’ by an

employer for one or more of its

employees, and that provides for the

‘‘deferral of compensation.’’ A plan

may constitute a nonqualified deferred

compensation plan under section

3121(v)(2), regardless of whether it is

an employee benefit plan under section

3(3) of the Employee Retirement Income Security Act of 1974, as

amended (ERISA), whether deferrals

under the plan are made pursuant to the

employee’s election, or whether the

amounts deferred are treated as deferred for income tax purposes.

Requirement that the plan be established. The regulations provide that an

amount deferred may not be taken into

account as FICA wages before the plan

is established, and that a plan is

considered ‘‘established’’ on the latest

of the date on which the plan is

adopted, the date on which it is

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effective, or the date on which its

material terms are set forth in writing.

Transition relief is provided for unwritten plans that were adopted and effective before March 25, 1996. Such a

plan is treated as established with

respect to an employee as of the later

of the date on which it was adopted or

became effective, provided that it is set

forth in writing within six months after

publication of the final regulations.

Requirement that the plan provide

for the deferral of compensation. In

general, the regulations specify that a

plan provides for the ‘‘deferral of

compensation’’ only if an employee

has a legally binding right to compensation that has not been actually or

constructively received and that is

payable in a later year. However, the

regulations provide that there is no

‘‘deferral of compensation’’ merely

because compensation is paid after the

last day of a calendar year pursuant to

the employer’s customary payment

scheme for compensation. Thus, if one

week of an employer’s customary twoweek payroll period falls in one year

and the second week of the period falls

in the next year, the compensation paid

at the end of the two-week period on

account of the services rendered in the

first week is not considered deferred

compensation and is not subject to the

special timing rule.

The regulations also provide a rule

of administrative convenience for

‘‘short-term’’ deferrals. Under this rule,

an employer may choose to treat an

amount that is deferred from one

calendar year to a date that is no more

than a brief period of time after the end

of that calendar year as if it were

subject to the general timing rule (i.e.,

treated as FICA wages when actually

or constructively paid) instead of the

special timing rule.

Plans, arrangements, and benefits

that do not provide for the deferral of

compensation. Consistent with the legislative history relating to section

3121(v)(2), certain types of plans,

arrangements, and benefits are not

covered by the special timing rule of

section 3121(v)(2), even though they

may be viewed in other contexts as

providing for the deferral of

compensation.

The regulations provide that stock

options, stock appreciation rights (described in Revenue Ruling 80–300,

1980–2 C.B. 165), and certain other

stock-related rights do not provide for

the deferral of compensation for FICA

tax purposes, even though there may be

no amount recognized for income tax

purposes until after the calendar year of

grant. In contrast, the regulations specify that a ‘‘phantom’’ stock plan that

awards a right to a fixed payment equal

to the value of a specified number of

shares of employer stock may be

treated as providing benefits that result

from the deferral of compensation for

purposes of section 3121(v)(2). Such a

plan typically involves the employer’s

unfunded, unsecured promise to pay

compensation in the future that is

measured by the value of a specified

number of shares of stock on the date

of payment. A phantom stock plan is a

nonqualified deferred compensation

plan under which the earnings portion

of the future compensation is based on

the change in the value of the

employer’s stock, rather than, for example, an equity mutual fund or a

specified rate of interest.

The regulations provide that certain

welfare benefits, including vacation

benefits, sick leave, compensatory time,

disability pay, severance pay, and death

benefits, do not result from the deferral

of compensation for FICA purposes.

Neither section 3121(v) nor the legislative history relating to section 3121(v)

indicates that Congress intended to

modify the long-established FICA tax

treatment of such benefits.

Nothing in the regulations is intended to determine the amount or the

timing of an employer’s deduction for

contributions to any type of welfare

benefit plan, including a plan that

provides severance benefits. Similarly,

although the regulations include a

severance pay plan under a heading

titled ‘‘certain welfare benefits,’’ no

inference is intended that a severance

plan is treated as a welfare benefit plan

under any other section of the Code.

The regulations provide that certain

other payments are not subject to the

special timing rule of section

3121(v)(2). In describing the Senate

Finance Committee proposal on golden

parachutes, the Conference Report to

DEFRA states that ‘‘payments under

golden parachute contracts, like termination pay, are to be subject to FICA

taxes when paid.’’ (Emphasis added.)

Conf. Rpt. 98–861, p. 85. Consistent

with this legislative history, the regulations provide that excess golden parachute payments and window benefits

do not result from the deferral of

compensation and, thus, are not subject

to the special timing rule.

Similarly, certain benefits established

within 12 months prior to an employee’s termination of employment are

treated as termination pay that is not

subject to the special timing rule. This

provision is intended to ensure that

termination pay is subject to FICA tax

when it is paid, even where there is no

explicit agreement to terminate employment. The regulations provide that a

benefit established within 12 months

prior to an employee’s termination of

employment is treated as termination

pay only if the facts and circumstances

indicate that the benefit was provided

in contemplation of the employee’s

impending termination of employment.

Benefits established after termination

of employment also do not result from

the deferral of compensation. In addition, there is no deferral of compensation where the facts and circumstances

indicate that the compensation is paid

for current services.

Determination of the Amount

Deferred

The ‘‘amount deferred’’ under a

nonqualified deferred compensation

plan for a period is the amount that

must be taken into account as wages

for that period under the special timing

rule of section 3121(v)(2)(A). Under

the regulations, the manner in which

the amount deferred for a period is

determined depends upon whether the

nonqualified deferred compensation

plan is an account balance plan or a

nonaccount balance plan.

Account balance plans. The regulations provide that, if benefits for an

employee are provided under an account balance plan, the amount deferred equals the principal amount

credited to the employee’s account for

the period, increased or decreased by

any income attributable to that amount

through the date such amount is required to be taken into account as

FICA wages. For purposes of the

regulations, a nonqualified deferred

compensation plan is an ‘‘account

balance plan’’ only if, under the terms

of the plan, (1) principal amounts are

credited to an individual account for an

employee, (2) the income attributable

to the principal amounts is credited (or

debited) to the individual account, and

(3) the benefits payable to the

employee are based solely on the

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balance credited to the individual

account.

Nonaccount balance plans. If a

nonqualified deferred compensation

plan is not an account balance plan, the

regulations provide that the amount

deferred for a period equals the present

value of the additional future payments

to which the employee has obtained a

legally binding right during that period.

For purposes of determining present

value, the regulations give employers

the flexibility to use any reasonable

actuarial assumptions and methods.

‘‘Taken Into Account’’ Defined

An amount deferred is treated as

‘‘taken into account’’ when it is

included in computing the amount of

FICA wages, but only if any additional

FICA tax for the year (including any

interest and penalties due if the payment is late) that results from the

inclusion is actually paid before the

period of limitations is closed for the

year. For years before 1994, the

amount deferred is treated as taken into

account even if its inclusion does not

result in any additional FICA tax

liability. For example, if, in 1993, an

employee participating in a nonqualified deferred compensation plan

had other wages that were at least

equal to the applicable OASDI and HI

wage bases for 1993, the inclusion in

wages of an amount deferred would not

have resulted in any additional FICA

tax liability for that year. Nonetheless,

the amount deferred would have been

considered taken into account as wages

for purposes of section 3121(v)(2).

Nonduplication Rule

As noted above, under the nonduplication rule of section 3121(v)(2)(B), if an amount deferred is taken

into account as wages under the special

timing rule, neither the amount deferred nor the related income is included in FICA wages when benefits

attributable to that amount are paid.

If an amount deferred is not taken

into account as wages under the special

timing rule, then benefits attributable to

that amount are required to be included

as wages when actually or constructively paid in accordance with the

general timing rule. For this purpose, a

Form W–2 (Wage and Tax Statement)

for an earlier (post-1993) year showing

FICA wages in excess of taxable in-

1996– 24 I.R.B.

come for the year and an explanation

showing that the payment is attributable to the excess could, for example, be

used by a taxpayer to demonstrate that

the payment is attributable to an

amount deferred that was previously

taken into account as wages under the

special timing rule. If a payment is

attributable to an amount deferred only

a portion of which was previously

taken into account, the portion of the

payment that is excluded from wages

pursuant to the nonduplication rule and

the portion that is included in wages

under the general timing rule are

generally determined on a pro rata

basis.

Income Attributable to an Amount

Deferred

Account balance plans. In the case

of an account balance plan, the regulations define ‘‘income attributable to the

amount taken into account’’ as any increase or decrease in the amount

credited to an employee’s account that,

under the terms of the plan, is attributable to an amount previously taken

into account, but only if the income is

based on a rate of return that does not

exceed either (1) the actual rate of

return on a predetermined actual investment, or (2) if no predetermined actual

investment has been specified, a reasonable rate of interest. If the rate of

return credited under the plan is not

reasonable, the income attributable to

the amount taken into account is

limited to the mid-term applicable

federal rate (as defined in section

1274(d)) for the first day of the

calendar year (the ‘‘AFR’’). However,

in the case of a predetermined actual

investment, if the actual rate of return

on that investment is lower than the

AFR, the income attributable to the

amount taken into account is limited to

the that actual rate of return. Any

excess of the income credited under the

plan over the income determined using

the AFR (or the actual rate of return, if

applicable) is considered an additional

amount deferred in the year credited,

and is required to be taken into account

in that year under the special timing

rule.

Nonaccount balance plans. In the

case of a nonaccount balance plan, the

regulations define the ‘‘income attributable to the amount taken into account’’ as the increase, due solely to

the passage of time, in the present

value of any future payments to which

the employee has obtained a legally

binding right, determined using reasonable actuarial assumptions and

methods. Thus, if an amount deferred

for a period is determined using a

reasonable interest rate and other reasonable actuarial assumptions and

methods, and that amount is taken into

account when required under the special timing rule, none of the future

payments attributable to that amount

will be subject to FICA tax when paid.

If any actuarial assumption or

method is not reasonable, then the

income attributable to the amount taken

into account is limited to the income

that would result from the application

of the AFR and, if applicable, the

applicable mortality table under section

417(e) of the Code, both determined as

of January 1 of the calendar year in

which the amount was taken into

account. If the present value of the

future benefit payments (determined

using the AFR and the section 417(e)

mortality table) exceeds the amount

taken into account plus attributable

income (as limited by using those same

assumptions), a portion of each benefit

payment will be excluded from wages

under the nonduplication rule and a

portion will be included in wages under

the general timing rule.

Time Amounts Deferred Are Taken

Into Account

Under the special timing rule, an

amount deferred is required to be taken

into account as FICA wages as of the

later of when (1) the services are performed or (2) the right to the amount

deferred is no longer subject to a

substantial risk of forfeiture. However,

the regulations allow an amount deferred to be taken into account at a later

date if all or a portion of the amount

deferred is not ‘‘reasonably ascertainable’’ until that later date. In

addition, consistent with Notice 94–96,

1994–2 C.B. 564, the regulations provide that no amount deferred under a

nonqualified deferred compensation plan

may be taken into account as FICA

wages before the plan is established.

Services creating the right to an

amount deferred. The regulations

provide that services creating the right

to an amount deferred are considered

performed when, under the terms of the

plan and the relevant facts and circumstances, the employee has performed all

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of the services necessary to obtain a

legally binding right to the amount

deferred, disregarding any substantial

risk of forfeiture.

Substantial risk of forfeiture. In accordance with the legislative history

relating to section 3121(v)(2), the regulations define a substantial risk of forfeiture for purposes of the special timing

rule of section 3121(v)(2) in accordance

with the principles of section 83. Thus,

in general, whether or not a substantial

risk of forfeiture exists will depend on

the facts and circumstances. See §1.83–

3(c) of the regulations.

Amounts deferred that are not reasonably ascertainable. A number of

commentators have emphasized the

problems that would arise if certain

amounts deferred were required to be

taken into account while still highly

uncertain and subject to fluctuation.

For example, under a nonaccount balance plan, an amount deferred (and

taken into account as wages) for a year

might decrease, or even be eliminated,

in a later year on account of changes in

the limitations on contributions and

benefits imposed on qualified plans

under section 401(a)(17) or 415, the

amount of an employee’s future compensation, the date on which payments

commence, or the form of benefit

elected by an employee. (The possibility that benefits may decrease

because of these contingencies does

not, however, generally cause the benefits to be subject to a substantial risk of

forfeiture within the meaning of section

83 or, therefore, section 3121(v)(2).)

Because these types of contingencies

generally cannot be predicted with a

high degree of certainty for an individual employee, the regulations provide

that an amount deferred under a nonaccount balance plan is not required to be

taken into account as wages until the

earliest date on which the amount deferred is reasonably ascertainable (the

‘‘resolution date’’). An amount deferred

is ‘‘reasonably ascertainable’’ when

there are no actuarial or other assumptions needed to determine the

amount deferred, other than interest,

mortality, or cost-of-living assumptions.

Thus, for example, if assumptions

relating to qualified plan offset variables, future pay, or the time or form

of benefit payments are needed to determine the amount deferred at the time

the services are performed (or, if

applicable, when the benefit is no

longer subject to a substantial risk of

forfeiture), the employer may choose to

delay taking the amount deferred into

account until the only assumptions

needed to determine the amount deferred are those relating to interest,

mortality, and cost of living. An

employer may choose to use this rule

for all of an amount deferred, even if

only a portion of the amount deferred

is not reasonably ascertainable. For

example, if the only portion of an

amount deferred that is not reasonably

ascertainable is an early retirement

subsidy, no portion of the amount

deferred is required to be taken into

account until the contingency relating

to early retirement has been resolved.

On the resolution date, the amount

deferred and the related income must

be determined in accordance with the

rules that generally apply to determine

those amounts under a nonaccount

balance plan. The rules that generally

apply to determine whether an amount

deferred is actually taken into account

as wages, and the consequences if it is

not so taken into account, also apply.

An employer may choose to take an

amount into account on a date (the

‘‘early inclusion date’’) that precedes

the resolution date. However, if the

amount taken into account at the early

inclusion date (plus related income

through the resolution date) is less than

the resolution date amount, then the

employer must ‘‘true up’’ by taking the

balance of the resolution date amount

into account as of the resolution date.

If the amount taken into account at the

early inclusion date (plus related income) exceeds the resolution date

amount, the taxpayer may claim a refund or credit, in accordance with

sections 6402 and 6413, for any overpayment of FICA tax in open years.

Rule of administrative convenience.

The regulations provide that an employer may treat an amount deferred as

required to be taken into account on a

date that is later than, but within the

same calendar year as, the actual date

on which the amount deferred is otherwise required to be taken into account.

Thus, for example, if an employee

obtains a legally binding right to an

amount deferred mid-year, the employer

may take the amount deferred into

account on any later date within the

same year (e.g., December 31).

Withholding

For purposes of withholding and

depositing FICA tax, an amount de-

ferred under a nonqualified deferred

compensation plan generally is treated

as wages paid by the employer and

received by the employee at the time it

is taken into account under section

3121(v)(2) and these regulations. However, in certain situations, the employer

may be unable to readily calculate the

amount deferred for a year by December 31 of that year. The regulations

provide two alternative methods for

withholding and depositing FICA tax in

these situations.

Under the ‘‘estimated method,’’ an

employer may treat a reasonably estimated amount as wages paid on the last

day of the calendar year (the ‘‘first

year’’). If the employer underestimates

the amount deferred that should have

been taken into account and, therefore,

deposits less FICA tax than the amount

due, the employer may choose to treat

the shortfall as wages either in the first

year or in the first quarter of the next

year. If the employer treats the shortfall

as wages in the first year and the

shortfall was not included on the

employee’s Form W–2, the employer

must issue Form W–2c. In addition, the

employer must correct the information

on the Form 941 for the last quarter of

the first year. In such a case, the

shortfall will not be considered a late

deposit subject to penalty if it is

deposited by the employer’s first regular deposit date following the first

quarter of the next year. Conversely, if

the employer overestimates the amount

deferred that should have been taken

into account as wages on the last day

of the year, the employer may claim a

refund or credit in accordance with

sections 6402 and 6413.

Under the second alternative method,

the ‘‘lag method,’’ an employer may

calculate the end-of-year amount deferred on any date in the first quarter

of the next calendar year. The amount

deferred will be treated as wages on

that date, and the amount deferred that

would otherwise have been taken into

account on the last day of the year

must be increased by income through

the date on which the amount is taken

into account.

Effective Date of the Regulations

Proposed effective date. These regulations generally are proposed to be

effective for amounts deferred and benefits paid on or after January 1, 1997.

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Comments and Requests for a Public

Hearing

Before these proposed regulations

are adopted as final regulations, consideration will be given to any written

comments (a signed original and eight

(8) copies) that are submitted timely to

the IRS. All comments will be available for public inspection and copying.

A public hearing may be scheduled if

requested in writing by a person that

timely submits written comments. If a

public hearing is scheduled, notice of

the date, time, and place for the

hearing will be published in the Federal

Drafting Information

The principal author of these regulations is David N. Pardys, Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations),

IRS. However, other personnel from

the IRS and Treasury Department

participated in their development.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 31 is

proposed to be amended as follows:

PART 31—EMPLOYMENT TAXES

AND COLLECTION OF INCOME

TAX AT SOURCE

Paragraph 1. The authority citation

for part 31 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Sections 31.3121(v)(2)–1 and

31.3121(v)(2)–2 are added to read as

follows:

§ 31.3121(v)(2)–1 Treatment of

amounts deferred under certain

nonqualified deferred compensation

plans.

(a) Timing of wage inclusion—(1)

General timing rule for wages. Remuneration for employment that constitutes wages within the meaning of

section 3121(a) of the Internal Revenue

Code generally is taken into account

for purposes of the Federal Insurance

Contributions Act (FICA) taxes imposed under sections 3101 and 3111 of

the Internal Revenue Code at the time

the remuneration is actually or constructively paid. See §31.3121(a)–2(a).

(2) Special timing rule for an

amount deferred under a nonqualified

deferred compensation plan—(i) In

general. To the extent that remuneration deferred under a nonqualified

deferred compensation plan constitutes

wages within the meaning of section

3121(a), the remuneration is subject to

the special timing rule described in this

paragraph (a)(2). Remuneration is considered deferred under a nonqualified

deferred compensation plan within the

meaning of section 3121(v)(2) and this

section only if it is provided pursuant

to a plan described in paragraph (b) of

this section. The amount deferred under

a nonqualified deferred compensation

plan is determined under paragraph (c)

of this section.

(ii) Special timing rule. Except as

otherwise provided in this section, an

amount deferred under a nonqualified

deferred compensation plan is required

to be taken into account as wages for

FICA purposes as of the later of—

(A) The date on which the services

creating the right to that amount are

performed (within the meaning of

paragraph (e)(2) of this section); or

(B) The date on which the right to

that amount is no longer subject to a

substantial risk of forfeiture (within the

meaning of paragraph (e)(3) of this

section).

(iii) Inclusion in wages only once

(nonduplication rule). Once an amount

deferred under a nonqualified deferred

compensation plan is taken into account (within the meaning of paragraph

(d)(1) of this section), then neither the

amount taken into account nor the income attributable to the amount taken

into account (within the meaning of

paragraph (d)(2) of this section) is

treated as wages for FICA purposes at

any time thereafter.

(iv) Benefits that do not result from

a deferral of compensation. If a nonqualified deferred compensation plan

(within the meaning of paragraph (b)(1)

of this section) provides both a benefit

that results from the deferral of compensation (within the meaning of paragraph (b)(3) of this section) and a

benefit that does not result from the

deferral of compensation, the benefit

that does not result from the deferral of

compensation is not subject to the

special timing rule described in this

paragraph (a)(2).

(v) Remuneration that does not constitute wages. If remuneration deferred

under a nonqualified deferred compensation plan does not constitute wages

within the meaning of section 3121(a),

then that remuneration is not taken into

account as wages for FICA purposes

under either the general timing rule

described in paragraph (a)(1) of this

section or the special timing rule

described in this paragraph (a)(2). For

example, benefits under a death benefit

plan described in section 3121(a)(13)

of the Internal Revenue Code do not

constitute wages for FICA purposes.

Therefore, these benefits are not included as wages under the general

timing rule described in paragraph

(a)(1) of this section or the special

timing rule described in this paragraph

(a)(2), even if the death benefit plan

would otherwise be considered a nonqualified deferred compensation plan

within the meaning of paragraph (b)(1)

of this section.

(b) Nonqualified deferred compensation plan—(l) In general—(i) Defined.

For purposes of this section, the term

‘‘nonqualified deferred compensation

plan’’ means any plan or other arrangement that is established (within the

meaning of paragraph (b)(2) of this

section) by an employer for one or

more of its employees, and that

provides for the deferral of compensation (within the meaning of paragraph

(b)(3) of this section), other than a plan

described in section 3121(a)(5). A

nonqualified deferred compensation

plan may be adopted unilaterally by the

employer or may be negotiated between

or agreed to by the employer and one

or more employees or employee representatives. A plan may constitute a

nonqualified deferred compensation

plan under this section without regard

to whether the deferrals under the plan

are made pursuant to an election by the

employee or whether the amounts

deferred are treated as deferred compensation for income tax purposes (e.g.,

whether the amounts are subject to the

deduction rules of section 404). In

addition, a plan may constitute a

nonqualified deferred compensation

plan under this section whether or not

it is an employee benefit plan under

section 3(3) of the Employee Retirement Income Security Act of 1974, as

amended.

(ii) Plan includes plan or other arrangement. For purposes of this section, except where the context indicates

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otherwise, the term ‘‘plan’’ includes a

plan or other arrangement.

(2) Plan establishment—(i) Date

plan is established. For purposes of

this section, a plan is ‘‘established’’ on

the latest of the date on which it is

adopted, the date on which it is

effective, or the date on which the

material terms of the plan are set forth

in writing. For purposes of this section,

a plan also will be deemed to be set

forth in writing if it is set forth in any

other form that is approved by the

Commissioner. The material terms of

the plan include the amount (or the

method or formula for determining the

amount) of deferred compensation to

be provided under the plan and the

time when it may or will be provided.

(ii) Plan amendments. In the case of

an amendment that increases the

amount deferred under a nonqualified

deferred compensation plan, the plan is

not considered established with respect

to the additional amount deferred until

the plan, as amended, satisfies the

requirements of paragraph (b)(2)(i) of

this section.

(iii) Transition rule. For purposes of

this section, an unwritten plan that is

adopted and effective before March 25,

1996, is treated as established under

this section as of the later of the date

on which it was adopted or became

effective, provided that it is set forth in

writing not later than [Date that is six

months after the date of publication of

final regulations in the Federal

(3) Plan must provide for the deferral of compensation—(i) Deferral of

compensation defined. A plan provides

for the ‘‘deferral of compensation’’

with respect to an employee only if,

under the terms of the plan and the

relevant facts and circumstances, the

employee has a legally binding right

during a calendar year to compensation

that has not been actually or constructively received and that, pursuant

to the terms of the plan, is payable in a

later year. An employee does not have

a legally binding right to compensation

if that compensation may be unilaterally reduced or eliminated by the

employer. For this purpose, compensation is not considered subject to unilateral reduction or elimination merely

because it may be reduced or eliminated by operation of the objective

terms of the plan, such as the application of a provision creating a substantial risk of forfeiture (within the

1996– 24 I.R.B.

meaning of section 83). Similarly, an

employee does not fail to have a

legally binding right to compensation

merely because the amount of compensation is determined under a formula

that provides for benefits to be offset

by benefits provided under a plan that

is qualified under section 401(a) of the

Internal Revenue Code.

(ii) Compensation payable pursuant

to the employer’s customary payment

timing arrangement. There is no deferral of compensation (within the meaning of this paragraph (b)(3)) merely

because compensation is paid after the

last day of a calendar year pursuant to

the timing arrangement under which

the employer ordinarily compensates

employees for services performed during a payroll period described in

section 3401(b).

(iii) Short-term deferrals. If, under a

nonqualified deferred compensation

plan, there is a deferral of compensation (within the meaning of this paragraph (b)(3)) that causes an amount to

be deferred from a calendar year to a

date that is no more than a brief period

of time after the end of that calendar

year, then, at the employer’s option,

that amount may be treated as if it

were not subject to the special timing

rule described in paragraph (a)(2) of

this section. An employer may apply

this option only if the employer does

so for all employees covered by the

plan and all substantially similar nonqualified deferred compensation plans.

For purposes of this paragraph (b)(3)(iii), whether compensation is deferred

to a date that is not more than a ‘‘brief

period of time’’ after the end of a

calendar year is determined in accordance with §1.404(b)–1T, Q&A–2, of

this chapter.

(4) Plans, arrangements, and benefits that do not provide for the deferral

of compensation—(i) In general. Notwithstanding paragraph (b)(3)(i) of this

section, an amount or benefit described

in any of paragraphs (b)(4)(ii) through

(viii) of this section is not treated as

resulting from the deferral of compensation for purposes of section 3121(v)(2) and this section and, thus, is not

subject to the special timing rule of

paragraph (a)(2) of this section.

(ii) Stock options, stock appreciation

rights and other stock value rights.

Amounts received as a result of a stock

option, or as a result of a stock

appreciation right or other stock value

right, do not result from the deferral of

compensation for purposes of section

3121(v)(2). For purposes of this paragraph (b)(4)(ii), a ‘‘stock value right’’

is a right granted to an employee with

respect to one or more shares of

employer stock that, to the extent

exercised, entitles the employee to a

payment for each share of stock equal

to the excess, or a percentage of the

excess, of the value of a share of the

employer’s stock on the date of exercise over a specified price (greater

than zero). Thus, for example, the term

‘‘stock value right’’ does not include a

phantom stock or other arrangement

under which an employee is awarded

the right to receive a fixed payment

equal to the value of a specified

number of shares of employer stock.

(iii) Restricted property. If an

employee receives property from, or

pursuant to a plan maintained by, an

employer, there is no deferral of

compensation (within the meaning of

section 3121(v)(2)) merely because the

value of the property is not includible

in income (under section 83) in the

year of receipt by reason of the

property being nontransferable and subject to a substantial risk of forfeiture.

However, a plan under which an

employee obtains a legally binding

right to receive property (whether or

not the property is restricted property)

in the future may provide for the

deferral of compensation within the

meaning of paragraph (b)(3) of this

section and, accordingly, may constitute a nonqualified deferred compensation plan, even though benefits under

the plan are or may be paid in the form

of property.

(iv) Certain welfare benefits. Vacation benefits, sick leave, compensatory

time, disability pay, severance pay, and

death benefits do not result from the

deferral of compensation for purposes

of section 3121(v)(2), even if those

benefits constitute wages within the

meaning of section 3121(a). Benefits

provided under a severance pay plan

that is not an employee pension benefit

plan pursuant to 29 CFR 2510.3–2(b)

are considered ‘‘severance pay’’ for

purposes of this paragraph (b)(4)(iv). If

a plan is an employee pension benefit

plan pursuant to 29 CFR 2510.3–2(b),

then whether benefits payable upon an

employee’s termination of employment

are considered severance pay for purposes of this paragraph (b)(4)(iv) depends upon the relevant facts and

circumstances. Notwithstanding the

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preceding sentence, a plan that is an

employee pension benefit plan pursuant

to 29 CFR 2510.3–2(b) is in all cases

considered to provide severance pay for

purposes of this paragraph (b)(4)(iv) if

benefits payable under the plan upon

an employee’s termination of employment are payable only if that termination is involuntary.

(v) Certain benefits provided in connection with impending termination—

(A) In general. Benefits provided in

connection with impending termination

of employment under paragraph (b)(4)(v)(B) or (b)(4)(v)(C) of this section do

not result from a deferral of compensation within the meaning of section

3121(v)(2).

(B) Window benefits—(1) In general. For purposes of this paragraph

(b)(4)(v), a window benefit is provided

in connection with impending termination of employment. For this purpose, a

‘‘window benefit’’ is an early retirement benefit, retirement-type subsidy,

social security supplement, or other

form of benefit made available by an

employer for a limited period of time

(no greater than one year) to employees

who terminate employment during that

period or to employees who terminate

employment during that period under

specified circumstances.

(2) Special rule for recurring window benefits. A benefit will not be

considered a window benefit if an

employer establishes a pattern of repeatedly providing for similar benefits

in similar situations for substantially

consecutive, limited periods of time.

Whether the recurrence of these benefits constitutes a pattern of amendments

is determined based on the facts and

circumstances. Although no one factor

is determinative, relevant factors include whether the benefits are on

account of a specific business event or

condition, the degree to which the

benefits relate to the event or condition, and whether the event or condition is temporary or discrete or is a

permanent aspect of the employer’s

business.

establishment of a benefit or plan. For

purposes of this paragraph (b)(4)(v), a

benefit is provided in connection with

impending termination of employment,

without regard to whether it constitutes

a window benefit, if—

(1) An employee’s termination of

employment occurs within 12 months

of the establishment of the benefit or

the plan providing the benefit; and

(2) The facts and circumstances indicate that the benefit or plan is

established in contemplation of the

employee’s impending termination of

employment.

(vi) Benefits established after termination of employment. Benefits established with respect to an employee

after the employee’s termination of

employment do not result from a

deferral of compensation within the

meaning of section 3121(v)(2).

(vii) Excess parachute payments. An

excess parachute payment (as defined

in section 280G(b)) under an agreement

entered into or renewed after June 14,

1984, in taxable years ending after such

date, does not result from the deferral

of compensation within the meaning of

section 3121(v)(2). For this purpose,

any contract entered into before June

15, 1984, that is amended after June

14, 1984 in any relevant significant

aspect, is treated as a contract entered

into after June 14, 1984.

(viii) Compensation for current services. A plan does not provide for the

deferral of compensation within the

meaning of section 3121(v)(2) if, based

on the relevant facts and circumstances,

the compensation is paid for current

services.

(5) Examples. This paragraph (b)

may be illustrated by the following

examples:

Example 1. (i) In December of 1997,

Employer M tells Employee A that, if specified

goals are satisfied for 1998, Employee A will

receive a bonus on July 1, 1999 equal to a

specified percentage of 1998 compensation.

Because Employee A meets the specified goals,

Employer M pays the bonus to Employee A on

July 1, 1999, consistent with its oral

commitment.

(ii) This arrangement is not a nonqualified

deferred compensation plan under this section

because its terms were not set forth in writing

and, therefore, it was not established in accordance with paragraph (b)(2) of this section.

Example 2. (i) Employer N establishes a

compensation arrangement for Employee B in

1997. Before the beginning of 1998, Employee B

and Employer N enter into a legally binding

salary reduction agreement to defer a specified

percentage of Employee B’s salary that would

otherwise be payable in 1998. The amounts

deferred remain a general asset of Employer N,

and are payable in 2008.

(ii) Employee B has a legally binding right

during 1998 to an amount of compensation that

has not been actually or constructively received

and that, pursuant to the terms of the arrangement, is payable in a later year. Therefore, the

arrangement provides for the deferral of

compensation.

Example 3. (i) Employer O establishes a

nonqualified deferred compensation plan (within

the meaning of paragraph (b)(1) of this section)

for Employee C in 1984. The plan is amended on

January 1, 1999 to increase benefits, and the

amendment provides that the increase in benefits

is on account of Employee C’s performance of

services for Employer O from 1985 through

1998.

(ii) The additional benefits that resulted from

the plan amendment cannot be taken into account

as amounts deferred for 1985 through 1998, even

though the plan was established before then.

Pursuant to paragraphs (b)(2)(ii) and (e)(1) of

this section, the additional benefits cannot be

taken into account before the latest of the date

on which the amendment is adopted, the date on

which the amendment is effective, or the date on

which the plan, as amended, is set forth in

writing.

Example 4. (i) In 1997, Employer P, a state or

local government, establishes a plan for certain

employees that provides for the deferral of

compensation and that is subject to section

457(a).

(ii) Paragraph (b)(1)(i) of this section provides

that ‘‘nonqualified deferred compensation plan’’

means any plan that is established by an

employer and that provides for the deferral of

compensation, other than a plan described in

section 3121(a)(5). Section 3121(a)(5) lists,

among other plans, an exempt governmental

deferred compensation plan as defined in section

3121(v)(3). Under section 3121(v)(3)(A), this

definition does not include any plan to which

section 457(a) applies. Thus, the plan established

by Employer P is not an exempt governmental

deferred compensation plan described in section

3121(v)(3) and, consequently,is not a plan

described in section 3121(a)(5). Accordingly, the

plan is a nonqualified deferred compensation

plan within the meaning of section 3121(v)(2)

and paragraph (b)(1) of this section.

(iii) However, the general timing rule of

paragraph (a)(1) of this section and the special

timing rule of paragraph (a)(2) of this section

apply only to remuneration for ‘‘employment’’

that constitutes wages. Under section 3121(b)(7),

certain service performed in the employ of a

state, or any political subdivision of a state is not

‘‘employment.’’ Thus, even though the plan is a

nonqualified deferred compensation plan, the

extent to which section 3121(v)(2) applies to a

participating employee will depend on whether

or not the service performed for Employer P is

excluded from the definition of employment

under section 3121(b)(7).

Example 5. (i) In 1997, Employer Q establishes a plan that provides for bonuses to be paid

to employees based on a specified formula that

takes into account the employees’ performance

for the year. The bonus is not actually calculated

until March 1 of the following year, and is paid

on March 15 of that following year.

(ii) The plan provides for the deferral of

compensation because the employees have a

legally binding right, as of the last day of a

calendar year, to an amount of compensation that

has not been actually or constructively received

and, pursuant to the terms of the plan, that

compensation is payable in a later year. However, because the bonuses under the plan are paid

within a brief period of time after the end of the

calendar year from which they are deferred,

Employer Q may choose, pursuant to paragraph

(b)(3)(iii) of this section, to treat the bonuses as

if they are not subject to the special timing rule

of paragraph (a)(2)(ii) of this section.

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Example 6. (i) Employer R establishes a plan

under which bonuses based on performance in

one year may be paid on February 1 of the

following year at the discretion of the board of

directors. The board of directors meets in

January of each year to determine the amount, if

any, of the bonuses to be paid based on

performance in the prior year.

(ii) Because an employee does not have a

legally binding right to a bonus until January of

the year in which the bonus is paid, any bonus

paid under the plan in that year will not be

considered deferred from the preceding calendar

year, and the plan will not be treated as providing for the deferral of compensation within

the meaning of paragraph (b)(3)(i) of this

section.

Example 7. (i) Employer S maintains a plan

for employees that provides nonqualified stock

options described in §1.83–7(a) of this chapter.

Under the plan, employees are granted in 1997

the option to acquire shares of employer stock at

the fair market value of the shares on the date of

grant ($50 per share). The options can be

exercised at any time from the date of grant

through 2006. The options do not have a readily

ascertainable fair market value for purposes of

section 83 at the date of grant, and shares issued

upon the exercise of the options are not subject

to a substantial risk of forfeiture within the

meaning of section 83. In 2002, when the fair

market value of a share of employer stock is

$100, Employee D exercises an option to acquire

1,000 shares.

(ii) Under paragraph (b)(4)(ii) of this section,

amounts received as a result of a stock option do

not result from the deferral of compensation for

purposes of section 3121(v)(2). Thus, the

$50,000 spread between the amount paid for the

shares ($50,000) and the fair market value of the

shares on the date of exercise ($100,000) is taken

into account as wages for FICA purposes in the

year of exercise.

(iii) If the options had been granted at $45 per

share, $5 per share below the fair market value

on date of grant, the $55,000 spread between the

amount paid for the shares ($45,000) and the fair

market value of the shares on the date of

exercise ($100,000) would similarly be taken

into account as wages for FICA purposes in the

year of exercise.

Example 8. (i) Employer T establishes a

‘‘phantom stock’’ plan for certain employees.

Under the plan, an employee is credited on the

last day of each calendar year with a dollar

amount equal to the fair market value of 1,000

shares of employer stock. Upon termination of

employment for any reason, each employee is

entitled to receive the value, in cash or employer

stock, of the shares with which he or she has

been credited.

(ii) Because compensation to which the

employee has a legally binding right as of the

last day of one year is paid in a subsequent year,

the phantom stock plan provides for the deferral

of compensation. The phantom stock plan does

not provide stock value rights within the meaning of paragraph (b)(4)(ii) of this section because

it provides for awards equal in value to the full

fair market value of a specified number of shares

of Employer T stock, rather than the excess of

that fair market value over a specified price.

Example 9. (i) Employer U establishes a plan

which provides for payments solely upon an

employee’s dismissal from employment, death,

or disability. The amount of the payments to an

1996– 24 I.R.B.

employee is based on the length of continuous

active service with Employer U at the time of

dismissal, and is paid in monthly installments

over a period of three years.

(ii) Because benefits payable under the plan

upon termination of employment are payable

only upon an employee’s involuntary termination, the plan is a severance pay plan within the

meaning of paragraph (b)(4)(iv) of this section.

Thus, the benefits are not treated as resulting

from the deferral of compensation for purposes

of section 3121(v)(2).

Example 10. (i) On January 1, 1997, Employer

V establishes a plan that covers only Employee

E, who owns a significant portion of the business

and who has 30 years of service as of that date.

The plan provides that, upon Employee E’s

termination of employment at any time, he will

receive $200,000 per year for each of the

immediately succeeding five years. Employee E

terminates employment on March 1, 1997.

(ii) Because Employee E terminates employment within 12 months of the establishment of

the plan and the facts and circumstances set forth

above indicate that the plan was established in

contemplation of impending termination of

employment, the plan is considered to be

established in connection with impending termination within the meaning of paragraph (b)(4)(v)

of this section. Therefore, the benefits provided

under the plan are not treated as resulting from

the deferral of compensation for purposes of

section 3121(v)(2).

Example 11. (i) Employer W establishes a plan

on January 1, 1998 to supplement the qualified

retirement benefits of recently hired 55-year old

Employee F who forfeited retirement benefits

with her former employer in order to accept

employment with Employer W. The plan

provides that Employee F will receive $50,000

per year for life beginning at age 65, regardless

of when she terminates employment. On April

15, 1998, Employee F unexpectedly terminates

employment.

(ii) The facts and circumstances indicate that

the plan was not established in contemplation of

impending termination. Thus, even though

Employee F terminated employment within 12

months of the establishment of the plan, the plan

is not considered to be established in connection

with impending termination within the meaning

of paragraph (b)(4)(v) of this section. Benefits

provided under the plan are treated as resulting

from the deferral of compensation for purposes

of section 3121(v)(2).

Example 12. (i) Employer X establishes a plan

to provide supplemental retirement benefits to a

group of management employees who are at

various stages of their careers. All employees

covered by the plan are subject to the same

benefit formula. Employee G is planning to (and

actually does) retire within six months of the

date on which the plan is established.

(ii) Even though Employee G terminated

employment within 12 months of the establishment of the plan, the plan is not considered to

have been established in connection with

Employee G’s impending termination within the

meaning of paragraph (b)(4)(v) of this section

because the facts and circumstances indicate

otherwise.

Example 13. (i) Employee H owns 100 percent

of Employer Y, a corporation that provides

consulting services. Substantially all of Employer

Y’s revenue is derived as a result of the services

performed by Employee H. In each of 1997,

1998, and 1999, Employer Y has gross receipts

of $180,000 and expenses (other than salary) of

$80,000. In each of 1997 and 1998, Employer Y

pays Employee H a salary of $100,000 for

services performed in each of those years. On

December 31, 1998, Employer Y establishes a

plan to pay Employee H $80,000 in 1999. The

plan recites that the payment is in recognition of

prior services. In 1999, Employer Y pays

Employee H a salary of $20,000 and the $80,000

due under the plan.

(ii) The facts and circumstances described

above indicate that the $80,000 paid pursuant to

the plan is based on services performed by

Employee H in 1999 and, thus, is paid for

current services within the meaning of paragraph

(b)(4)(viii) of this section. Accordingly, the plan

does not provide for the deferral of compensation

within the meaning of section 3121(v)(2), and

the $80,000 payment is included as wages in

1999 under the general timing rule of paragraph

(a)(1) of this section.

deferred—(1) Account balance plans—

(i) General rule. For purposes of this

section, if benefits for an employee are

provided under a nonqualified deferred

compensation plan that is an account

balance plan, the ‘‘amount deferred’’

for a period equals the principal

amount credited to the employee’s

account for the period, increased or

decreased by any income attributable to

the principal amount through the date

the principal amount is required to be

taken into account as wages under

paragraph (e) of this section. A nonqualified deferred compensation plan is

an account balance plan for purposes of

this section only if, under the terms of

the plan, a principal amount (or

amounts) is credited to an individual

account for an employee, the income

attributable to each principal amount is

credited (or debited) to the individual

account, and the benefits payable to the

employee are based solely on the

balance credited to the individual account. A plan does not fail to be an

account balance plan merely because,

under the terms of the plan, benefits

payable to an employee are based

solely on a specified percentage of an

account maintained for all (or a portion

of) plan participants, under which

principal amounts and income are

credited (or debited) to such account.

(ii) Income defined. For purposes of

this section, ‘‘income’’ means any

increase or decrease in the amount

credited to an employee’s account that

is attributable to amounts previously

credited to the employee’s account,

regardless of whether the plan denominates that increase or decrease as

income.

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(2) Nonaccount balance plans—(i)

General rule. For purposes of this

section, if benefits for an employee are

provided under a nonqualified deferred

compensation plan that is not an

account balance plan (a ‘‘nonaccount

balance plan’’), the ‘‘amount deferred’’

for a period equals the present value of

the additional future payment or payments to which the employee has obtained a legally binding right (as

described in paragraph (b)(3)(i) of this

section) under the plan during that

period.

(ii) Bifurcation permitted. An

employer may treat a portion of a

nonaccount balance plan as a separate

account balance plan if that portion

satisfies the requirements of paragraph

(c)(1) of this section and the amount

payable to employees under that portion is determined independently of the

amount payable under the other portion

of the plan.

(iii) Present value defined. For purposes of this section, ‘‘present value’’

means the value as of a specified date

of an amount or series of amounts due

thereafter, where each amount is multiplied by the probability that the condition or conditions on which payment of

the amount is contingent will be satisfied, and is discounted according to an

assumed rate of interest to reflect the

time value of money. For purposes of

this section, the present value must be

determined as of the date the amount

deferred is required to be taken into

account as wages under paragraph

(e)(1) of this section using actuarial

assumptions and methods that are

reasonable as of that date. For this

purpose, a discount for pre-retirement

mortality is permitted, but only to the

extent that benefits will be forfeited

upon death. In addition, the present

value cannot be discounted for the risk

that payments will not be made (or will

be reduced) because of the unfunded

status of the plan, the risk associated

with any deemed or actual investment

of amounts deferred under the plan, the

risk that the employer, the trustee, or

another party will be unwilling or

unable to pay, the possibility of future

plan amendments, the possibility of a

future change in the law, or similar

risks or contingencies.

(3) Separate determination for each

period. The amount deferred under this

paragraph (c) is determined separately

for each period for which there is an

amount deferred under the plan. In

addition, paragraphs (d) and (e) of this

section are applied separately with

respect to the amount deferred for each

such period. Thus, for example, the

fraction described in paragraph

(d)(1)(ii)(A) of this section and the

resolution date amount described in

paragraph (e)(4)(ii) of this section are

determined separately with respect to

each amount deferred.

(4) Examples. This paragraph (c)

may be illustrated by the following

examples:

Example 1. (i) Employer M establishes a

nonqualified deferred compensation plan for

Employee A. Under the plan, 10 percent of

annual compensation is credited on behalf of

Employee A on December 31 of each year. In

addition, a reasonable rate of interest is credited

quarterly on the balance credited to Employee A

as of the last day of the preceding quarter. All

amounts credited under the plan are 100 percent

vested, and the benefits payable to Employee A

are based solely on the balance credited to

Employee A’s account.

(ii) The plan is an account balance plan. Thus,

pursuant to paragraph (c)(1) of this section, the

amount deferred for a calendar year is equal to

10 percent of annual compensation.

Example 2. (i) Employer N establishes a

nonqualified deferred compensation plan for

Employee B. Under the plan, 2.5 percent of

annual compensation is credited quarterly on

behalf of Employee B. In addition, a reasonable

rate of interest is credited quarterly on the

balance credited to Employee B’s account as of

the last day of the preceding quarter. All

amounts credited under the plan are 100 percent

vested, and the benefits payable to Employee B

are based solely on the balance credited to

Employee B’s account. As permitted by paragraph (e)(5) of this section, any amount deferred

under the plan for the calendar year is taken into

account as wages on the last day of the year.

(ii) The plan is an account balance plan. Thus,

pursuant to paragraph (c)(1) of this section, the

amount deferred for a calendar year equals 10

percent of annual compensation (i.e., the sum of

the principal amounts credited to Employee B’s

account for the year) plus the interest credited

with respect to that 10 percent principal amount

through the last day of the calendar year. If

Employer N had not chosen to apply paragraph

(e)(5) of this section and, thus, had taken into

account 2.5 percent of compensation quarterly,

the interest credited with respect to those

quarterly amounts would not have been treated

as part of the amount deferred for the year.

Example 3. (i) Employer O establishes a

nonqualified deferred compensation plan for a

group of employees. Under the plan, each

participating employee has a fully vested right to

receive a life annuity, payable monthly beginning

at age 65, equal to the product of (a) 2 percent

for each year of service and (b) Employee C’s

highest average annual compensation for a threeyear period. The plan also provides that, if

Employee C dies before age 65, the present

value of the future payments will be paid to his

or her beneficiary. As permitted under paragraph

(e)(5) of this section, any amount deferred under

the plan for a calendar year is taken into account

as FICA wages as of the last day of the year. As

of December 31, 1998, Employee C has 25 years

of service and high three-year average compensation of $100,000 (the average for the years

1996-98). As of December 31, 1999, Employee

C is age 61, has 26 years of service, and has

high three-year average compensation of

$104,000. As of December 31, 2000, Employee

C is age 62, has 27 years of service, and has

high three-year average compensation of

$105,000. The assumptions that Employer O uses

to determine the amount deferred for 1999 (a 7

percent interest rate and, for the period after

commencement of benefits, the GAM 83 (male)

mortality table) and for 2000 (a 7.5 percent

interest rate and, for the period after commencement of benefits, the GAM 83 (male) mortality

table) are assumed, solely for purposes of this

example, to be reasonable actuarial assumptions.

(ii) As of December 31, 1998, Employee C

has a legally binding right to receive lifetime

payments of $50,000 (2 percent 3 25 years 3

$100,000) per year. As of December 31, 1999,

Employee C has a legally binding right to

receive lifetime payments of $54,080 (2 percent

3 26 years 3 $104,000) per year. Thus, during

1999, Employee C has earned a legally binding

right to additional lifetime payments of $4,080

($54,080 – $50,000) per year beginning at age

65. The amount deferred for 1999 is the present

value, as of December 31, 1999, of these

additional payments, which is $27,426 ($4,080 3

the present value factor for a deferred annuity

payable at age 65, using the specified actuarial

assumptions). Similarly, during 2000, Employee

C has earned a legally binding right to additional

lifetime payments of $2,620 (2 percent 3 27

years 3 $105,000 – $54,080) per year beginning

at age 65. The amount deferred for 2000 is the

present value, as of December 31, 2000, of these

additional payments, which is $18,149 ($2,620 3

the present value factor for a deferred annuity

payable at age 65, using the specified actuarial

assumptions).

(d) Amounts taken into account and

income attributable thereto—(1) Taken

into account—(i) Taken into account

defined. For purposes of this section,

an amount deferred under a nonqualified deferred compensation plan is

‘‘taken into account’’ as of the date it

is included in computing the amount of

‘‘wages’’ as defined in section 3121(a),

but only to the extent that any additional FICA tax that results from such

inclusion (including any interest and

penalties for late payment) is actually

paid no later than the expiration of the

applicable period of limitation for the

year in which the amount deferred was

required to be taken into account under

paragraph (e) of this section. Because

an amount deferred for a calendar year

is combined with the employee’s other

wages for the year for purposes of

computing FICA taxes with respect to

the employee for the year, if the

employee has other wages that equal or

exceed the wage base limitations for

the Old-Age, Survivors, and Disability

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Insurance (OASDI) or Hospital Insurance (HI) portions of FICA for the

year, no portion of the amount deferred

will actually result in additional

OASDI or HI tax, respectively. However, because there is no wage base

limitation for the HI portion of FICA

for years after 1993, the entire amount

deferred (in addition to all other wages)

is subject to the HI tax for the year

and, thus, will not be considered taken

into account for purposes of this

section unless the HI tax relating to the

amount deferred is actually paid. In

determining whether any additional

FICA tax relating to the amount

deferred is actually paid, any FICA tax

paid in a year is treated as paid with

respect to an amount deferred only

after FICA tax is paid on all other

wages for the year.

(ii) Amounts not taken into account—(A) Failure to take an amount

deferred into account under the special

timing rule. If an amount deferred for a

period (as determined under paragraph

account, then the nonduplication rule of

paragraph (a)(2)(iii) of this section does

not apply, and benefits attributable to

that amount deferred are included as

wages in accordance with the general

timing rule of paragraph (a)(1) of this

section. For example, if an amount

deferred is required to be taken into

account in a particular year under

paragraph (e) of this section, but the

employer fails to pay the additional

FICA tax on that amount, then the

amount deferred and the income attributable to that amount must be

included as wages when actually or

constructively paid.

(B) Failure to take a portion of an

amount deferred into account under the

special timing rule. If only a portion of

an amount deferred (as determined

under paragraph (c) of this section) is

taken into account, then a portion of

each benefit payment attributable to

that amount deferred is excluded from

wages pursuant to the nonduplication

rule of paragraph (a)(2)(iii) of this

section and the balance is subject to the

general timing rule of paragraph (a)(1)

of this section. The portion that is

excluded from wages is fixed when the

attributable benefits commence and is

determined by multiplying each such

payment by a fraction, the numerator of

which is the amount that was taken into

account (plus income attributable to

that amount) and denominator of which

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is the present value of the future

benefit payments attributable to the

amount deferred. If the amount deferred was determined using reasonable

actuarial assumptions, the present value

is determined using those assumptions.

(2) Income attributable to the

amount taken into account—(i) Account balance plans. For purposes of

the nonduplication rule of paragraph

(a)(2)(iii) of this section, in the case of

an account balance plan, the ‘‘income

attributable to the amount taken into

account’’ means any amount credited

on behalf of an employee under the

terms of the plan that is income (within

the meaning of paragraph (c)(1) of this

section) attributable to an amount previously taken into account (within the

meaning of paragraph (d)(1) of this

section), but only if the income is

based on a rate of return that does not

exceed either the actual rate of return

on a predetermined actual investment

(whether or not assets associated with

the plan or the employer are actually

invested therein) or, if no predetermined actual investment has been

specified for the period, a reasonable

rate of interest. For purposes of this

paragraph (d)(2)(i), an actual investment includes an investment identified

by reference to any stock index with

respect to which there are positions

traded on a national securities exchange

described in section 1256(g)(7)(A). The

actual rate of return includes any

decrease as well as any increase in the

value of the investment.

(ii) Nonaccount balance plans. For

purposes of the nonduplication rule of

paragraph (a)(2)(iii) of this section, in

the case of a nonaccount balance plan,

the ‘‘income attributable to the amount

taken into account’’ means the increase, due solely to the passage of

time, in the present value of the future

payments to which the employee has

obtained a legally binding right, the

present value of which constituted the

amount taken into account (determined

as of the date such amount was taken

into account), but only if the amount

taken into account was determined

using reasonable actuarial assumptions

and methods. Thus, each year there

will be an increase (determined using

the same interest rate used to determine

the amount taken into account) resulting from the shortening of the discount

period before the future payments are

made, plus, if applicable, an increase in

the present value resulting from the

employee’s survivorship during the current year. As a result, if the amount

deferred for a period is determined

using a reasonable interest rate and

other reasonable actuarial assumptions

and methods, and the amount is taken

into account when required under paragraph (e) of this section, then, under

the nonduplication rule of paragraph

(a)(2)(iii) of this section, none of the

future payments attributable to that

amount will be subject to FICA tax

when paid.

(iii) Unreasonable rates of return—

(A) Account balance plans. If, under an

account balance plan, the rate of

interest credited is not reasonable, as

determined by the Commissioner, or

the rate of return credited otherwise

exceeds the applicable limitation in

paragraph (d)(2)(i) of this section, then

the income attributable to the amount

taken into account is limited to the

income that would result from application of the mid-term applicable federal

rate (as defined pursuant to section

1274(d)) for January 1 of the calendar

year, compounded annually (the

‘‘AFR’’). However, in the case of a

predetermined actual investment, if the

actual rate of return on that investment

is lower than the AFR, then the income

attributable to the amount taken into

account is limited to the income that

would result from application of that

actual rate of return. Any excess of the

income credited under the plan over the

income determined using the AFR (or,

if applicable, the actual rate of return)

is considered an additional amount

deferred in the year the income is

credited, and is required to be taken

into account under the special timing

rule of paragraph (a)(2) of this section.

If the excess is not taken into account

as an additional amount deferred in the

year credited, then, pursuant to paragraph (d)(1)(ii) of this section, the

excess and any income attributable to

the excess are subject to the general

timing rule of paragraph (a)(1) of this

section.

(B) Nonaccount balance plans. If

any actuarial assumption or method

used to determine the amount taken

into account under a nonaccount balance plan is not reasonable, as determined by the Commissioner, then the

income attributable to the amount taken

into account is limited to the income

that would result from the application

of the AFR and, if applicable, the

applicable mortality table under section

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417(e)(3)(A)(ii)(I) (the ‘‘417(e) mortality table’’), both determined as of

the January 1 of the calendar year in

which the amount was taken into account. In addition, paragraph (d)(1)(ii)(B) of this section applies and, in

calculating the fraction described in

that paragraph, the numerator is the

amount taken into account plus income

(as limited under this paragraph

(d)(2)(iii)(B)), and the present value in

the denominator is determined using

the AFR, the 417(e) mortality table,

and reasonable assumptions as to cost

of living, each determined as of the

time the amount deferred was taken

into account.

(3) Examples. This paragraph (d)

may be illustrated by the following

examples:

Example 1. (i) In 1997, Employer M

establishes a nonqualified deferred compensation

plan for Employee A under which all benefits are

100 percent vested. In 1998, Employee A has

$200,000 of current annual compensation from

Employer M that is subject to FICA tax. The

amount deferred under the plan on behalf of

Employee A for 1998 is $20,000. Thus,

Employee A has total wages for FICA purposes

of $220,000. Because Employee A has other

wages that exceed the OASDI wage base for

1998, no additional OASDI tax is owed as a

result of the $20,000 amount deferred. Because

there is no wage base limitation for the HI

portion of FICA, additional HI tax liability

results from the $20,000 amount deferred.

However, Employer M fails to pay the additional

tax.

(ii) Under paragraph (d)(1)(i) of this section,

an amount deferred is considered taken into

account as wages for FICA purposes as of the

date it is included in computing FICA wages, but

only if any additional FICA tax liability that

results from inclusion of the amount deferred is

actually paid. Because the HI tax resulting from

the $20,000 amount deferred was not paid, that

amount deferred was not taken into account

within the meaning of paragraph (d)(1) of this

section. Thus, pursuant to paragraph (d)(1)(ii) of

this section, benefits attributable to the $20,000

amount deferred will be included as wages in

accordance with the general timing rule of

paragraph (a)(1) of this section.

Example 2. (i) The facts are the same as in

Example 1, except that Employer M takes all

actions necessary to correct its failure to pay the

additional tax before the applicable period of

limitation expires for 1998 (including payment of

any applicable interest and penalties).

(ii) Because the HI tax resulting from the

$20,000 amount deferred is paid, that amount

deferred is considered taken into account for

1998. Thus, in accordance with paragraph

(a)(2)(iii) of this section, neither the amount

deferred nor the income attributable to the

amount taken into account will be treated as

wages for FICA purposes at any time thereafter.

Example 3. (i) Employer N establishes a

nonqualified deferred compensation plan under

which all benefits are 100 percent vested. Under

the plan, an employee’s account is credited with

a contribution equal to 10 percent of salary on

December 31 of each year. The employee’s

account balance also is increased each December

31 by ‘‘interest’’ on the total amounts credited to

the executive’s account as of the preceding

December 31. The interest rate specified in the

plan results in an increase that is not based on

the return on a predetermined actual investment

within the meaning of paragraph (d)(2)(i) of this

section, and that is greater than the increase that

would result from application of a reasonable

rate of interest within the meaning of paragraph

(d)(2)(i) of this section.

(ii) Pursuant to paragraph (d)(2)(iii)(A) of this

section, the excess over the AFR is considered

an additional amount deferred in the year

credited and is required to be taken into account

in the year credited.

Example 4. (i) The facts are the same as in

Example 3, except that the annual increase is

based on Moody’s Average Corporate Bond

Yield.

(ii) Because this index reflects a reasonable

rate of interest, it is considered income attributable to the amount taken into account within the

meaning of paragraph (d)(2)(i) of this section.

Example 5. (i) The facts are the same as in

Example 3, except that the annual increase or

decrease is equal to the greater of the rate of

return on a specified aggressive growth mutual

fund or the rate of return on a specified incomeoriented mutual fund.

(ii) Because the increase or decrease is based

on the greater of the two investment returns and,

thus, is not based on the actual rate of return on

either specific investment, the increase is not

based on the return on a predetermined actual

investment within the meaning of paragraph

(d)(2)(i) of this section. Thus, if the resulting

increase exceeds the AFR, the excess is not

considered income attributable to the amount

taken into account within the meaning of

paragraph (d)(2)(i) of this section and, pursuant

to paragraph (d)(2)(iii)(A) of this section, is

considered an additional amount deferred.

Example 6. (i) The facts are the same as in

Example 5, except that the annual increase or

decrease with respect to 50 percent of the

employee’s account is equal to the rate of return

on a specified aggressive growth mutual fund

and the annual increase or decrease with respect

to the other 50 percent of the employee’s

account is equal to the increase or decrease in

the Standard & Poor’s 500 Index.

(ii) Because the increase or decrease attributable to any portion of the employee’s account is

based on the return on a predetermined actual

investment, the increase or decrease does not

exceed a reasonable rate of return within the

meaning of paragraph (d)(2)(i) of this section.

Thus, the entire increase or decrease is considered income attributable to the amount taken into

account within the meaning of paragraph

(d)(2)(i) of this section.

Example 7. (i) The facts are the same as in

Example 3, except that, pursuant to the terms of

the plan, before the beginning of each year, the

board of directors of Employer N designates a

specific investment on which the following

year’s annual increase or decrease will be based.

The board is authorized to switch investments

more frequently on a prospective basis. Before

the beginning of 1998, the board designates

Company A stock as the investment for 1998.

Before the beginning of 1999, the board designates Company B stock as the investment for

1999. At the end of 1999, the board determines

that the return on Company B stock was lower

than expected and changes its designation for

1999 to a stock that had a higher return during

1999.

(ii) The annual increase or decrease for 1998

is based on the return of a predetermined actual

investment. Although the annual increase or

decrease for 1999 is based on an actual

investment, the actual investment is not predetermined since it was designated after its return was

known. In addition, the increase or decrease for

1999 is greater than the actual rate of return on

the actual investment that was predetermined.

Thus, pursuant to paragraph (d)(2)(iii)(A) of this

section, the income attributable to the amount

taken into account is limited to the AFR or, if

lower, the actual rate of return on the predetermined actual investment that was designated for

1999.

Example 8. (i) Employer O establishes a

nonqualified deferred compensation plan for

Employee B. Under the plan, if Employee B

survives until payment is to be made, he has a

fully vested right to receive a lump sum payment

at age 65, equal to the product of (a) 10 percent

per year of service and (b) Employee B’s highest

average annual compensation for a three-year

period. As permitted under paragraph (e)(5) of

this section, any amount deferred under the plan

for the calendar year is taken into account as

wages as of the last day of the year. As of

December 31, 1998, Employee B has 25 years of

service and Employee B’s high three-year

average compensation is $100,000 (the average

for the years 1996-98). As of December 31,

1998, Employee B has a legally binding right to

receive a payment at age 65 of $250,000 (10

percent 3 25 years 3 $100,000). As of

December 31, 1999, Employee B is age 63, has

26 years of service, and has high three-year

average compensation of $104,000. As of December 31, 1999, Employer O has a legally

binding right to receive a payment at age 65 of

$270,400 (10 percent 3 26 years 3 $104,000).

Thus, during 1999, Employee B has earned a

legally binding right to an additional payment at

age 65 of $20,400 ($270,400 – $250,000). The

assumptions that Employer O uses to determine

the amount deferred for 1999 are a 7 percent

interest rate and the GAM 83 (male) mortality

table, which, solely for purposes of this example,

are assumed to be reasonable actuarial assumptions. The amount deferred for 1999 is the

present value, as of December 31, 1999, of the

$20,400 payment, which is $17,353. Employer O

takes this amount into account by including it in

Employee B’s FICA wages for 1999 and paying

the additional FICA tax.

(ii) Under paragraph (d)(2)(ii) of this section,

the income attributable to the amount that was

taken into account is the increase in the present

value of the future payment due solely to the

passage of time, because the amount deferred

was determined using reasonable actuarial assumptions and methods. As of the payment date

at age 65, the present value of the future

payments earned during 1999 is $20,400. The

entire difference between the $20,400 and the

$17,353 amount deferred ($3,047) is the increase

in the present value of the future payment due

solely to the passage of time, and thus falls

within the definition of ‘‘income attributable to

the amount taken into account.’’ Because the

amount deferred was taken into account, the

entire payment of $20,400 represents either an

amount deferred that was previously taken into

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account ($17,353) or income attributable to that

amount ($3,047). Accordingly, pursuant to the

nonduplication rule of paragraph (a)(2)(iii) of

this section, none of the payment is included in

wages.

Example 9. (i) The facts are the same as in

Example 8, except that, instead of providing a

lump sum equal to 10 percent of average

compensation per year of service, the plan

provides Employee B with a fully vested right to

receive a life annuity, payable monthly beginning

at age 65, equal to the product of (a) 2 percent

for each year of service and (b) Employee B’s

highest average annual compensation for a threeyear period. The plan also provides that, if

Employee B dies before age 65, the present

value of the future payments will be paid to his

or her beneficiary. As of December 31, 1998,

Employee B has a legally binding right to

receive lifetime payments of $50,000 (2 percent

3 25 years 3 $100,000) per year. As of

December 31, 1999, Employee B has a legally

binding right to receive lifetime payments of

$54,080 (2 percent 3 26 years 3 $104,000) per

year. Thus, during 1999, Employee B has earned

a legally binding right to additional lifetime

payments of $4,080 ($54,080 – $50,000) per year

beginning at age 65. The amount deferred for

1999 is the present value, as of December 31,

1999, of these additional payments, determined

using reasonable actuarial assumptions and

methods. Employer O takes this amount into

account by including it in Employee B’s FICA

wages for 1999 and paying the additional FICA

tax.

(ii) Under paragraph (d)(2)(ii) of this section,

the income attributable to the amount that was

taken into account is the increase in the present

value of the future payment due solely to the

passage of time, because the amount deferred

was determined using reasonable actuarial assumptions and methods. Because the amount

deferred was taken into account, the entire

benefit stream of $4,080 attributable to the

amount deferred in 1999 represents either an

amount deferred that was previously taken into

account or income attributable to that amount.

Accordingly, pursuant to the nonduplication rule

of paragraph (a)(2)(iii) of this section, none of

the payments are included in wages.

Example 10. (i) The facts are the same as in

Example 9, except that no amount is taken into

account for 1999 because Employer O fails to

pay the additional FICA tax.

(ii) Under paragraph (d)(1)(ii)(A) of this section, if an amount deferred for a period is not

taken into account, then the benefits attributable

to that amount deferred are included as wages in

accordance with the general timing rule of

paragraph (a)(1) of this section. In this case,

assuming that the amounts deferred in other

periods were taken into account, $4,080 of each

year’s total benefit payment will be included in

wages when paid.

Example 11. (i) Employer P establishes a

nonqualified deferred compensation plan on

January 1, 1998 under which all benefits are 100

percent vested. The plan provides that amounts

deferred will be credited annually with interest

beginning in 1999 at a rate that is greater than a

reasonable rate of interest. Pursuant to paragraph

(d)(2)(iii)(A) of this section, Employer P treats

the excess over the AFR as an additional amount

deferred for 1999 and in each year thereafter,

and takes the additional amount into account by

including it in FICA wages and paying the

additional FICA tax for the year.

1996– 24 I.R.B.

(ii) Consequently, in accordance with paragraph (a)(2)(iii) of this section, the excess over

the AFR and any income (at the AFR) attributable to the excess will not be treated as wages for

FICA purposes in any subsequent year.

Example 12. (i) The facts are the same as in

Example 11, except that Employer P does not

treat the excess over the AFR as an additional

amount deferred and, accordingly, does not take

the excess into account as FICA wages for 1999

and years thereafter.

(ii) Because this excess was not taken into

account as an additional amount deferred for

1999 and years thereafter, the excess and any

amount attributable to the excess are subject to

the general timing rule of paragraph (a)(1) of this

section and will be included as wages for FICA

purposes when actually or constructively paid.

Example 13. (i) The facts are the same as in

Example 8, except that, in determining the

amount deferred, Employer P uses a 15 percent

interest rate, which, solely for purposes of this

example, is assumed not to be a reasonable

interest rate. Employer P determines that the

amount deferred is the present value, as of

December 31, 1999, of this payment, which is

$15,023. Employer P includes this amount in

wages and pays any resulting FICA tax. Assume

that the AFR as of January 1, 1999, is 7 percent.

(ii) Under paragraph (d)(2)(iii)(B) of this

section, if any actuarial assumption or method is

not reasonable, then the income attributable to

the amount taken into account is limited to the

income that would result from application of the

AFR and, if applicable, the 417(e) mortality

table. Because the 15 percent interest rate is

unreasonable, the income attributable to the

amount taken into account is limited to the

income that would result from using a 7 percent

interest rate and, in this case, an increase for

survivorship using the 417(e) mortality table.

Under these assumptions, the income attributable

to the $15,023 amount deferred is $1,199 in the

year 2000 and $1,313 in the year 2001. Under

paragraph (d)(1)(ii) of this section, the sum of

these amounts ($17,535) is excluded from

Employee B’s wages pursuant to the nonduplication rule of paragraph (a)(2)(iii) of this section,

and the balance of the payment ($2,865) is

subject to the general timing rule of paragraph

(a)(1) of this section and, thus, is included in

Employee B’s wages when actually or constructively paid.

(iii) The same result can be reached by

multiplying the attributable benefits by a fraction, the numerator of which is the amount taken

into account, and the denominator of which is

the amount deferred that would have been taken

into account at the same time had the amount

deferred been calculated using the AFR, the

417(e) mortality table, and a reasonable assumption as to cost of living. All three assumptions

are determined as of January 1 of the calendar

year in which the amount was taken into

account. In this Example 13, the fraction would

be $15,023 divided by $17,478, which equals

.85954. The $20,400 payment is multiplied by

this fraction to determine the amount of the

payment that is excluded from wages pursuant to

the nonduplication rule of paragraph (a)(2)(iii) of

this section. Thus, $17,535 ($20,400 3 .85954)

is excluded from wages and the balance ($2,865)

is subject to FICA tax when actually or

constructively paid.

Example 14. (i) The facts are the same as

Example 9, except that Employer O calculates

the amount deferred for 1999 as $18,252 and

takes that amount into account by including this

amount in wages and paying any resulting FICA

tax. The assumptions that Employer O uses to

determine the amount deferred are a 15 percent

interest rate and, for the period after commencement of benefits, the GAM 83 (male) mortality

table. The 15 percent interest rate is assumed,

solely for purposes of this example, not to be a

reasonable actuarial assumption. Assume that the

AFR as of January 1, 1999, is 7 percent.

(ii) Under paragraph (d)(2)(iii)(B) of this

section, if any actuarial assumption or method

used is not reasonable, then the income attributable to the amount taken into account is limited to

the income that would result from application of

the AFR and, if applicable, the 417(e) mortality

table. Because the 15 percent interest rate is not

reasonable, the income attributable to the amount

taken into account is equal to the income that

would result from using a 7 percent interest rate

and the amount taken into account is treated as if

it represented a portion of the amount deferred

for purposes of applying paragraph (d)(1)(ii)(B)

of this section. Under these assumptions, the

income attributable to the $18,252 amount

deferred is $1,278 in the year 2000 and $1,367 in

the year 2001. Under paragraph (d)(1)(ii)(B) of

this section, the portion of each of benefit

payment attributable to the amount deferred that

is excluded from wages pursuant to the nonduplication rule of paragraph (a)(2)(iii) of this

section is determined at benefit commencement

by multiplying each benefit payment by a

fraction, the numerator of which is the amount

taken into account (plus income attributable to

that amount) and the denominator of which is the

present value of future benefit payments attributable to the amount deferred. Because the interest

rate assumption is not reasonable, not only is the

income limited to the application of the AFR, but

the present value in the denominator must be

determined using the AFR and (if applicable) the

417(e) mortality table. In this case, the present

value is $40,283 and thus the fraction is

$20,897/$40283, or .51875. Thus, $2,116 (.51875

3 $4,080) of each year’s benefit payment is

excluded from wages and the balance of each

year’s payment ($1,964) is subject to the general

timing rule of paragraph (a)(1) of this section

and is included in wages when actually or

constructively paid.

(iii) The same result can be reached by

multiplying the attributable benefits by a fraction

the numerator of which is the amount taken into

account, and the denominator of which is the

amount deferred that would have been taken into

account at the same time had the amount

deferred been calculated using the AFR, the

417(e) mortality table, and a reasonable assumption as to cost of living. All three assumptions

are determined as of January 1 of the calendar

year in which the amount was taken into

account. In this Example 14, the fraction would

be $18,252 divided by $35,165, which equals

.51875. The $4,080 annual payment is multiplied

by this fraction to determine the amount of the

payment that is excluded from wages pursuant to

the nonduplication rule of paragraph (a)(2)(iii) of

this section. Thus, $2,116 ($4,080 x .51875) is

excluded from wages and the balance ($1,964) is

subject to FICA tax when actually or constructively paid.

(e) Time amounts deferred are taken

into account—(1) In general. Except as

otherwise provided in this paragraph

SEQ 0029 JOB C07-007-005 PAGE-0027 PT 4 PGS 18REVISED 28MAY96 AT 12:03 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS

COMPOSITE COLOR

778/20049/28MAY96/C07-007

(e), an amount deferred under a nonqualified deferred compensation plan

must be taken into account as wages

for FICA purposes as of the later of the

date on which services creating the

right to the amount deferred are performed (within the meaning of paragraph (e)(2) of this section), or the date

on which the right to the amount

deferred is no longer subject to a

substantial risk of forfeiture (within the

meaning of paragraph (e)(3) of this

section). However, in no event may any

amount deferred under a nonqualified

deferred compensation plan be taken

into account as wages for FICA purposes prior to the establishment of the

plan providing for the amount deferred

(or, if later, the plan amendment

providing for the amount deferred).

Therefore, if an amount is deferred

pursuant to the terms of a legally

binding agreement that is not put in

writing until after the amount would

otherwise be taken into account under

this paragraph (e)(1), the amount deferred (including any attributable income) must be taken into account as

wages for FICA purp

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