IRS Updates Nonqualified Plans Audit Guide

The Internal Revenue Service (IRS) recently updated its nonqualified plans audit guide. Accordingly, the IRS announced the “Nonqualified Deferred Compensation Audit Techniques Guide” (2021 Guide) on July 1st, 2021. Previously, a version dated June 2015 was the guide of record. Given that, the 2021 Guide now replaces the 2015 version and provides essential updated information. For example, the new nonqualified plans audit guide includes details on Nonqualified Deferred Compensation (NQDC) plans. Also included is an increased emphasis on sections of the Internal Revenue Code. Previously, in May 2021, the IRS issued new guidance on COBRA continuation health coverage.

Overview of the 2021 Nonqualified Plans Audit Guide

Overall, the 2021 Guide provides an expanded discussion of the legal authority surrounding nonqualified plans. For example, the document pays particular focus on the longstanding constructive receipt and economic benefit doctrines. In summary, the constructive receipt doctrine provides that constructively received income is money:

• credited to the taxpayer’s possession,
• credited to the taxpayer’s account,
• set apart for the taxpayer, or
• otherwise made available to the taxpayer in the same taxable year.

Similarly, the economic benefit doctrine reviews any economic or financial benefit or property as compensation for services. Basically, any payment of money or property for services is part of the individual’s gross income. Additionally, the new nonqualified plans audit guide emphasizes Internal Revenue Code Section 409A(b). Generally, suppose an employer uses a funding arrangement to pay for deferred compensation. In that case, it will not constitute a funded plan subject to immediate taxation. However, this only occurs if the funding arrangement does not result in assets being set aside from general creditors.  Subsequently, the 2021 Guide includes three exceptions where funding results in a taxable transfer of property and potentially additional taxes.

Employer Takeaways

In conclusion, financial examiners should apply the information provided in the 2021 Guide to businesses they audit. In particular, this could include examining election forms, funding arrangements, and public company disclosures. Therefore, the 2021 Guide release reminds employers to audit benefits and pay documentation and recordkeeping safeguards to meet full compliance.