Federal Insurance Contributions Act (FICA) Taxation of Amounts Under Employee Benefit Plans

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 31 and 602

[TD 8814]

RIN 1545-AT27

Federal Insurance Contributions Act (FICA) Taxation of Amounts

Under Employee Benefit Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section

3121(v)(2) of the Internal Revenue Code (Code) that provide guidance as

to when amounts deferred under or paid from a nonqualified deferred

compensation plan are taken into account as wages for purposes of the

employment taxes imposed by the Federal Insurance Contributions Act

(FICA). Section 3121(v)(2), relating to treatment of certain

nonqualified deferred compensation, was added to the Code by section

324 of the Social Security Amendments of 1983. These regulations

provide guidance to employers who maintain nonqualified deferred

compensation plans and to participants in those plans.

DATES: Effective Date: These regulations are effective January 29,

1999.

Applicability Date: These regulations are applicable on and after

January 1, 2000. In addition, these regulations provide certain

transition rules for amounts deferred and benefits paid before January

1, 2000, including allowing employers to use a reasonable, good faith

interpretation of section 3121(v)(2).

FOR FURTHER INFORMATION CONTACT: Janine Cook, Linda E. Alsalihi, or

Margaret A. Owens, (202) 622-6040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this final rule has been

reviewed and, pending receipt and evaluation of public comments,

approved by the Office of Management and Budget (OMB) under 44 U.S.C.

3507 and assigned control number 1545-1643.

The collection of information in this regulation is in

Sec. 31.3121(v)(2)-1(b)(2). This information is required to implement

Code section 3121(v). This information will be used to identify the

material terms of a plan. The collection of information is required to

obtain a benefit. The likely recordkeepers are business or other for-

profit institutions.

Comments on the collection of information should be sent 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, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.

Comments on the collection of information should be received by March

30, 1999.

Comments are specifically requested concerning:

Whether the collection of information is necessary for the proper

performance of the functions of the IRS, including whether the

information will have practical utility;

The accuracy of the estimated burden associated with the collection

of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the collection of information may

be minimized, including through the application of automated collection

techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of services to provide information.

The estimated total annual recordkeeping burden for

Sec. 31.3121(v)(2)-1(b)(2) is 12,500 hours. The annual estimated burden

per recordkeeper varies from 2 hours to 10 hours, depending on the

individual circumstances, with an estimated average of 5 hours. The

estimated number of recordkeepers is 2,500.

Estimates of the reporting burden in Sec. 31.3121(v)(2)-1(f) and

(g) are reflected in the burden estimates of Form 941, Employer's

Quarterly Federal Tax Return, Form 941c, Supporting Statement To

Correct Information, Form W-2, Wage and Tax Statement, and Form W-2c,

Corrected Wage and Tax Statement.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

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

These regulations amend the Employment Tax Regulations (26 CFR part

31) under section 3121(v)(2). Section 3121(v)(2) was added to the

Internal Revenue Code (Code) by section 324 of the Social Security

Amendments of 1983 (1983 Amendments). Section 2662(f)(2) of the Deficit

Reduction Act of 1984 (DEFRA) amended section 324 of the 1983

Amendments.

Notice 94-96 (1994-2 C.B. 564) provides that until final

regulations are issued, the IRS will not challenge an employer's

determination of FICA tax liability with respect to a nonqualified

deferred compensation plan for periods before the effective date of any

final regulations if the determination is based on a reasonable, good

faith interpretation of section 3121(v)(2). On January 25, 1996, a

notice of proposed rulemaking (EE-142-87) under section 3121(v)(2) was

published in the Federal Register (61 FR 2194), providing guidance

related to the Federal Insurance Contributions Act (FICA) tax treatment

of amounts deferred under or paid from certain nonqualified deferred

compensation plans. On December 24, 1997, a notice of proposed

rulemaking (REG-209484-87 and REG-209807-95) under section 3121(v)(2)

extending the proposed general effective date of the regulations to

January 1, 1998, was published in the Federal Register (62 FR 67304).

Comments regarding the 1996 proposed regulations were received from

the public, and on June 24, 1996, the IRS held a public hearing

concerning the proposed amendments. After consideration of the public

comments received and the statements made at the public hearing, the

proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

Sections 3101 and 3111 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.

Generally, FICA tax 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. Section 31.3121(a)-2(a) provides that FICA tax is imposed

at the time the remuneration is actually or constructively paid.

1983 Amendments

Prior to the 1983 Amendments, benefits under a nonqualified

deferred

[[Page 4543]]

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 exclusions (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 under a

nonqualified deferred compensation plan.\1\

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\1\ The 1983 Amendments did not amend the definition of net

earnings from self-employment under section 1402(a) or the timing of

the tax on self-employment income under section 1401. Accordingly,

the special timing rule under section 3121(v)(2) does not apply to

nonqualified deferred compensation that constitutes net earnings

from self-employment.

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Under section 3121(v)(2)(A), any amount deferred under a

nonqualified deferred compensation plan must be taken into account as

wages for FICA tax 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.

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 attributable income.

Conversely, benefits under a nonqualified deferred compensation 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.

Repeal of Wage Based Limitation

Section 3121(a)(1) imposes a dollar limit on the annual amount of

wages subject to the OASDI portion of FICA tax. Section 13207 of the

Omnibus Budget Reconciliation Act of 1993 repealed the dollar limit on

the annual amount of wages subject to the HI portion of FICA tax,

effective for 1994 and later years.

Application of these Regulations to Taxes Imposed by the Railroad

Retirement Tax Act

In accordance with the cross-reference in section 3231(e)(8)(B),

the provisions of section 3121(v)(2) and these final regulations also

apply for purposes of the taxes imposed by the Railroad Retirement Tax

Act under sections 3201 through 3231.

Overview of Final Regulations

In general, comments received on the proposed regulations were

favorable and, accordingly, the final regulations retain the general

structure and substance of the proposed regulations, including a wide

variety of examples illustrating the substance of the final

regulations. However, commentators made a number of specific

recommendations for modifications and clarifications of the

regulations. In response to these comments, the final regulations

incorporate the modifications and clarifications described below.

The proposed regulations provided that certain types of

benefits do not result from the deferral of compensation and,

accordingly, are not subject to the special timing rule under section

3121(v)(2). The final regulations generally retain these rules.

However, in response to comments, the final regulations allow certain

cost-of-living adjustments provided to former employees to be treated

as deferred compensation for purposes of section 3121(v)(2) and provide

transition relief for window programs that begin before the effective

date of the final regulations. The final regulations also clarify the

rules under which stock options, death benefits, disability benefits,

and severance pay are excluded from the special timing rule.

The final regulations retain the distinction between the

method of calculating the amount deferred (and the income on that

amount) for account balance plans and the method for nonaccount balance

plans, but provide additional guidance simplifying those calculations.

The final regulations provide that a plan that bases benefits on an

account balance but permits optional forms (such as annuities) can use

the simple methodology that applies to account balance plans if the

plan terms preclude a subsidized optional form. Also, a nonaccount

balance plan that provides multiple benefit distribution options or

commencement dates under plan terms that preclude subsidized optional

forms and commencement dates can determine the amount deferred by

assuming that a participant elects to receive the normal form of

payment (regardless of which option is actually elected).

The final regulations clarify the rules governing when

income under an account balance plan is excluded from FICA wages. The

final regulations also provide that, while the determination of whether

an account balance plan is using a reasonable interest rate generally

is made annually, a rate that is specified for a fixed period of up to

five years is treated as reasonable for that period if it was

reasonable when it was specified (even if it ceases to be reasonable

during the period for which it is specified).

The final regulations retain the structure of the rules in

the proposed regulations under which FICA tax payments are not required

to be made on amounts that are not reasonably ascertainable until

certain uncertainties related to benefit payments are resolved. Those

rules permit earlier inclusion with a true-up at the resolution date,

when those uncertainties are resolved. However, the final regulations

modify the calculation of the true-up to eliminate the risk that

additional amounts will have to be taken into account at the resolution

date because of changes in interest rates between the early inclusion

date and the resolution date.

The final regulations permit an employer to choose how the

amounts deferred under a plan over a series of years can be allocated

among those years when the plan formula does not do so by its terms

(for example, where the plan has a benefit formula that includes an

offset of another plan's benefit).

The final regulations retain the flexibility provided in

the proposed regulations permitting an employer to delay the date on

which amounts deferred are taken into account to a later date within

the year, and also broaden and simplify two options that provide

additional time to calculate the amount deferred. The first option

permits an employer to estimate the amount deferred and then adjust it

at any time within three months. Alternatively, FICA tax payment can be

postponed by treating the entire amount deferred as if it were deferred

on a date that is within

[[Page 4544]]

three months of the date the amount is otherwise required to be taken

into account, provided that the amount deferred is increased by

interest at the applicable federal rate \2\ (AFR) until it is included

in wages.

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\2\ The regulations define the applicable federal rate as the

mid-term applicable federal rate, as defined pursuant to section

1274(d), for January 1 of the calendar year, compounded annually.

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The final regulations include a number of special

transition rules that provide relief to employers that, prior to the

effective date of the regulations, followed a reasonable, good faith

interpretation of section 3121(v)(2). Under the final regulations,

amounts deferred for 1994 and 1995 can be taken into account, without

interest, as late as March 31, 2000. Further, the final regulations

reflect the transition rule in the proposed regulations under which

amounts deferred that would have been required or permitted to be taken

into account before 1994 are treated as having been correctly taken

into account before 1994.

Summary of Comments Received and Changes Made

a. Application of the Special Timing Rule

The special timing rule provided under section 3121(v)(2) is set

forth in paragraph (a) of the regulations. The special timing rule

imposes FICA tax on amounts deferred under nonqualified deferred

compensation plans at the later of the date when the services creating

the right to the amount deferred are performed and the date on which

the right to that amount is no longer subject to a substantial risk of

forfeiture. This date usually is earlier than when any benefit is paid.

Several commentators requested clarification as to whether the special

timing rule is elective and whether failure to comply with the special

timing rule may lead to the imposition of interest or penalties. The

special timing rule is not elective and, if an employer does not take

an amount deferred into account (including payment of any resulting

FICA tax) when required by section 3121(v)(2), interest and penalties

may be imposed. Moreover, to the extent that the amount deferred is not

taken into account in accordance with the special timing rule, the

nonduplication rule, under which amounts deferred that are properly

taken into account under the special timing rule are excluded from FICA

wages upon payment, does not apply.

b. Amounts or Benefits That Do Not Result From the Deferral of

Compensation

The definition of a nonqualified deferred compensation plan for

purposes of section 3121(v)(2) is set forth in paragraph (b) of the

regulations. A number of comments were received on the rules in the

proposed regulations for determining whether an amount or benefit

results from the deferral of compensation subject to the special timing

rule of section 3121(v)(2). The final regulations make several

clarifications and changes to reflect these comments. The regulations

clarify that the grant (as well as the exercise) of stock options,

stock appreciation rights, and other stock value rights generally is

not subject to section 3121(v)(2). Thus, FICA tax is not imposed at the

time of grant, but is generally imposed at the time of exercise. No

inference is intended as to whether or not these options and rights are

deferred compensation for any tax purposes other than section

3121(v)(2).

The final regulations retain the rule in the proposed regulations

that benefits established after termination of employment are not

subject to section 3121(v)(2). However, in response to comments, the

final regulations provide an exception under which certain payments to

which the employee obtains a legally binding right after termination of

employment that are in the nature of cost-of-living adjustments are

nonetheless subject to section 3121(v)(2).

The final regulations retain the rule in the proposed regulations

that window benefits do not result from the deferral of compensation.

However, the final regulations include a transition rule under which

window benefits can be treated as subject to section 3121(v)(2) if the

window program commences prior to January 1, 2000 (the general

effective date of the final regulations). Payments made pursuant to a

window program that qualifies for the transition rule are not subject

to FICA tax under the general timing rule at the time payment is made,

provided that the present value of the window benefits has been taken

into account under section 3121(v)(2) on a timely basis.

c. Account Balance Plans

Paragraph (c) of the regulations defines account balance plan and

provides that, for purposes of section 3121(v)(2), the amount deferred

under an account balance plan generally is based on the amount of

principal credited to the account. Commentators asked whether a plan

that permits optional forms of benefit can be treated as an account

balance plan. The final regulations provide that if the plan's terms

preclude subsidies of optional forms of benefit (for example, if, under

the terms of the plan at the time the amount is deferred, alternative

forms of payment will be actuarially equivalent to the account balance

based on a rate of interest that will be reasonable at the time the

optional form is elected), the plan does not fail to be an account

balance plan merely because of the availability of optional forms of

benefit.

d. Income and Reasonable Rate of Interest

Under paragraph (d) of the proposed regulations, if an account

balance plan credits income based on a reasonable rate of interest or a

rate of return that does not exceed the rate of return on a

predetermined actual investment specified under the plan, FICA tax

would not be imposed on that income. A number of commentators requested

clarification as to whether a rate of interest that was fixed for an

extended period could be reasonable for this purpose. The final

regulations clarify that the determination of whether interest credited

under an account balance plan is reasonable is generally made annually.

However, a rate that is specified for a fixed period of up to five

years and that was reasonable when it was specified is treated as

continuing to be reasonable (even if it subsequently ceases to be

reasonable during the period for which it is specified).

The final regulations also clarify what constitutes a predetermined

actual investment and provide rules for determining the amount deferred

in cases in which income is credited under a plan that uses neither a

predetermined actual investment nor a reasonable interest rate. In

these cases, the final regulations generally provide for the income

credited in excess of AFR to be treated as an additional amount

deferred. However, the final regulations provide that if the employer

takes into account as an additional amount deferred the income credited

to the extent it exceeds a reasonable rate of interest calculated by

the employer, the remaining income (which is no greater than a

reasonable rate of interest) is excluded from FICA wages.

Some commentators suggested that the employer's creditworthiness

should be permitted to be considered in determining whether the

interest rate credited under a plan of the employer is reasonable. The

final regulations, like the proposed regulations, permit the amount

deferred to be calculated after application of a discount to reflect

the

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time value of money and the risk that benefits will not be paid due to

death. However, no discount is permitted for the risk that the amount

deferred will not be paid by the employer. Permitting employers to

implicitly achieve the same result through the interest rate credited

under an account balance plan would be inconsistent with this

restriction. Accordingly, the final regulations do not permit the

employer's creditworthiness to be considered in determining whether the

interest rate credited under a plan of the employer is reasonable.

e. Treatment of Amounts Deferred That Are Not Reasonably Ascertainable

Paragraph (e) of the final regulations retains the rule in the

proposed regulations that the amount deferred need not be taken into

account until it is reasonably ascertainable. This rule addresses the

difficulty of determining the appropriate amount to be taken into

account for a plan that provides benefits that are not fixed until

certain future events occur, such as a nonaccount balance plan with

subsidized optional forms or a long-term incentive plan that depends on

subsequent corporate performance. The final regulations retain the rule

in the proposed regulations that allows optional inclusion of these

amounts at an earlier date with a true-up at the resolution date when

the amount deferred becomes reasonably ascertainable.

Under the proposed regulations, the early inclusion amount was to

be accumulated to the resolution date at an interest rate (and with a

mortality assumption, if appropriate) that was reasonable at the early

inclusion date. That accumulated amount was then compared to the

present value of payments using actuarial assumptions that were

reasonable at the resolution date. This methodology exposes the

employer to the risk that an additional amount could be required to be

taken into account at the resolution date solely as a result of changes

in interest rates between the early inclusion date and the resolution

date. In response to comments, this true-up methodology has been

modified.

Under the final regulations, in performing the true-up, the amount

taken into account at the early inclusion date is converted to an

actuarially equivalent benefit payment stream in the form, and with the

commencement date, in which benefits are actually paid. The conversion

is done using actuarial assumptions that were reasonable as of the

early inclusion date. The benefit payment stream thus derived is

compared to the benefits actually payable. To the extent the benefit

payment stream actually payable exceeds the benefit payment stream that

is actuarially equivalent to the amount taken into account at the early

inclusion date, the present value of the excess (determined using

actuarial assumptions that are reasonable as of the resolution date)

must be taken into account on the resolution date. If the benefit

payment stream that is actuarially equivalent to the amount taken into

account at the early inclusion date equals (or exceeds) the actual

benefit payment stream, no additional amount is required to be taken

into account at the resolution date, regardless of any changes in

interest rates between the early inclusion date and the resolution

date. This method--an annuity purchase model--eliminates the risk that

the employer will be required to take additional amounts into account

merely because of interest rate changes between the early inclusion

date and the resolution date.

In addition, the final regulations provide that an amount deferred

under certain nonaccount balance plans that permit optional forms of

benefit or alternative commencement dates will not fail to be

reasonably ascertainable merely because the form or commencement date

has not been selected. If the terms of a nonaccount balance plan, at

the time an amount is deferred, provide that the amount payable under

each optional form and commencement date will be equivalent using

actuarial assumptions that are reasonable at the resolution date

(generally, the time the optional form and commencement date are

selected) the amount deferred can be calculated based solely on the

normal form of payment commencing at normal commencement date

(regardless of which optional form or commencement date is ultimately

selected). For this purpose, the normal form of benefit commencing at

normal commencement date is the form and date of commencement under

which the payments due to an employee under the plan are expressed,

before adjustments for form or timing of commencement of payments.

The final regulations clarify how to allocate amounts deferred

among periods for purposes of the early inclusion rules, including a

rule requested by commentators concerning plan offsets. For example,

the final regulations provide a rule to determine how amounts deferred

are to be allocated among years in cases in which an employee obtains a

legally binding right in each of several years to receive payments from

a nonqualified deferred compensation plan that provides a specified

gross benefit for the years which is to be offset by the benefits

payable under a qualified plan. Under this rule, the amount deferred in

the first year may be treated as equal to the gross benefit for the

year, reduced by the offset applicable at the end of the first year

(even if the offset increases after the end of that year). The same

method applies to subsequent years, with adjustments for amounts

allocated to an earlier year.

The regulations also retain the rule of administrative convenience

that was in the proposed regulations under which the amount deferred

during a year can be treated as required to be taken into account at

any later date during the year, provided that income attributable to

the amount deferred through that date is included. Thus, in a

nonaccount balance plan this rule permits the present value of amounts

deferred throughout a year to be determined as of the end of the year

based on the employee's age and appropriate actuarial assumptions at

the end of the year.

f. Withholding Rules

For purposes of withholding and depositing FICA tax, paragraph (f)

of the final regulations provides that an amount deferred 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 given year by December 31 of that

year. The proposed regulations provided relief in these situations by

allowing employers to use either of two alternative methods, the

estimated method and the lag method, for withholding and depositing

FICA tax.

The final regulations provide broader relief by permitting these

methods to be used as of any date during the year and for the methods

to be available without regard to whether the amount deferred can be

readily calculated. Thus, the final regulations provide that, under the

estimated method, an employer may make a reasonable estimate of the

amount deferred as of the date the amount deferred is required to be

taken into account. 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 treat the shortfall as

wages either on the estimate date or on any date that is within three

months thereafter. If the

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employer overestimates the amount deferred that should have been taken

into account as wages on the estimate date, the employer may claim a

refund or credit in accordance with sections 6402, 6413, and 6511. If

the employer treats any shortfall as wages on the estimate date or

overestimates the amount deferred on the estimate date, the employer

must correct any previously-reported wage information.

Further, the final regulations provide that, under the second

alternative method, the lag method, an employer may treat the amount

deferred on any date as wages paid on any date that is no later than

three months following the date the amount deferred is required to be

taken into account. In addition, in response to comments, the final

regulations simplify use of the lag method by permitting the FICA tax

due to be calculated using a fixed rate of interest, not less than AFR,

rather than on the basis of income under the plan.

Effective Dates

These final regulations are applicable on and after January 1,

2000. However, the final regulations include certain special transition

provisions for periods before January 1, 2000.

For amounts deferred and benefits paid before the January 1, 2000

general effective date, an employer may rely on a reasonable, good

faith interpretation of section 3121(v)(2), taking into account Notice

94-96. The final regulations specifically provide that an employer will

be deemed to have determined FICA tax liability and satisfied FICA tax

withholding requirements in accordance with a reasonable, good faith

interpretation of section 3121(v)(2) if that liability is determined in

accordance with the final regulations and the withholding method and

timing comply with the final regulations. An employer will also be

deemed to have determined FICA tax liability and satisfied FICA tax

withholding requirements in accordance with a reasonable, good faith

interpretation of section 3121(v)(2) if that liability is determined in

accordance with the proposed regulations and the withholding method and

timing comply with the proposed regulations. Whether an employer has

made a reasonable, good faith interpretation of section 3121(v)(2) will

be determined based on the relevant facts and circumstances, including

consistency of treatment by the employer and the extent to which the

employer has resolved unclear issues in its favor.

The regulations address consistency in the treatment of stock

options, stock appreciation rights, or other stock value rights that

are exercised before the January 1, 2000 general effective date. Under

the final regulations, the grant of these options and rights cannot be

treated as subject to section 3121(v)(2) after December 31, 1999, and

FICA tax generally applies at exercise. For periods before January 1,

2000, an employer that treats the grant of such an option or right as

subject to section 3121(v)(2) has not acted in accordance with a

reasonable, good faith interpretation of section 3121(v)(2) if the

employer has not treated that grant and all earlier grants as subject

to section 3121(v)(2).

The final regulations include a transition rule for periods

3 before 1994 that applies if the employer acted in

accordance with a reasonable, good faith interpretation of section

3121(v)(2). Under this rule, an amount deferred that would be required

or permitted to be taken into account in any period that ends prior to

January 1, 1994, under the final regulations, is treated as if it had

been taken into account in accordance with the final

regulations.4 For example, in the case of an amount deferred

before 1994 that was not reasonably ascertainable, the employer is

treated as having taken the amount deferred into account at an early

inclusion date before 1994 using a method permitted in the final

regulations, including anticipation of the actual form in which the

benefit payments attributable to the amount deferred are paid and the

actual date of commencement. Thus, the employer is not required to pay

any additional FICA tax when the amount deferred becomes reasonably

ascertainable or when the benefit payments attributable to the amount

deferred are actually or constructively paid.

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\3\ For purposes of FICA tax, the period of limitations is

generally based on calendar quarters (whereas, for purposes of the

Federal Unemployment Tax Act (FUTA) tax, the period of limitations

is based on calendar years). See section 6501.

\4\ The proposed regulations (as amended in 1997) included a

similar rule applicable to periods that were closed as of January 1,

1998 (which generally would have been periods before 1994).

Commentators recommended that this rule apply even if the period is

kept open beyond the normal period of limitations, such as by

agreement with the IRS or by a claim for refund. In response to

those comments, the final regulations provide that this rule applies

to all periods prior to 1994 regardless of whether the period

remains open.

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The final regulations include a new transition rule for amounts

deferred that were required to be taken into account in 1994 or 1995.

Under the final regulations, an employer will be treated as taking the

amount deferred into account under the final regulations to the extent

the employer takes the amount into account by treating it as wages paid

by the employer and received by the employee as of any date prior to

April 1, 2000. The amount taken into account before April 1, 2000, is

not required to be increased by attributable income or interest.

These and the other transition provisions of the final regulations

are in addition to the interest-free adjustment procedures that are

available under section 6205 at any time before the period of

limitations has expired. Thus, for example, with respect to a FICA tax

return (Form 941) for a period before the effective date, an employer

may make an adjustment to take an amount deferred under a nonqualified

deferred compensation plan into account in accordance with the final

regulations if the period is still open.

Section 31.3121(v)(2)-2 of the final regulations provides special

rules relating to a March 24, 1983 agreement and certain agreements

adopted after March 24, 1983, and before January 1, 1984. The final

regulations also include certain clarifications to the transition rules

that have been made in response to comments on the proposed

regulations, including clarification of the effect of post-1983

amendments.

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 also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations, and because the notice of proposed

rulemaking was issued prior to March 29, 1996, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue Code, the notice of proposed

rulemaking preceding these regulations was submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on their impact on small business.

Drafting Information

The principal authors of these regulations are Janine Cook, Linda

E. Alsalihi, and Margaret A. Owens, Office of the Associate Chief

Counsel (Employee Benefits and Exempt Organizations). However, other

personnel from the IRS and Treasury Department participated in their

development.

List of Subjects

26 CFR Part 31

Employment taxes, Income taxes, Penalties, Pensions, Railroad

retirement,

[[Page 4547]]

Reporting and recordkeeping requirements, Social security,

Unemployment compensation.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 31 and 602 are 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:

Sec. 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) generally is taken into account for purposes of the

Federal Insurance Contributions Act (FICA) taxes imposed under sections

3101 and 3111 at the time the remuneration is actually or

constructively paid. See Sec. 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 tax

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 tax

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). For example, if a nonqualified

deferred compensation plan provides retirement benefits which result

from the deferral of compensation and disability pay (within the

meaning of paragraph (b)(4)(iv)(C) of this section) which does not

result from the deferral of compensation, the retirement benefits

provided under the plan are subject to the special timing rule in this

paragraph (a)(2) and the disability pay is not.

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

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 tax 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) do not constitute wages for FICA tax 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--(1) In general. For

purposes of this section, the term nonqualified deferred compensation

plan means any plan or other arrangement, other than a plan described

in section 3121(a)(5), 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). A nonqualified

deferred compensation plan may be adopted unilaterally by the employer

or may be negotiated among 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 (ERISA), as amended (29 U.S.C. 1002(3)). For purposes of this

section, except where the context indicates 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, and the date on

which the material terms of the plan are set forth in writing. For

purposes of this section, a plan 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, is established in

accordance with paragraph (b)(2)(i) of this section.

(iii) Transition rule for written plan requirement. For purposes of

this section, an unwritten plan that was 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 the material

[[Page 4548]]

terms of the plan are set forth in writing before January 1, 2000.

(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 to (or on behalf of) the employee 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 after the services creating the right to the

compensation have been performed. 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 an objective provision

creating a substantial risk of forfeiture (within the 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), or because benefits are reduced due to investment losses or, in

a final average pay plan, subsequent decreases in compensation.

(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 not 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 Sec. 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. The grant of a stock option, stock appreciation right, or

other stock value right does not constitute the deferral of

compensation for purposes of section 3121(v)(2). In addition, amounts

received as a result of the exercise of a stock option, stock

appreciation right, or other stock value right do not result from the

deferral of compensation for purposes of section 3121(v)(2) if such

amounts are actually or constructively received in the calendar year of

the exercise. 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 a future year 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--(A) In general. 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).

(B) Severance pay. Benefits that are provided under a severance pay

arrangement (within the meaning of section 3(2)(B)(i) of ERISA) that

satisfies the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii) are

considered severance pay for purposes of this paragraph (b)(4)(iv). If

benefits are provided under a severance pay arrangement (within the

meaning of section 3(2)(B)(i) of ERISA), but do not satisfy one or more

of the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii), then

whether those benefits are severance pay within the meaning of this

paragraph (b)(4)(iv) depends upon the relevant facts and circumstances.

For this purpose, relevant facts and circumstances include whether the

benefits are provided over a short period of time commencing

immediately after (or shortly after) termination of employment or for a

substantial period of time following termination of employment and

whether the benefits are provided after any termination or only after

retirement (or another specified type of termination). Benefits

provided under a severance pay arrangement (within the meaning of

section 3(2)(B)(i) of ERISA) are in all cases severance pay within the

meaning of this paragraph (b)(4)(iv) if the benefits payable under the

plan upon an employee's termination of employment are payable only if

that termination is involuntary.

(C) Death benefits and disability pay--(1) General definition.

Payments made under a nonqualified deferred compensation plan in the

event of death are death benefits within the meaning of this paragraph

(b)(4)(iv), but only to the extent the total benefits payable under the

plan exceed the lifetime benefits payable under the plan. Similarly,

payments made under a nonqualified deferred compensation plan in the

event of disability are disability pay within the meaning of this

paragraph (b)(4)(iv), but only to the extent the disability benefits

payable under the plan exceed the lifetime benefits payable under the

plan. Accordingly, any benefits that a nonqualified deferred

compensation plan provides in the event of death or disability that are

associated with an amount deferred under this section are

[[Page 4549]]

disregarded in applying this section to the extent the benefits payable

under the plan in the event of death or in the event of disability have

a value in excess of the lifetime benefits payable under the plan.

(2) Total benefits payable defined. For purposes of paragraph

(b)(4)(iv)(C)(1) of this section, the term total benefits payable under

a plan means the present value of the total benefits payable to or on

behalf of the employee (including benefits payable in the event of the

employee's death) under the plan, disregarding any benefits that are

payable only in the event of disability and determined separately with

respect to each form of distribution or other election that may apply

with respect to the employee.

(3) Disability benefits payable defined. For purposes of paragraph

(b)(4)(iv)(C)(1) of this section, the term disability benefits payable

under a plan means the present value of the benefits payable to or on

behalf of the employee under the plan, including benefits payable in

the event of the employee's disability but excluding death benefits

within the meaning of this paragraph (b)(4)(iv).

(4) Lifetime benefits payable defined. For purposes of paragraph

(b)(4)(iv)(C)(1) of this section, the term lifetime benefits payable

under a plan means the present value of the benefits that could be

payable to the employee under the plan during the employee's lifetime,

determined under the plan's optional form of distribution or other

election that is or was available to the employee at any time with

respect to the amount deferred and that provides the largest present

value to the employee during the employee's lifetime of any such form

or election so available.

(5) Rules of application. For purposes of determining present value

under this paragraph (b)(4)(iv)(C), present value is determined as of

the time immediately preceding the time the amount deferred under a

nonqualified deferred compensation plan is required to be taken into

account under paragraph (e) of this section, using actuarial

assumptions that are reasonable as of that date but taking into

consideration only benefits that result from the deferral of

compensation, as determined under this paragraph (b), and benefits

payable in the event of death or disability. In addition, for purposes

of paragraph (b)(4)(iv)(C)(4) of this section, present value must be

determined without any discount for the probability that the employee

may die before benefit payments commence and without regard to any

benefits payable solely in the event of disability.

(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 (C)

of this section do not result from the 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), except as provided in paragraph (b)(4)(v)(B)(3) of this

section, 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.

(3) Transition rule for window benefits. In the case of a window

benefit that is made available for a period of time that begins before

January 1, 2000, an employer may choose to treat the window benefit as

a benefit that results from the deferral of compensation if the sole

reason the window benefit would otherwise fail to be provided pursuant

to a nonqualified deferred compensation plan is the application of

paragraph (b)(4)(v)(B)(1) of this section.

(C) Termination within 12 months of 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 plan (or amendment) providing the benefit;

and

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

amendment) is established in contemplation of the employee's impending

termination of employment.

(vi) Benefits established after termination. 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). However, cost-of-living adjustments on

benefit payments under a nonqualified deferred compensation plan

(within the meaning of paragraph (b) of this section) shall not be

considered benefits established after the employee's termination of

employment for purposes of this paragraph (b)(4)(vi) merely because the

employee does not obtain the right to the adjustment until after the

employee's termination of employment. For purposes of the preceding

sentence, cost-of-living adjustments are payments that satisfy

conditions similar to those of 29 CFR 2510.3-2(g)(1)(ii) and (iii).

(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) is illustrated by the following

examples:

Example 1. (i) In December of 2001, Employer L tells Employee A

that, if specified goals are satisfied for 2002, Employee A will

receive a bonus on July 1, 2003, equal to a specified percentage of

2002 compensation. Because Employee A meets the specified goals,

Employer L pays the bonus to Employee A on July 1, 2003, 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) In 2004, Employer M establishes a compensation

arrangement for Employee B under which Employer M agrees to pay

Employee B a specified amount based on a percentage of his salary

for 2004. The amount due is to be paid out of the general assets of

Employer M and is payable in 2008.

(ii) Employee B has a legally binding right during 2004 to an

amount of compensation

[[Page 4550]]

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 N 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,

2001, to increase benefits, and the amendment provides that the

increase in benefits is on account of Employee C's performance of

services for Employer N from 1985 through 2000.

(ii) The additional benefits that resulted from the plan

amendment cannot be taken into account as amounts deferred for 1985

through 2000, 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 material terms of

the plan, as amended, are set forth in writing.

Example 4. (i) In 2002, Employer O, 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) 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 O 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 O is excluded from the definition of

employment under section 3121(b)(7).

Example 5. (i) In 2000, Employer P establishes a plan that

provides for bonuses to be paid to employees based on an objective

formula that takes into account the employees' performance for the

year. Employer P does not have the discretion to reduce the amount

of any employee's bonus after the end of 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 P may choose, pursuant to paragraph (b)(3)(iii)

of this section, to treat all the bonuses as if they are not subject

to the special timing rule of paragraph (a)(2) of this section.

(iii) If the employer uses the special timing rule, the amount

deferred would be taken into account as wages on December 31, 2000.

If the employer chooses not to use the special timing rule, the

amount of the bonus is wages on the date it is actually or

constructively paid, March 15, 2000.

Example 6. (i) Employer Q 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 any bonus until January of the year in which the bonus is paid,

any bonus paid under the plan in that year is not deferred from the

preceding calendar year, and the plan does not provide for the

deferral of compensation within the meaning of paragraph (b)(3)(i)

of this section.

Example 7. (i) Employer R maintains a plan for employees that

provides nonqualified stock options described in Sec. 1.83-7(a) of

this chapter. Under the plan, employees are granted in 2001 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 2010. The

options do not have a readily ascertainable fair market value for

purposes of section 83 at the date of grant, and shares are issued

upon the exercise of the options without being subject to a

substantial risk of forfeiture within the meaning of section 83. In

2005, when the fair market value of a share of employer stock is

$80, Employee D exercises an option to acquire 1,000 shares.

(ii) Under paragraph (b)(4)(ii) of this section, neither the

grant of a stock option nor amounts received currently as a result

of the exercise of a stock option result from the deferral of

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

general timing rule of paragraph (a)(1) of this section, the $30,000

spread between the amount paid for the shares ($50,000) and the fair

market value of the shares on the date of exercise ($80,000) is

taken into account as wages for FICA tax 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 $35,000

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

market value of the shares on the date of exercise ($80,000) would

similarly be taken into account as wages for FICA tax 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 on the date of termination, 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 severance pay

arrangement (within the meaning of section 3(2)(b)(i) of ERISA)

which provides for payments solely upon an employee's death,

disability, or dismissal from employment. The amount of the payments

to an 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)(B) 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) Employer V establishes a nonqualified deferred

compensation plan under which employees will receive benefit

payments commencing at age 65 as a life annuity or in one of several

actuarially equivalent annuity forms. If an employee dies before

benefit payments commence under the plan, a benefit is payable to

the employee's designated beneficiary in a single sum payment equal

to the present value of the employee's annuity benefit. This benefit

(sometimes called a full reserve death benefit) is calculated using

the applicable interest rate specified in section 417(e) and, for

the period after age 65, the applicable mortality table specified in

section 417(e), both of which are reasonable actuarial assumptions.

During 2002, Employee E obtains a legally binding right to an

annuity benefit under the plan, payable at age 65. This annuity

benefit has a present value of $10,000 at the end of 2002,

determined using the same assumptions as are used under the plan to

calculate the full reserve death benefit.

(ii) The present value, at the end of 2002, of the total

benefits payable to or on behalf of Employee E (i.e., the sum of the

present

[[Page 4551]]

value of the annuity benefit commencing at age 65, and the present

value of the full reserve death benefit, with both determined using

the actuarial assumptions described in paragraph (i) of this Example

10, except also taking into account the probability of death prior

to age 65) is $10,000. This present value does not exceed the

present value of the annuity benefits that could be payable to

Employee E under the plan during Employee E's lifetime determined

without a discount for the possibility that Employee E might die

before age 65 (also $10,000). Thus, the benefit payable in the event

of the Employee E's death is not a death benefit for purposes of

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

(iii) The same result would apply in the case of a plan that

bases benefits on an interest bearing account balance and pays the

account balance at termination of employment or death (because the

sum of the deferred benefits payable in the future if the employee

terminates employment before death with a discount for the

probability of death before that date plus the present value of the

benefit payable in the event of death necessarily equals the present

value of the deferred benefits payable with no discount for the

probability of death).

Example 11. (i) The facts are the same as in Example 10, except

that, in lieu of the full reserve death benefit, the plan provides a

monthly life annuity benefit to an employee's spouse in the event of

the employee's death before benefit payments commence equal to 100

percent of the monthly annuity that would be payable to the employee

at age 65 under the life annuity form. Employee E is age 63 and has

a spouse who is age 51. The sum of the present value of Employee E's

annuity benefit commencing at age 65 determined with a discount for

the possibility that Employee E might die before age 65 and the

present value of the 100 percent annuity death benefit for Employee

E's spouse exceeds $10,000.

(ii) The amount deferred for 2002 is $10,000 (because the 100

percent annuity death benefit for Employee E's spouse is disregarded

to the extent that the total benefits payable to or on behalf of

Employee E exceeds the present value of the annuity benefits that

could be payable to Employee E under the plan during the Employee

E's lifetime without a discount for the probability of Employee E's

death before benefit payments commence).

Example 12. (i) On January 1, 2001, Employer W establishes a

plan that covers only Employee F, 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 F's termination of employment at

any time, he will receive $200,000 per year for each of the

immediately succeeding five years. Employee F terminates employment

on March 1, 2001.

(ii) Because Employee F 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 13. (i) Employer X establishes a plan on January 1,

2004, to supplement the qualified retirement benefits of recently

hired 55-year old Employee G, who forfeited retirement benefits with

her former employer in order to accept employment with Employer X.

The plan provides that Employee G will receive $50,000 per year for

life beginning at age 65, regardless of when she terminates

employment. On April 15, 2004, Employee G unexpectedly terminates

employment.

(ii) The facts and circumstances indicate that the plan was not

established in contemplation of impending termination. Thus, even

though Employee G 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 14. (i) Employer Y 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 H is

planning to (and actually does) retire within six months of the date

on which the plan is established.

(ii) Even though Employee H terminated employment within 12

months of the establishment of the plan, the plan is not considered

to have been established in connection with Employee H's impending

termination within the meaning of paragraph (b)(4)(v) of this

section because the facts and circumstances indicate otherwise.

Example 15. (i) Employee J owns 100 percent of Employer Z, a

corporation that provides consulting services. Substantially all of

Employer Z's revenue is derived as a result of the services

performed by Employee J. In each of 2001, 2002, and 2003, Employer Z

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

$80,000. In each of 2001 and 2002, Employer Z pays Employee J a

salary of $100,000 for services performed in each of those years. On

December 31, 2002, Employer Z establishes a plan to pay Employee J

$80,000 in 2003. The plan recites that the payment is in recognition

of prior services. In 2003, Employer Z pays Employee J 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 J in 2003 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 2003 under the general timing rule of paragraph

(a)(1) of this section.

(c) Determination of the amount 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.

(ii) Definitions--(A) Account balance plan. For purposes of this

section, an account balance plan is a nonqualified deferred

compensation plan under the terms of which 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.

(B) Income. 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.

(iii) Additional rules--(A) Commingled accounts. 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.

(B) Bifurcation permitted. An employer may treat a portion of a

nonqualified deferred compensation plan as a separate account balance

plan if that portion satisfies the requirements of this paragraph

(c)(1) and the amount payable to employees under that portion is

determined independently of the amount payable under the other portion

of the plan.

(C) Actuarial equivalents. A plan does not fail to be an account

balance plan merely because the plan permits employees to elect to

receive their benefits under the plan in a form of benefit other than

payment of the account balance, provided the amount of benefit payable

in that other form is actuarially equivalent to payment of the account

balance using actuarial assumptions that are reasonable. Conversely, a

plan is not an account

[[Page 4552]]

balance plan if it provides an optional form of benefit that is not

actuarially equivalent to the account balance using actuarial

assumptions that are reasonable. For this purpose, the determination of

whether forms are actuarially equivalent using actuarial assumptions

that are reasonable is determined under the rules applicable to

nonaccount balance plans under paragraph (c)(2)(iii) of this section.

(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) 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) of this section using actuarial assumptions

and methods that are reasonable as of that date. For this purpose, a

discount for the probability that an employee will die before

commencement of benefit payments is permitted, but only to the extent

that benefits will be forfeited upon death. In addition, the present

value cannot be discounted for the probability 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. Nor is the

present value affected by the possibility that some of the payments due

under the plan will be eligible for one of the exclusions from wages in

section 3121(a).

(iii) Treatment of actuarially equivalent benefits--(A) In general.

In the case of a nonaccount balance plan that permits employees to

receive their benefits in more than one form or commencing at more than

one date, the amount deferred is determined by assuming that payments

are made in the normal form of benefit commencing at normal

commencement date if the requirements of paragraph (c)(2)(iii)(B) of

this section are satisfied. Accordingly, in the case of a nonaccount

balance plan that permits employees to receive their benefits in more

than one form or commencing at more than one date, unless the

requirements of paragraph (c)(2)(iii)(B) of this section are satisfied,

the amount deferred is treated as not reasonably ascertainable under

the rules of paragraph (e)(4)(i)(B) of this section until a form of

benefit and a time of commencement are selected.

(B) Use of normal form commencing at normal commencement date. The

requirements of this paragraph (c)(2)(iii)(B) are satisfied by a

nonaccount balance plan if the plan has a single normal form of benefit

commencing at normal commencement date for the amount deferred and each

other optional form is actuarially equivalent to the normal form of

benefit commencing at normal commencement date using actuarial

assumptions that are reasonable. For this purpose, each form of benefit

for payment of the amount deferred commencing at a date is a separate

optional form. For purposes of this paragraph (c)(2)(iii)(B), each

optional form is actuarially equivalent to the normal form of benefit

commencing at normal commencement date only if the terms of the plan in

effect when the amount is deferred provide for every optional form to

be actuarially equivalent and further provide for actuarial assumptions

to determine actuarial equivalency that will be reasonable at the time

the optional form is selected, without regard to whether market

interest rates are higher or lower at the time the optional form is

selected than at the time the amount is deferred. Thus, a plan that

provides for every optional form to be actuarially equivalent satisfies

this paragraph (c)(2)(iii)(B) if it provides for actuarial equivalence

to be determined--

(1) When an optional form is selected or when benefit payments

under the optional form commence, based on assumptions that are

reasonable then;

(2) Based on an index that reflects market rates of interest from

time to time (for example, the plan specifies that all benefits will be

actuarially equivalent using the applicable interest rate and

applicable mortality table specified in section 417(e)); or

(3) Based on actuarial assumptions specified in the plan and

provides for those assumptions to be revised to be reasonable

assumptions if they cease to be reasonable assumptions.

(C) Fixed mortality assumptions permitted. A plan does not fail to

satisfy paragraph (c)(2)(iii)(B) of this section merely because the

plan specifies a fixed mortality assumption that is reasonable at the

time the amount is deferred, even if that assumption is not reasonable

at the time the optional form is selected. (But see paragraph

(c)(2)(iii)(E) of this section for additional rules that apply if the

mortality assumption is not reasonable at the time the optional form is

selected.)

(D) Normal form of benefit commencing at normal commencement date

defined. For purposes of this paragraph (c)(2)(iii), the normal form of

benefit commencing at normal commencement date under the plan is the

form, and date of commencement, under which the payments due to the

employee under the plan are expressed, prior to adjustments for form or

timing of commencement of payments.

(E) Rule applicable if actuarial assumptions cease to be

reasonable. If the terms of the plan in effect when an amount is

deferred provide for actuarial assumptions to determine actuarial

equivalency that will be reasonable at the time the optional form is

selected or payments commence as provided in paragraph (c)(2)(iii)(B)

of this section, but, at that time, the actuarial assumptions used

under the plan are not reasonable, the employee will be treated as

obtaining a legally binding right at that time (or, if earlier, at the

date on which the plan is amended to provide actuarial assumptions that

are not reasonable) to any additional benefits that result from the use

of an unreasonable actuarial assumption. This might occur, for example,

if the plan specifies that the actuarial assumptions will be reasonable

assumptions to be set at the time the optional form is selected and the

assumptions used are in fact not reasonable at that time.

(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)(B) of this section and

the amount of the true-up at the resolution date described in paragraph

(e)(4)(ii)(B) of this section are determined separately with respect to

each amount deferred. See paragraph (e)(4)(ii)(D) of this section

[[Page 4553]]

for special rules for allocating amounts deferred over more than one

year.

(4) Examples. This paragraph (c) is illustrated by the following

examples. (The examples illustrate the rules in this paragraph (c) and

include various interest rate and mortality table assumptions,

including the applicable section 417(e) mortality table, the GAM 83

(male) mortality table, and UP-84 mortality table. These tables can be

obtained from the Society of Actuaries at its internet site at http://

www.soa.org.) The examples are as follows:

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 five employees. Under the plan, a

specified sum is credited to an account for the benefit of the group

of employees on July 31 of each year. Income on the balance of the

account is credited annually at a rate that is reasonable for each

year. The benefit payable to an employee is equal to one-fifth of

the account balance and is payable, at the employee's option, in a

lump sum or in 10 annual installments that reflect income on the

balance.

(ii) The plan is an account balance plan notwithstanding the

fact that the employee's benefit is equal to a specified percentage

of an account maintained for a group of employees.

Example 4. (i) The facts are the same as in Example 3, except

that the plan also permits an employee to elect a life annuity that

is actuarially equivalent to the account balance based on the

applicable interest rate and applicable mortality table specified in

section 417(e) at the time the benefit is elected by the employee.

(ii) Under paragraphs (c)(1)(iii)(C) and (c)(2)(iii) of this

section, the plan does not fail to be an account balance plan merely

because the plan permits employees to elect to receive their

benefits under the plan in a form that is actuarially equivalent to

payment of the account balance using actuarial assumptions that are

reasonable at the time the form is selected.

Example 5. (i) Employer P 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 2 percent for each year of service and the employee's highest

average annual compensation for any 3-year period. The plan also

provides that, if an employee 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, 2002,

Employee C is age 60, has 25 years of service, and high 3-year

average compensation of $100,000 (the average for the years 2000

through 2002). As of December 31, 2003, Employee C is age 61, has 26

years of service, and has high 3-year average compensation of

$104,000. As of December 31, 2004, Employee C is age 62, has 27

years of service, and has high 3-year average compensation of

$105,000. The assumptions that Employer P uses to determine the

amount deferred for 2003 (a 7 percent interest rate and, for the

period after commencement of benefit payments, the GAM 83 (male)

mortality table) and for 2004 (a 7.5 percent interest rate and, for

the period after commencement of benefit payments, the GAM 83 (male)

mortality table) are assumed, solely for purposes of this example,

to be reasonable actuarial assumptions.

(ii) As of December 31, 2002, Employee C has a legally binding

right to receive lifetime payments of $50,000 (2 percent x 25

years x $100,000) per year. As of December 31, 2003, Employee C

has a legally binding right to receive lifetime payments of $54,080

(2 percent x 26 years x $104,000) per year. Thus, during 2003,

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 2003 is the present value, as of December

31, 2003, of these additional payments, which is $28,767 ($4,080 x

the present value factor for a deferred annuity payable at age 65,

using the specified actuarial assumptions for 2003). Similarly,

during 2004, Employee C has earned a legally binding right to

additional lifetime payments of $2,620 (2 percent x 27 years x

$105,000, minus $54,080) per year beginning at age 65. The amount

deferred for 2004 is the present value, as of December 31, 2004, of

these additional payments, which is $18,845 ($2,620 x the present

value factor for a deferred annuity payable at age 65, using the

specified actuarial assumptions for 2004).

Example 6. (i) Employer Q establishes a nonqualified deferred

compensation plan for Employee D on January 1, 2001, when Employee D

is age 63. During 2001, Employee D obtains a fully vested right to

receive a life annuity under the nonqualified deferred compensation

plan equal to the excess of $200,000 over the life annuity benefits

payable to Employee D under a qualified defined benefit pension plan

sponsored by Employer Q. The life annuity benefit payable annually

under the qualified plan is the lesser of $200,000 and the section

415(b)(1)(A) limitation in effect for the year, where the section

415(b)(1)(A) limitation is automatically adjusted to reflect changes

in the cost of living. Benefits under both the qualified and

nonqualified plan are payable monthly beginning at age 65. For

purposes of this example, the section 415(b)(1)(A) limit for 2001 is

assumed to be $140,000. The nonqualified plan provides no benefits

in the event Employee D dies prior to commencement of benefit

payments. 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. The

assumptions that Employer Q uses to determine the amount deferred

for 2001 (a 7 percent interest rate, a 3 percent increase in the

cost of living and the GAM 83 (male) mortality table) are assumed,

solely for purposes of this example, to be reasonable actuarial

assumptions. As of December 31, 2001, Employee D has a legally

binding right to receive lifetime payments as set forth in the

following table:

[[Page 4554]]

----------------------------------------------------------------------------------------------------------------

Assumed

qualified plan Net annual

Year Annual gross annual payment payment under

amount (based on cost nonqualified

of living) plan

----------------------------------------------------------------------------------------------------------------

2003............................................................ $200,000 $145,000 $55,000

2004............................................................ 200,000 150,000 50,000

2005............................................................ 200,000 155,000 45,000

2006............................................................ 200,000 160,000 40,000

2007............................................................ 200,000 165,000 35,000

2008............................................................ 200,000 170,000 30,000

2009............................................................ 200,000 175,000 25,000

2010............................................................ 200,000 180,000 20,000

2011............................................................ 200,000 185,000 15,000

2012............................................................ 200,000 190,000 10,000

2013............................................................ 200,000 195,000 5,000

2014 and thereafter............................................. 200,000 205,000 or

greater 0

----------------------------------------------------------------------------------------------------------------

(ii) The amount deferred for 2001 is the present value, as of

December 31, 2001, of the net lifetime payments under the

nonqualified plan, or $223,753.

(d) Amounts taken into account and income attributable thereto--(1)

Amounts taken into account--(i) In general. 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 before the expiration of the applicable period of limitations for

the period 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

Insurance (OASDI) portion (or, in the case of years before 1994, the

Hospital Insurance (HI) portion) of FICA for the year, no portion of

the amount deferred will actually result in additional OASDI (or HI)

tax. 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 (c) of this

section) is not taken into account, then the nonduplication rule of

paragraph (a)(2)(iii) of this section does not apply, and benefit

payments 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 resulting from

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, as of the date an amount deferred is

required to be taken into account, only a portion of the amount

deferred (as determined under paragraph (c) of this section) has been

taken into account, then a portion of each subsequent benefit payment

that is attributable to that amount 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

immediately before the attributable benefit payments commence (or, if

later, the date the amount deferred is required to be taken into

account) 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 determined under

paragraph (d)(2) of this section through the date the portion is fixed)

and the denominator of which is the present value of the future benefit

payments attributable to the amount deferred, determined as of the date

the portion is fixed. For this purpose, if the requirements of

paragraph (c)(2)(iii)(B) of this section are satisfied, the present

value is determined by assuming that payments are made in the normal

form of benefit commencing at normal commencement date. In addition, if

the employer demonstrates that the amount deferred was determined using

reasonable actuarial assumptions as determined by the Commissioner, the

present value of the future benefit payments attributable to the amount

deferred is determined using those assumptions. In any other case, see

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

(2) Income attributable to the amount taken into account--(i)

Account balance plans--(A) In general. 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)(ii)(B) 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 reflects a rate of return that

does not exceed either the rate of return on a predetermined actual

investment (as determined in accordance with paragraph (d)(2)(i)(B) of

this section) or, if the income does not reflect the rate of return on

a predetermined actual investment (as so determined), a reasonable rate

of interest (as

[[Page 4555]]

determined in accordance with paragraph (d)(2)(i)(C) of this section).

(B) Rules relating to actual investment--(1) In general. For

purposes of this paragraph (d)(2)(i), the rate of return on a

predetermined actual investment for any period means the rate of total

return (including increases or decreases in fair market value) that

would apply if the account balance were, during the applicable period,

actually invested in one or more investments that are identified in

accordance with the plan before the beginning of the period. For this

purpose, an account balance plan can determine income based on the rate

of return of a predetermined actual investment regardless of whether

assets associated with the plan or the employer are actually invested

therein and regardless of whether that investment is generally

available to the public. For example, an account balance plan could

provide that income on the account balance is determined based on an

employee's prospective election among various investment alternatives

that are available under the employer's section 401(k) plan, even if

one of those investment alternatives is not generally available to the

public. In addition, 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).

(2) Certain rates of return not based on predetermined actual

investment. A rate of return will not be treated as the rate of return

on a predetermined actual investment within the meaning of this

paragraph (d)(2)(i)(B) if the rate of return (to any extent or under

any conditions) is based on the greater of the rate of return of two or

more actual investments, is based on the greater of the rate of return

on an actual investment and a rate of interest (whether or not the rate

of interest would otherwise be reasonable under paragraph (d)(2)(i)(C)

of this section), or is based on the rate of return on an actual

investment that is not predetermined. For example, if a plan bases the

rate of return on the greater of the rate of return on a predetermined

actual investment (such as the value of the employer's stock), and a 0

percent interest rate (i.e., without regard to decreases in the value

of that investment), the plan is using a rate of return that is not a

rate of return on a predetermined actual investment within the meaning

of this paragraph (d)(2)(i)(B).

(C) Rules relating to reasonable interest rates--(1) In general. If

income for a period is credited to an account balance plan on a basis

other than the rate of return on a predetermined actual investment (as

determined in accordance with paragraph (d)(2)(i)(B) of this section),

then, except as otherwise provided in this paragraph (d)(2)(i)(C), the

determination of whether the income for the period is based on a

reasonable rate of interest will be made at the time the amount

deferred is required to be taken into account and annually thereafter.

(2) Fixed rates permitted. If, with respect to an amount deferred

for a period, an account balance plan provides for a fixed rate of

interest to be credited, and the rate is to be reset under the plan at

a specified future date that is not later than the end of the fifth

calendar year that begins after the beginning of the period, the rate

is reasonable at the beginning of the period, and the rate is not

changed before the reset date, then the rate will be treated as

reasonable in all future periods before the reset date.

(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, for 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

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. This

paragraph (d)(2)(iii)(A) applies to an account balance plan under which

the income credited is based on neither a predetermined actual

investment, within the meaning of paragraph (d)(2)(i)(B) of this

section, nor a rate of interest that is reasonable, within the meaning

of paragraph (d)(2)(i)(C) of this section, as determined by the

Commissioner. In that event, the employer must calculate the amount

that would be credited as income under a reasonable rate of interest,

determine the excess (if any) of the amount credited under the plan

over the income that would be credited using the reasonable rate of

interest, and take that excess into account as an additional amount

deferred in the year the income is credited. If the employer fails to

calculate the amount that would be credited as income under a

reasonable rate of interest and to take the excess into account as an

additional amount deferred in the year the income is credited, or the

employer otherwise fails to take the full amount deferred into account,

then the excess of the income credited under the plan over the income

that would be credited using AFR will be treated as an amount deferred

in the year the income is credited. For purposes of this section, AFR

means the mid-term applicable federal rate (as defined pursuant to

section 1274(d)) for January 1 of the calendar year, compounded

annually. In addition, pursuant to paragraph (d)(1)(ii) of this

section, the excess over the income that would result from the

application of AFR and any income attributable to that 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

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 paragraph (d)(1)(ii)(B)

of this section (at the date specified in paragraph (d)(1)(ii)(B) of

this section), 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

[[Page 4556]]

the amount deferred was required to be taken into account.

(3) Examples. This paragraph (d) is illustrated by the following

examples:

Example 1. (i) In 2001, Employer M establishes a nonqualified

deferred compensation plan for Employee A under which all benefits

are 100 percent vested. In 2002, 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 2002 is

$20,000. Thus, Employee A has total wages for FICA tax purposes of

$220,000. Because Employee A has other wages that exceed the OASDI

wage base for 2002, no additional OASDI tax is due 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 HI tax.

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

deferred is considered taken into account as wages for FICA tax

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, benefit payments 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 and will

be subject to the HI portion of FICA tax when actually or

constructively paid (and the OASDI portion of FICA tax to the extent

Employee A's wages do not exceed the OASDI wage base limitation).

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

limitations expires for 2002 (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 2002. 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 tax 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 employee's

account as of the preceding December 31. The interest rate specified

in the plan results in income credits that are not based on the rate

of return on a predetermined actual investment within the meaning of

paragraph (d)(2)(i)(B) of this section, and that are greater than

the income that would result from application of a reasonable rate

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

section. Employer N fails to take into account an additional amount

for the excess of the income credited under the plan over a

reasonable rate of interest.

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

income credits in excess of the income that would be credited using

the AFR are considered additional amounts deferred 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,

the income credited under the plan 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 based on the rate of total

return on Employer N's publicly traded common stock.

(ii) Because the income credited under the plan does not exceed

the actual rate of return on a predetermined actual investment, the

income credited is considered income attributable to the amount

taken into account within the meaning of paragraph (d)(2)(i) of this

section.

Example 6. (i) The facts are the same as in Example 3, except

that the annual rate of increase or decrease is equal to the greater

of the rate of total return on a specified aggressive growth mutual

fund or the rate of return on a specified income-oriented mutual

fund. Employer N fails to take into account an additional amount for

the excess of the income credited under the plan over a reasonable

rate of interest.

(ii) Because the rate of increase or decrease is based on the

greater of two rates of returns, the increase is not based on the

return on a predetermined actual investment within the meaning of

paragraph (d)(2)(i)(B) of this section. Thus, if the rate of return

credited under the plan (i.e., the greater of the rates of return of

the two mutual funds) exceeds the income that would be credited

using 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 7. (i) The facts are the same as in Example 6, except

that the annual increase or decrease with respect to 50 percent of

the employee's account is equal to the rate of total return on the

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 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 8. (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 2004, the board designates Company A stock as the

investment for 2004. Before the beginning of 2005, the board

designates Company B stock as the investment for 2005. At the end of

2005, the board determines that the return on Company B stock was

lower than expected and changes its designation for 2005 to the rate

of return on Company C stock, which had a higher return during 2005.

Employer N fails to take into account an additional amount for the

excess of the income credited under the plan over a reasonable rate

of interest.

(ii) The annual increase or decrease for 2004 is based on the

return of a predetermined actual investment. Although the annual

increase or decrease for 2005 is based on an actual investment, the

actual investment is not predetermined since it was not designated

before the beginning of 2005. Pursuant to paragraph (d)(2)(iii)(A)

of this section, the excess of the income credited under the plan

over the income determined using AFR is an additional amount

deferred for 2005.

Example 9. (i) Employer O establishes a nonqualified deferred

compensation plan for Employee B. Under the plan, if Employee B

survives until age 65, he has a fully vested right to receive a lump

sum payment at that age, equal to the product of 10 percent per year

of service and Employee B's highest average annual compensation for

any 3-year period, but no benefits are payable in the event Employee

B dies prior to age 65. 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, 2002, Employee B has 25 years of service and Employee

B's high 3-year average compensation is $100,000 (the average for

the years 2000 through 2002). As of December 31, 2002, Employee B

has a legally binding right to receive a payment at age 65 of

$250,000 (10 percent x 25 years x $100,000). As of December 31,

2003, Employee B is age 63, has 26 years of service, and has high 3-

year average compensation of $104,000. As of December 31, 2003,

Employee B has a legally binding right to receive a payment at age

65 of $270,400 (10 percent x 26 years x $104,000). Thus, during

2003, 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 2003 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 2003 is

the present value, as of December 31, 2003, 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 2003 and paying the

additional FICA tax.

[[Page 4557]]

(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 payment

earned during 2003 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 constitutes 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 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 10. (i) The facts are the same as in Example 9, 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 2 percent for each year

of service and Employee B's highest average annual compensation for

any 3-year 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, 2002, Employee B has a

legally binding right to receive lifetime payments of $50,000 (2

percent x 25 years x $100,000) per year. As of December 31,

2003, Employee B has a legally binding right to receive lifetime

payments of $54,080 (2 percent x 26 years x $104,000) per year.

Thus, during 2003, 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 2003 is $32,935, which

is the present value, as of December 31, 2003, of these additional

payments, determined using the same actuarial assumptions and

methods used in Example 9, except that there is no discount for the

probability of death prior to age 65. Employer O takes this amount

into account by including it in Employee B's FICA wages for 2003 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 payments 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, each annual payment of

$4,080 attributable to the amount deferred in 2003 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 11. (i) The facts are the same as in Example 10, except

that no amount is taken into account for 2003 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 benefit

payments 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 payments will be included in wages when actually or

constructively paid, in accordance with the general timing rule.

Example 12. (i) Employer P establishes an account balance plan

on January 1, 2002, under which all benefits are 100 percent vested.

The plan provides that amounts deferred will be credited annually

with interest beginning in 2002 at a rate that is greater than a

reasonable rate of interest. Employer P treats the excess over the

applicable interest rate in section 417(e) as an additional amount

deferred for 2002 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.

(ii) Under the nonduplication rule in paragraph (a)(2)(iii) of

this section, the benefits paid under the plan will be excluded from

wages for FICA tax purposes.

Example 13. (i) The facts are the same as in Example 9, except

that, in determining the amount deferred, Employer O uses a 15

percent interest rate, which, solely for purposes of this example,

is assumed not to be a reasonable interest rate. Employer O

determines that the amount deferred for 2003 is the present value,

as of December 31, 2003, of the $20,400 payment, which is $15,023.

Employer O includes $15,023 in wages and pays any resulting FICA

tax. Solely for purposes of this example, it is assumed that the AFR

as of January 1, 2003, 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 taken

into account for 2003 is $1,199 in 2004 and $1,313 in 2005. 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 benefit payments 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 and

the 417(e) mortality table. These 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 x .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 10, except

that Employer O calculates the amount deferred for 2003 as $18,252

and takes that amount into account by including that 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 benefit payments, 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. Solely for purposes of this example, it is

assumed that the AFR as of January 1, 2003, 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 taken into account for 2003 is $1,278 in 2004 and

$1,367 in 2005. Under paragraph (d)(1)(ii)(B) of this section, the

portion of each 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

divided by $40,283, or .51875. Thus, $2,116 (.51875 x $4,080) of

each year's benefit payment is excluded from

[[Page 4558]]

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 benefit payments 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 and

the 417(e) mortality table. These 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 $35,185, 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 required to be taken into account--

(1) In general. Except as otherwise provided in this paragraph (e), an

amount deferred under a nonqualified deferred compensation plan must be

taken into account as wages for FICA tax 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 tax 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 tax purposes as of the date the material terms of the plan are

put in writing.

(2) Services creating the right to an amount deferred. For purposes

of this section, services creating the right to an amount deferred

under a nonqualified deferred compensation plan are considered to be

performed as of the date on which, under the terms of the plan and all

the facts and circumstances, the employee has performed all of the

services necessary to obtain a legally binding right (as described in

paragraph (b)(3)(i) of this section) to the amount deferred.

(3) Substantial risk of forfeiture. For purposes of this section,

the determination of whether a substantial risk of forfeiture exists

must be made in accordance with the principles of section 83 and the

regulations thereunder.

(4) Amount deferred that is not reasonably ascertainable under a

nonaccount balance plan--(i) In general--(A) Date required to be taken

into account. Notwithstanding any other provision of this paragraph

(e), an amount deferred under a nonaccount balance plan is not required

to be taken into account as wages under the special timing rule of

paragraph (a)(2) of this section until the first date on which all of

the amount deferred is reasonably ascertainable (the resolution date).

In this case, the amount required to be taken into account as of the

resolution date is determined in accordance with paragraph (c)(2) of

this section.

(B) Definition of reasonably ascertainable. For purposes of this

paragraph (e)(4), an amount deferred is considered reasonably

ascertainable on the first date on which the amount, form, and

commencement date of the benefit payments attributable to the amount

deferred are known, and the only actuarial or other assumptions

regarding future events or circumstances needed to determine the amount

deferred are interest and mortality. For this purpose, the form and

commencement date of the benefit payments attributable to the amount

deferred are treated as known if the requirements of paragraph

(c)(2)(iii)(B) of this section (under which payments are treated as

being made in the normal form of benefit commencing at normal

commencement date) are satisfied. In addition, an amount deferred does

not fail to be reasonably ascertainable on a date merely because the

exact amount of the benefit payable cannot readily be calculated on

that date or merely because the exact amount of the benefit payable

depends on future changes in the cost of living. If the exact amount of

the benefit payable depends on future changes in the cost of living,

the amount deferred must be determined using a reasonable assumption as

to the future changes in the cost of living. For example, the amount of

a benefit is treated as known even if the exact amount of the benefit

payable cannot be determined until future changes in the cost of living

are reflected in the section 415 limitation on benefits payable under a

qualified retirement plan.

(ii) Earlier inclusion permitted--(A) In general. With respect to

an amount deferred that is not reasonably ascertainable, an employer

may choose to take an amount into account at any date or dates (an

early inclusion date or dates) before the resolution date (but not

before the date described in paragraph (e)(1) of this section with

respect to the amount deferred). Thus, for example, with respect to an

amount deferred under a nonaccount balance plan that is not reasonably

ascertainable because the plan permits employees to receive their

benefits in more than one form or commencing at more than one date (and

the requirements of paragraph (c)(2)(iii) of this section are not

satisfied), an employer may choose to take an amount into account on

the date otherwise described in paragraph (e)(1) of this section before

the form and commencement date are selected (based on assumptions as to

the form and commencement date for the benefit payments) or may choose

to wait until the form and commencement date of the benefit payments

are selected. An employer that chooses to take an amount into account

at an early inclusion date under this paragraph (e)(4)(ii) for an

employee under a plan is not required until the resolution date to

identify the period to which the amount taken into account relates.

(B) True-up at resolution date. If, with respect to an amount

deferred for a period, an employer chooses to take an amount into

account as of an early inclusion date in accordance with this paragraph

(e)(4)(ii) and the benefit payments attributable to the amount deferred

exceed the benefit payments that are actuarially equivalent to the

amount taken into account at the early inclusion date (payable in the

same form and using the same commencement date as the benefit payments

attributable to the amount deferred), then the present value of the

difference in the benefits, determined in accordance with paragraph

(c)(2) of this section, must be taken into account as of the resolution

date.

(C) Actuarial assumptions. For purposes of determining the benefits

that are actuarially equivalent to the amount taken into account as of

an early inclusion date, the amount taken into account is converted to

an actuarially equivalent benefit payable in the same form and

commencing on the same date as the actual benefit payments attributable

to the amount deferred using an interest rate, and, if applicable,

mortality and cost-of-living assumptions, that were reasonable as of

the early inclusion date. Thus, with respect to an amount deferred for

a

[[Page 4559]]

period, the amount required to be taken into account as of the

resolution date is the present value (determined using an interest

rate, and, if applicable, mortality and cost-of-living assumptions,

that are reasonable as of the resolution date) of the excess, if any,

of the future benefit payments attributable to the amount deferred over

the future benefits payable in the same form and commencing on the same

date that are actuarially equivalent to the portion of the amount

deferred that was taken into account as of the early inclusion date

(where actuarial equivalence is determined using an interest rate, and,

if applicable, mortality and cost-of-living assumptions, that were

reasonable as of the early inclusion date).

(D) Allocation rules for amounts deferred over more than one

period--(1) General rule. The rules of this paragraph (e)(4)(ii)(D)

apply for purposes of determining whether an amount has been included

under this paragraph (e)(4) before the earliest date permitted under

paragraph (e)(1) of this section.

(2) Future compensation increases. Increases in an employee's

compensation after the early inclusion date must be disregarded.

(3) Early retirement subsidies. An early retirement subsidy that

the employee ultimately receives may be taken into account at an early

inclusion date if the employee would have a legally binding right to

the subsidy at the early inclusion date but for any condition that the

employee continue to render services. Accordingly, an employer may take

into account at an early inclusion date any early retirement subsidy

that the employee ultimately receives to the extent that elimination or

reduction of that subsidy would violate section 411(d)(6)(B)(i) if that

section applied to the plan.

(4) Allocation with respect to offsets. In any case in which a

series of amounts are deferred over more than one period, the amounts

deferred are not reasonably ascertainable until a single resolution

date and the benefit payments attributable to the entire series are

determined under a formula that provides a gross benefit that in the

aggregate is subject to an objective reduction for future events under

the terms of the plan, such as an offset for the aggregate benefits

payable under a plan qualified under section 401(a), the attribution of

benefit payments to the amount deferred in each period is determined

under the rules of this paragraph (e)(4)(ii)(D)(4). In a case described

in the preceding sentence, the benefit payments made as a result of the

series of amounts deferred may be treated as attributable to the amount

deferred as of the earliest period in which the employee obtained a

legally binding right to a benefit under the plan equal to the excess,

if any, of the amount of the gross benefit attributable to that period

(determined at the resolution date), over the amount of the reduction

determined as of the end of that period. Thus, for example, if an

employee obtains a legally binding right in each of several years to

benefit payments from a nonqualified deferred compensation plan that

provides for a specified gross benefit for the years to be offset by

the benefits payable under a qualified plan, the amount deferred in the

first year may be treated as equal to the gross benefit for the year,

reduced by the offset applicable at the end of the year (even if the

offset increases after the end of the year).

(E) Treatment of benefits paid before the resolution date. If a

benefit payment is attributable to an amount deferred that is not

reasonably ascertainable at the time of payment (or is paid before the

date selected under paragraph (e)(5) of this section), and the employer

has previously taken an amount into account with respect to the amount

deferred under the early inclusion rule of this paragraph (e)(4), then,

in lieu of the pro rata rule provided in paragraph (d)(1)(ii)(B) of

this section, a first-in-first-out rule applies in determining the

portion of the benefit payment attributable to the amount taken into

account. Under this first-in-first-out rule, the benefit payment is

compared to the sum of the amount taken into account at the early

inclusion date and the income attributable to that amount. If the

benefit payment equals or exceeds the amount taken into account at the

early inclusion date and the income attributable to that amount as of

the date of the benefit payment, the benefit payment is included as

wages under the general timing rule of paragraph (a)(1) of this section

to the extent of any excess, and the amount taken into account at the

early inclusion date (and income attributable to that amount) is

disregarded thereafter with respect to the amount deferred. If the

amount taken into account at the early inclusion date and the income

attributable to that amount as of the date of the benefit payment

exceeds the benefit payment, the benefit payment is not included as

wages under the general timing rule of paragraph (a)(1) of this section

and, in determining the amount that must be taken into account

thereafter with respect to the amount deferred, the amount taken into

account at the early inclusion date, plus attributable income as of the

date of the benefit payment, is reduced by the amount of the benefit

payment, and only the excess plus future income attributable to the

excess (credited using assumptions that were reasonable on the early

inclusion date) is taken into consideration. If amounts have been taken

into account at more than one early inclusion date, this paragraph

(e)(4)(ii)(E) applies on a first-in-first-out basis, beginning with the

amount taken into account at the earliest early inclusion date

(including income attributable thereto).

(5) Rule of administrative convenience. For purposes of this

section, an employer may treat an amount deferred as required to be

taken into account under this paragraph (e) on any 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

under this paragraph (e). For example, if services creating the right

to an amount deferred are considered performed under paragraph (e)(2)

of this section periodically throughout a year, the employer may

nevertheless treat the services creating the right to that amount

deferred as performed on December 31 of that year. If an employer uses

the rule of administrative convenience described in this paragraph

(e)(5), any determination of whether the income attributable to an

amount deferred under an account balance plan is based on a reasonable

rate of interest or whether the actuarial assumptions used to determine

the present value of an amount deferred in a nonaccount balance plan

are reasonable will be made as of the date the employer selects to take

the amount into account.

(6) Portions of an amount deferred required to be taken into

account on more than one date. If different portions of an amount

deferred are required to be taken into account under paragraph (e)(1)

of this section on more than one date (e.g., on account of a graded

vesting schedule), then each such portion is considered a separate

amount deferred for purposes of this section.

(7) Examples. This paragraph (e) is illustrated by the following

examples:

Example 1. (i) Employer M establishes a nonqualified deferred

compensation plan for Employee A on November 1, 2005. Under the

plan, which is an account balance plan, Employee A obtains a legally

binding right on the last day of each calendar year (if Employee A

is employed on that date) to be credited with a principal amount

equal to 5 percent of compensation for the year. In addition, a

reasonable rate of interest is credited quarterly. Employee A's

account balance is nonforfeitable and is payable upon Employee A's

termination of employment. For 2006, the principal amount credited

to

[[Page 4560]]

Employee A under the plan (which, in this case, is also the amount

deferred within the meaning of paragraph (c) of this section) is

$25,000.

(ii) Under paragraph (e)(2) of this section, the services

creating the right to the $25,000 amount deferred are considered

performed as of December 31, 2006, the date on which Employee A has

performed all of the services necessary to obtain a legally binding

right to the amount deferred. Thus, in accordance with paragraph

(e)(1) of this section, the $25,000 amount deferred must be taken

into account as of December 31, 2006, which is the later of the date

on which services creating the right to the amount deferred are

performed or the date on which the right to the amount deferred is

no longer subject to a substantial risk of forfeiture.

Example 2. (i) The facts are the same as in Example 1, except

that the principal amount credited under the plan on the last day of

each year (and attributable interest) is forfeited if the employee

terminates employment within five years of that date.

(ii) Under paragraph (e)(3) of this section, the determination

of whether the right to an amount deferred is subject to a

substantial risk of forfeiture is made in accordance with the

principles of section 83. Under Sec. 1.83-3(c) of this chapter, a

substantial risk of forfeiture generally exists where rights in

property that are transferred are conditioned, directly or

indirectly, upon the future performance of substantial services.

Because Employee A's right to receive the $25,000 principal amount

(and attributable interest) is conditioned on the performance of

services for five years, a substantial risk of forfeiture exists

with respect to that amount deferred until December 31, 2011.

(iii) December 31, 2011, is the later of the date on which

services creating the right to the amount deferred are performed or

the date on which the right to the amount deferred is no longer

subject to a substantial risk of forfeiture. Thus, in accordance

with paragraph (e)(1) of this section, the amount deferred (which,

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

$25,000 principal amount credited to Employee A's account on

December 31, 2006, plus the interest credited with respect to that

principal amount through December 31, 2011) must be taken into

account as of December 31, 2011.

Example 3. (i) The facts are the same as in Example 2, except

that the principal amount credited under the plan on the last day of

each year (and attributable interest) becomes nonforfeitable

according to a graded vesting schedule under which 20 percent is

vested as of December 31, 2007; 40 percent is vested as of December

31, 2008; 60 percent is vested as of December 31, 2009; 80 percent

is vested as of December 31, 2010; and 100 percent is vested as of

December 31, 2011. Because these dates are later than the date on

which the services creating the right to the amount deferred are

considered performed (December 31, 2006), the amount deferred is

required to be taken into account as of these dates that fall in

five different years.

(ii) Paragraph (e)(6) of this section provides that, if

different portions of an amount deferred are required to be taken

into account under paragraph (e)(1) of this section on more than one

date, then each such portion is considered a separate amount

deferred for purposes of this section. Thus, $5,000 of the principal

amount, plus interest credited through December 31, 2007, is taken

into account as an amount deferred on December 31, 2007; $5,000 of

the principal amount, plus interest credited through December 31,

2008, is taken into account as a separate amount deferred on

December 31, 2008; etc.

Example 4. (i) On November 21, 2001, Employer N establishes a

nonqualified deferred compensation plan under which all benefits are

100 percent vested. The plan provides for Employee B (who is age 45)

to receive a lump sum benefit of $500,000 at age 65. This benefit

will be forfeited if Employee B dies before age 65.

(ii) Because the amount, form, and commencement date of the

benefit are known, and the only assumptions needed to determine the

amount deferred are interest and mortality, the amount deferred is

reasonably ascertainable within the meaning of paragraph (e)(4)(i)

of this section on November 21, 2001.

Example 5. (i) The facts are the same as in Example 4, except

that plan provides that the lump sum will be paid at the later of

age 65 or termination of employment and provides that the $500,000

payable to Employee B is increased by 5 percent per year for each

year that payment is deferred beyond age 65.

(ii) Because the commencement date of the benefit payment is

contingent on when Employee B terminates employment, the

commencement date of the benefit payment is not known. Thus, the

amount deferred is not reasonably ascertainable within the meaning

of paragraph (e)(4)(i) of this section, unless the plan satisfies

the requirements of paragraph (c)(2)(iii)(B) of this section.

Because the fixed 5 percent factor may not be reasonable at the time

benefit payments commence (i.e., 5 percent might be higher or lower

than a reasonable interest rate when payments commence), the plan

fails to satisfy paragraph (c)(2)(iii)(B) of this section and

accordingly the amount deferred is not reasonably ascertainable

until termination of employment.

Example 6. (i) The facts are the same as in Example 4, except

that the $500,000 is payable to Employee B at the later of age 55 or

termination of employment.

(ii) Because the commencement date of the benefit payment is

contingent on when Employee B terminates employment, the

commencement date of the benefit payment is not known. Thus, the

amount deferred is not reasonably ascertainable until termination of

employment.

Example 7. (i) The facts are the same as in Example 4, except

that Employee B may elect to take the benefit in the form of a life

annuity of $50,000 per year (commencing at age 65).

(ii) Because the plan permits employees to elect to receive

benefits in more than one form and the alternative forms may not

have the same value when Employee B makes his election, the plan

fails to satisfy the requirements of paragraph (c)(2)(iii)(B) of

this section until a form of benefit is selected. Thus, the amount

deferred is not reasonably ascertainable until then.

Example 8. (i) Employer O establishes a nonqualified deferred

compensation plan. The plan is a supplemental executive retirement

plan (SERP) that provides Employee C with a fully vested right to

receive a pension, in the form of a life annuity payable monthly,

beginning at age 65, equal to the excess of 3 percent of Employee

C's final 3-year average pay for each year of participation up to 15

years, over the amount payable to Employee C from Employer O's

qualified pension plan. The amount payable under the qualified

pension plan is a life annuity payable monthly, beginning at age 65,

equal to 1.5 percent of final 3-year average pay for each year of

employment, excluding pay in excess of the section 401(a)(17)

compensation limit. No benefits are payable under the SERP if

Employee C dies before age 65. Employee C becomes a participant in

the SERP on January 1, 2001, at age 44. The amount deferred under

the SERP for any year is not reasonably ascertainable prior to

termination of employment because the amount of the benefit is not

known and the determination of the amount deferred requires

assumptions other than interest and mortality (e.g., an assumption

as to Employee C's average pay for the final three years of

employment). As permitted by paragraph (e)(4)(i) of this section,

Employer O chooses not to take any amount into account for any year

before the resolution date. Employee C terminates employment on

December 31, 2018 when he is age 62.

(ii) As of the date Employee C terminates employment, the amount

of the benefit is known and the only actuarial or other assumptions

needed to determine the amount deferred are an interest rate

assumption and a mortality assumption. At that time, the amount

deferred in each past year becomes reasonably ascertainable, and

Employer O is able to determine that during 2001 Employee C earned a

legally binding right to a life annuity of $4,000 per year beginning

in 2021 when Employee C is age 65. Employer O determines the present

value of Employee C's future benefit payments under the SERP as of

this resolution date (December 31, 2018), using a 7 percent interest

rate and the UP-84 mortality table, which, solely for purposes of

this example, are assumed to be reasonable actuarial assumptions for

December 31, 2018. The special timing rule will be satisfied if the

resulting present value, $26,950, is taken into account on that date

in accordance with paragraph (d)(1) of this section.

Example 9. (i) The facts are the same as in Example 8, except

that the plan provides that Employee C may choose to receive early

retirement benefits on an unreduced basis at any time after age 60

if Employee C has completed 15 years of service by that date.

(ii) As of the date Employee C terminates employment, the amount

of the benefit is known and the only actuarial or other assumptions

needed to determine the amount deferred are an interest rate

assumption and a mortality assumption. At that time, the amount

deferred in each past year becomes reasonably ascertainable, and

Employer O is able to determine that during 2001 Employee C earned a

legally binding right to a life annuity of $4,000 per year beginning

on

[[Page 4561]]

December 31, 2018 when Employee C is age 62. Employer O determines

the present value of Employee C's future benefit payments under the

SERP as of this resolution date (December 31, 2018), using a 7

percent interest rate and the UP-84 mortality table, which, solely

for purposes of this example, are assumed to be reasonable actuarial

assumptions for December 31, 2018. The special timing rule will be

satisfied if the resulting present value, $37,576, is taken into

account on that date in accordance with paragraph (d)(1) of this

section.

Example 10. (i) The facts are the same as in Example 9, except

that, as permitted under paragraph (e)(4)(ii) of this section,

Employer O chooses to take an amount into account before the amount

deferred for 2001 is reasonably ascertainable. The amount that

Employer O takes into account on December 31, 2001, is $13,043 (the

present value of a life annuity of $4,000 per year, payable at age

62, using a 6 percent interest rate and the UP-84 mortality table).

Employer O does not take any other amount into account before the

resolution date.

(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,

Employer O must determine any additional amount required to be taken

into account in 2018. If the $4,000 payable in the form of a life

annuity beginning at age 62 exceeds the life annuity which is

actuarially equivalent to the $13,043 previously taken into account,

the present value of the excess must be taken into account. In this

Example 10, the $13,043 previously taken into account is actuarially

equivalent to a $4,000 annuity commencing at age 62 using a 6

percent interest rate and the UP-84 mortality table ( which, solely

for purposes of this example, are assumed to be reasonable actuarial

assumptions for December 31, 2001). Accordingly, no additional

amount need be taken into account in 2018, regardless of any changes

in market rates of interest between 2001 and 2018.

Example 11. (i) The facts are the same as in Example 9, except

that, as permitted under paragraph (e)(4)(ii) of this section,

Employer O chooses to take an amount into account before the amount

deferred for 2001 is reasonably ascertainable. The amount that

Employer O takes into account on December 31, 2001, is $9,569 (the

present value of a life annuity of $4,000 per year, payable at age

65, using a 6 percent interest rate and the UP-84 mortality table).

Employer O does not take any other amount into account before the

resolution date.

(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,

Employer O must determine any additional amount required to be taken

into account in 2018. If the $4,000 payable in the form of a life

annuity beginning in 2018 at age 62 exceeds the life annuity which

is actuarially equivalent to the $9,569 previously taken into

account, the present value of the excess must be taken into account.

In this case, the $9,569 previously taken into account is

actuarially equivalent to a $2,935 annuity commencing at age 62

using a 6 percent interest rate and the UP-84 mortality table

(which, solely for purposes of this example, are assumed to be

reasonable actuarial assumptions for December 31, 2001).

Accordingly, an additional amount needs to be taken into account in

2018 equal to the present value of the excess of the $4,000 annual

stream of benefit payments to which Employee C obtained a legally

binding right during 2001 over the $2,935 annual stream of benefit

payments which is actuarially equivalent to the amount previously

taken into account. This present value (i.e., the present value of a

life annuity equal to $4,000 minus $2,935, or $1,065 annually) is

determined by Employer O to be $10,005 as of the resolution date

using a 7 percent interest rate and the UP-84 mortality table

(which, solely for purposes of this example, are assumed to be

reasonable actuarial assumptions for December 31, 2018).

Example 12. (i) The facts are the same as in Example 9, except

that the amount that Employer O takes into account on December 31,

2001, is $15,834 (the present value of $4,000, payable at age 60,

using a 6 percent interest rate and the UP-84 mortality table).

Employer O does not take any other amount into account before the

resolution date.

(ii) In accordance with paragraph (e)(4)(ii)(B) of this section,

Employer O must determine any additional amount required to be taken

into account in 2018. If the $4,000 payable in the form of a life

annuity beginning at age 62 exceeds the life annuity which is

actuarially equivalent to the $15,834 previously taken into account,

the present value of the excess must be taken into account. In this

case, the $15,834 previously taken into account is actuarially

equivalent to a $4,856 annuity commencing at age 62 using a 6

percent interest rate and the UP-84 mortality table (which, solely

for purposes of this example, are assumed to be reasonable actuarial

assumptions for December 31, 2001). Because the life annuity of

$4,856 per year (which is equivalent to the amount taken into

account at the early inclusion date) exceeds the $4,000 annuity

attributable to the amount deferred in 2001, no additional amount is

required to be taken into account for that amount deferred as of the

resolution date. Employer O may claim a refund or credit for the

overpayment of FICA tax with respect to amounts taken into account

prior to the resolution date to the extent permitted by sections

6402, 6413, and 6511.

Example 13. (i) The facts are the same as in Example 12, except

that Employee C became a participant in the SERP on January 1, 2000.

In addition, Employer O determines in 2018 that during 2000 Employee

C earned a legally binding right to a life annuity of $1,500 per

year beginning on December 31, 2018.

(ii) Employer O may allocate the $15,834 previously taken into

account among any amounts deferred on or before the early inclusion

date. At the resolution date, Employer O will have to take into

a

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