Nonqualified deferred compensation (NQDC) plans allow participants to set aside large amounts of tax-deferred compensation while enjoying the flexibility to schedule distributions to align with their financial goals. However, the plans also pose substantial risks. If your (or a prospective) employer offers an NQDC plan, or you’re considering one for your business, weigh the pros and cons carefully.

NQDC plans differ significantly from qualified defined contribution plans. The latter allows employers to contribute on their employees’ behalf and employees to direct a portion of their salaries into segregated accounts held in trust.

Qualified defined contribution plans also generally allow participants to direct the investment of their account balances among the plan’s investment options. The plans are subject to the applicable requirements of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code, including annual contribution limits, penalties for early withdrawals, required minimum distributions and nondiscrimination rules.

By contrast, an NQDC plan is simply an agreement with your employer to defer a portion of your compensation to a future date or dates. Many NQDC plans provide for matching or other employer contributions, while some permit only employer contributions. Employer contributions may be subject to a vesting schedule based on years of service, performance or the occurrence of an event (an IPO or sale, for example).

To avoid current taxation, NQDC plans may not be “funded,” and they can’t escape your employer’s creditors. The plan is secured only by your employer’s promise to pay. It’s possible to set aside funds in a special type of trust to ensure that your employer doesn’t use them for other purposes, but they remain subject to creditors’ claims.

Like qualified plans, NQDC plans allow you to defer income taxes on compensation until you receive it—although you may have to pay FICA taxes in the year the compensation is earned. NQDC plans also offer significant advantages over qualified plans. Depending on the specific plan’s limits and distribution rules, you may have no contribution limits, allowing you to set aside substantial amounts of wealth. Participants may also enjoy greater flexibility to schedule distributions to fund retirement, college expenses or other financial goals without penalty for distributions before age 59½ or required distributions at a certain age.

From an employer’s perspective, NQDC plans are attractive because they can be limited to highly compensated employees and they avoid the cost of compliance with ERISA’s reporting and administrative requirements. However, unlike contributions to qualified plans, deferred compensation isn’t deductible by the employer until it’s paid.

The biggest disadvantage of NQDC plans for participants is that deferred compensation is subject to the claims of the employer’s creditors and could be lost in the event of bankruptcy or insolvency. Also, you may not be able to take loans from the plan and can’t roll over distributions into an IRA, qualified plan or other retirement account. What’s more, there are limitations on the timing of deferral elections.

An NQDC plan offers attractive benefits, but it can be risky. Contact our firm to discuss how such a plan might affect your financial situation or whether it’s right for your company.

If you’re planning to sell capital assets at a loss to offset gains that have been realized during the year, it’s important to beware of the “wash sale” rule. Under this tax rule, if you sell stock or securities for a loss and buy substantially identical stock shares or securities back within the 30-day period before or after the sale date, the loss can’t be claimed for tax purposes.

The wash sale rule is designed to prevent taxpayers from benefiting from a loss without parting with ownership in any significant way. Note that the rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold. (If you participate in any dividend reinvestment plans, the wash sale rule may be inadvertently triggered when dividends are reinvested under the plan, if you’ve separately sold some of the same stock at a loss within the 30-day period.)

Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock. So, the disallowed amount can be claimed when the new stock is finally disposed of (other than in a wash sale).

Assume you buy 500 shares of XYZ Inc. for $10,000 and sell them on Nov. 5 for $3,000. On Nov. 29, you buy 500 shares of XYZ again for $3,200. Since the shares were “bought back” within 30 days of the sale, the wash sale rule applies. Therefore, you can’t claim a $7,000 loss. Your basis in the new 500 shares is $10,200: The actual cost plus the $7,000 disallowed loss.

If only a portion of the stock sold is bought back, only that portion of the loss is disallowed. So, in the above example, if you’d only bought back 300 of the 500 shares (60 percent), you would be able to claim 40 percent of the loss on the sale ($2,800). The remaining $4,200 loss that is disallowed under the wash sale rule would be added to your cost of the 300 shares.

The wash sale rule can come as a nasty surprise at tax time. Contact us for assistance.

As an employer, you know that year-end payroll processing and reporting is a complex undertaking that adds to the stress of closing the books for the year. To help ensure a smooth, error-free year and get the latest information register for this webinar with Accounting Services Manager Debbie Denny.

Debbie will address compliance issues of year-end payroll processing and reporting, and bring you up-to-date on the latest changes that affect the close of 2020 and the beginning of 2021. Topics covered in the two-hour webinar will include:

This calendar notes important tax deadlines for the fourth quarter of 2020:

Personal federal income tax returns for 2019 that received an automatic extension must be filed today and any tax, interest, and penalties due must be paid.

The third quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is due today and any undeposited tax must be deposited. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 10 to file the return.

If the monthly deposit rule applies, employers must deposit the tax for payments in October for Social Security, Medicare, withheld income tax and nonpayroll withholding.

Calendar-year corporations must deposit the fourth installment of estimated income tax for 2020.