Tax Consequences Insurance, Reciprocal Taxation/Deduction

Presented by Paystrubmakr.com      By John Wolf and Tom Cullen CPA

PAYS TUB MAKER informing about Insurance

Tax Consequences Insurance

There was a time, in the early days of the income tax system in this country, when it was possible for an employer to “accrue” a deferred compensation expense and take a deduction for it. At the same time, the employee did not have to report, as income, the deferred compensation until it was paid.

Paystubs easy to make just a few clicks and it is done

Reciprocal Taxation/Deduction Rule

The Revenue Act of 1942, however, killed this favorable situation. That Act installed a provision, now known as §404(a)(5), which provides that accruals under non-qualified deferred compensation plans are deductible on the employer’s tax return only in the year in which the employee receives the cash (or other property) from the deferred compensation plan.

Working under danger needs insurance to be pay on payroll

---

Publication 525 (2017), Taxable and Nontaxable Income

TRA ‘86 Clarification

The TRA ‘86 clarified that the deduction-timing rules for deferred compensation arrangements, apply to any plan or method of deferring compensation regardless of the Code section. Under which the amounts might otherwise be deductible, and that deductibility is governed (and where appropriate, allowable) by §404 and not by any other Code section (§404(a), §404(d) & §404A(a)). This clarification was necessary to prevent taxpayers from asserting that deferred compensation is attributable to capitalizable compensation expenses and, thereby, accelerate the timing of the deduction for such deferred compensation.

---

Thus, the tax position of the employer and the employee are reciprocal. The employer will normally only receive a deduction for the contribution to the non-qualified deferred compensation plan when the employee suffers taxation on the same amount. Benefit payments will be taxable to the employee only as and when received. See James F. Oates, 18 T.C. 570 (1953); Harold Johnson, 14 T.C. 560 (1950); J.D. Amend, 13 T.C. 178 (1949); and Frederick J. Wolfe, 8 T.C. 689 (1948). No deduction is allowed to the employer at the time the promise of future benefits is made to the employee.

Your low-cost Paystubs Generator.

No Difference in Cash or Accrual

Section 404(a)(5) permits the employer a deduction only when payments (or benefits) are received by the employee, no meter of whether the employer is on a cash or accrual basis of accounting (see also Sol Jacobs, Jr., 45 T.C. No. 10 (1965)). The language of §404(a)(5) is as follows:

 “In case that the plan is not qualified, the deduction may be taken only in the same taxable year, in which an amount attributable to the contribution is includable in the gross income of employees participating in the plan, but, in the case of a plan in which more than one employee participated only if separate accounts are maintained for each employee.”   IRS

Employee Benefits

Separate Accounts for Two or More Participants

Section 404(a)(5) provides that in a funded plan if more than one employee participates in the non-qualified plan, separate accounts must be kept for each to obtain the deduction. Remember also, in a funded plan the determining factor for the employer’s deduction is the time when the employee’s interest becomes nonprofitable since this constitutes receipt of the benefits equal to actual payment.

1,2,3 and it is done

Employer Deduction Traps

It would seem the delay of the tax deduction would be penalty enough, and the IRS would have no grounds to challenge the deduction when the employer finally takes it. However, there are several grounds on which the IRS could attack the deduction:

(1) The payments are not paid under a “plan;”

(2) The total compensation is unreasonable;

(3) The corporation is not contractually bound;

(4) The payments are “allocable” to tax-exempt income; and

(5) The payments are part of a “golden parachute” arrangement.

Income Tax on Employer Held Assets

If a company sets aside assets to brace itself against future liabilities, the

Earnings on those assets are usually taxable to the company. The company

might minimize the tax burden of carrying those assets by:

(1) Buying stock qualifying for the dividends-received deduction;

(2) Investing in municipal bonds or other tax-exempt securities; and

(3) Purchasing life insurance policies.

  Paystub Generator

Deferred Annuities

Employers frequently purchased deferred annuities to fund the employer’s obligation to provide their employees with non-qualified deferred compensation. Income credited to a deferred annuity contract was not currently included in the gross income of the owner of the contract. Under the TRA‘86, if an annuity contract is held by a person who is not a natural person, then the annuity contract is not treated as an annuity contract and the “income on the contract” (for any taxable year of the policyholder) is treated as ordinary income received or accrued by the owner during that taxable year (§72(u)(1)). Thus, the annuity’s inside buildup can no longer be used to accumulate tax-free investment earnings to pay out later as (deductible) deferred compensation. IRS 1   IRS 2

 Life Insurance & Disability Insurance Proceeds

Inclusion in Income Under §409A

Since 2005, new §409A provides comprehensive rules regarding the inclusion in the gross income of deferred compensation under non-qualified deferred compensation plans. 

The three requirements that must continuously be met to avoid early taxation plus a penalty and interest are:

(1) The distribution rule;

(2) The election rule; and

(3) The acceleration of benefits rule (i.e., under which the plan may not apply the acceleration of the time or schedule of any instalment, except as provided in regulations) Essentially, all amounts deferred under a non-qualified deferred compensation plan in tax years beginning after 2004, now become taxable when they are no longer subject to a substantial risk of forfeiture unless specific requirements are satisfied. The above effectively means that the distinction between funded and unfunded plans will no longer apply. This change in the law also appears to make the Rabbi trust a less attractive funding mechanism for non-qualified deferred compensation plans (§409A). Under §409A(a)(1)(A)(i), which was added by the 2004 Jobs Act, all amounts deferred under a non-qualified deferred compensation (NQDC) plan for all tax years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income, unless the plan:  https://www.irs.gov/pub/irs-drop/n-06-64.pdf

(1) meets the distribution, acceleration of benefit, and election requirements under §409A; and

(2)  §409A is operated by these requirements. If an NQDC plan is not in compliance with or does not operate in compliance with these rules at any time during a tax year (i.e., starting with the 2005 tax year and thereafter), all amounts deferred under the plan for that tax year and all preceding tax years, by any participant with respect to whom the failure relates, are included in gross income for that year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.

Life Insurance & Disability Insurance Proceeds 1

PAYS TUB MAKER  

The amount included in income also is subject to:

(1) interest (at the underpayment rate plus one percentage point) on the tax underpayments that would have occurred had the compensation been included in income for the tax year when first deferred, or if later, when not subject to a substantial risk of forfeiture;

(2) Additional income tax equal to 20% of the compensation required to be included in gross income.

Qualified deferred compensation plans (§409A). Under §409A(a)(1)(A)(i), which was added by the 2004 Jobs Act, all amounts deferred under a non-qualified deferred compensation (NQDC) plan for all tax years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income, unless the plan:  IRS

(1) meets the distribution, acceleration of benefit, and election requirements under §409A; and

(2) is operated by these requirements.

If an NQDC plan is not in compliance with or does not operate in compliance

With these rules at any time during a tax year (i.e., starting with the 2005 tax year and thereafter), all amounts deferred under the plan for that tax year and all preceding tax years, by any participant with respect to whom the failure relates, are included in gross income for that year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.

The amount included in income also is subject to:

(1) interest (at the underpayment rate plus one percentage point) on the tax underpayments that would have occurred had the compensation been included in income for the tax year when first deferred, or if later, when not subject to a substantial risk of forfeiture; and    IRS https://www.irs.gov/pub/irs-wd/07-0015.pdf

(2) Additional income tax equal to 20% of the compensation required to be included in gross income. 8-25

Thanks for reading, Paystubs team hope that you enjoyed learning about Non-Qualified Deferred Compensation 

  Paystub Generator

paystumbmakr.com team thanks you for a visit and reading this blog    Pays tub online       About pay stubs

Learn how to create your pay stub

paystubmakr.com