WHEN MUST DEFERRALS BE MADE
TO HAVE A VALID NQDC PLAN?
Strict compliance with IRS Code Section 409A is mandatory.
If the IRS determines on an audit of your plan that there has been a failure of statutory compliance, all of the deferrals to-date will be subject to taxation as ordinary income and a 20% penalty will be imposed. This penalty is not imposed on the employer but instead is imposed on the service provider....which can be an employee or an independent contractor.
The last quarter of the year is the enrollment period nationally for most NQDC plans. The timing of a deferral election under section 409A must be made timely. Here is a summary of the governing rules:
“THE YEAR BEFORE THE YEAR RULE’
The deferral election must be made by the end of the calendar year before the year in which services are performed (i.e., The Year Before The Year Rule).
One exception to the Year Before The Year Rule is for NQDC plans that pay bonuses based on performance criteria (The Performance Plan Exception). This exception requires that the deferral election be made no later than six (6) months before the end of the performance period (June 30 for most plans).
The second exception to the Year Before The Year Rule is for first year participants (The First Year Eligibility Exception). This exception requires that individuals make their deferral election within 30 days of when they become eligible for the plan and applies to compensation earned after the deferral election.