[Federal Register Volume 61, Number 17 (Thursday, January 25, 1996)]
[Proposed Rules]
[Pages 2194-2214]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-715]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[EE-142-87]
RIN 1545-AF97


FICA Taxation of Amounts Under Employee Benefit Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under section 
3121(v)(2) of the Internal Revenue Code of 1986, relating to when 
amounts deferred under or paid from certain nonqualified deferred 
compensation plans are taken into account as ``wages'' for purposes of 
the employment taxes imposed by the Federal Insurance Contributions Act 
(FICA). The regulations provide guidance to taxpayers who must comply 
with section 3121(v)(2), which was added to the Code by section 324 of 
the Social Security Amendments of 1983.

DATES: Written comments and requests for a public hearing must be 
received by April 24, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (EE-142-87), room 5228, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (EE-
142-87), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: David N. Pardys, (202) 622-4606 (not a 
toll-free number), concerning the regulations, and Michael Slaughter, 
(202) 622-7190 (not a toll-free number), concerning submissions.

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Employment Tax 
Regulations (26 CFR part 31) under section 3121(v)(2) of the Internal 
Revenue Code of 1986 (the ``Code'') relating to the employment tax 
treatment of amounts deferred under or paid from certain nonqualified 
deferred compensation plans. These amendments are proposed to reflect 
the statutory changes made by section 324 of the Social Security 
Amendments of 1983 (the ``1983 Amendments''), which added section 
3121(v)(2) to the Code, and section 2662(f)(2) of the Deficit Reduction 
Act of 1984 (DEFRA), which amended section 324 of the 1983 Amendments.

Explanation of Provisions

    Sections 3101 and 3111 of the Code 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, and generally 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. Existing regulations (Sec. 31.3121(a)-2(a)) provide that 
FICA tax is imposed at the time the remuneration is actually or 
constructively paid.
    Prior to the 1983 Amendments, benefits under a nonqualified 
deferred 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 exceptions (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\

    \1\ The 1983 Amendments did not amend the definition of net 
earnings from self-employment under section 1402(a) of the Code or 
the timing of the tax on self-employment income under section 1401 
of the Code. 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 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, thus accelerating the imposition of FICA tax on benefits under a 
nonqualified deferred compensation plan.
    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 the attributable income. 

[[Page 2195]]

    Conversely, benefits under a nonqualified 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.
    Section 3121(a)(1) imposes a dollar limit on the annual amount of 
wages that is subject to the OASDI portion of FICA tax. Section 13207 
of the Omnibus Budget Reconciliation Act of 1993 repealed the dollar 
limit on annual wages subject to the HI portion of FICA tax, effective 
for 1994 and later years.

Overview of Regulations

    In contrast to most FICA wages, nonqualified deferred compensation 
is subject to FICA tax not when paid, but earlier--generally when the 
related services are performed. (FICA taxation is deferred if the 
compensation is subject to a substantial risk of forfeiture.) A benefit 
that was subject to FICA tax at this earlier date generally is not 
subject to tax again when paid to the participant. Applying these 
statutory rules often requires difficult valuations of future benefits.
    Recognizing the practical administrative problems that can be 
encountered by taxpayers in this area, the proposed regulations are 
designed to be workable, to minimize complexity, and to provide 
appropriate flexibility for taxpayers. For example, the regulations:
     Permit use of any reasonable assumptions. For the purpose 
of calculating the present value of a benefit earned in a given year 
(an ``amount deferred'' under the statute), the regulations do not 
prescribe specific actuarial assumptions or methods that must be used. 
Instead, the regulations simply allow taxpayers to determine present 
value using any reasonable actuarial assumptions and methods.
     Establish a reasonably ascertainable rule. In some cases, 
uncertainties pertaining to future benefits make it especially 
difficult to determine the present value of a benefit (for example, 
where a benefit can fluctuate depending on the varying amount of a 
qualified plan benefit). In such cases, under the regulations, the 
present value of the benefit need not be included in FICA wages 
(``taken into account'') until it becomes reasonably ascertainable.
     Provide flexibility with respect to withholding. The 
regulations ease the administrative burdens of withholding by 
permitting payors to delay the inclusion of any deferred compensation 
in wages until the end of the year. In addition, where amounts deferred 
cannot be readily calculated by year-end, the payor may either estimate 
the amounts (and make later adjustments without interest or penalties) 
or postpone the inclusion in wages until the first quarter of the 
following year.
     Provide reasonable, good faith transition relief. The 
regulations provide transition relief for actions taken before the 
effective date of the regulations based on a reasonable, good faith 
interpretation of the statute.

Structure of the Regulations

    The regulations generally consist of three parts. The first part of 
the regulations, paragraphs (a) and (b), describes the special timing 
rule and the related nonduplication rule of section 3121(v)(2), defines 
a nonqualified deferred compensation plan, and specifies the types of 
benefits that are subject to the special timing rule. The second part 
of the regulations, paragraphs (c), (d), and (e), describes how the 
special timing rule and the nonduplication rule operate. In the 
remainder of the regulations, paragraph (f) provides withholding rules, 
paragraph (g) contains the regulatory effective date and the transition 
rules, and Sec. 31.3121(v)-2 sets forth the statutory effective dates.
    The most significant items included in these regulations are 
discussed below.

Definition of Nonqualified Deferred Compensation Plan

    In general. Section 3121(v)(2)(C) of the Code defines a 
``nonqualified deferred compensation plan'' as any plan or arrangement 
established and maintained by an employer for one or more of its 
employees that provides for the deferral of compensation, other than a 
plan described in section 3121(a)(5) (such as qualified plans and 
certain other plans and arrangements). The regulations provide that a 
``nonqualified deferred compensation plan'' is a plan that is 
``established'' by an employer for one or more of its employees, and 
that provides for the ``deferral of compensation.'' A plan may 
constitute a nonqualified deferred compensation plan under section 
3121(v)(2), regardless of whether it is an employee benefit plan under 
section 3(3) of the Employee Retirement Income Security Act of 1974, as 
amended (ERISA), whether deferrals under the plan are made pursuant to 
the employee's election, or whether the amounts deferred are treated as 
deferred for income tax purposes.
    Requirement that the plan be established. The regulations provide 
that an amount deferred may not be taken into account as FICA wages 
before the plan is established, and that a plan is considered 
``established'' on the latest of the date on which the plan is adopted, 
the date on which it is effective, or the date on which its material 
terms are set forth in writing. Transition relief is provided for 
unwritten plans that were adopted and effective before March 25, 1996. 
Such a plan is treated as established with respect to an employee as of 
the later of the date on which it was adopted or became effective, 
provided that it is set forth in writing within six months after 
publication of the final regulations.
    Requirement that the plan provide for the deferral of compensation. 
In general, the regulations specify that a plan provides for the 
``deferral of compensation'' only if an employee has a legally binding 
right to compensation that has not been actually or constructively 
received and that is payable in a later year. However, the regulations 
provide that there is no ``deferral of compensation'' merely because 
compensation is paid after the last day of a calendar year pursuant to 
the employer's customary payment scheme for compensation. Thus, if one 
week of an employer's customary two-week payroll period falls in one 
year and the second week of the period falls in the next year, the 
compensation paid at the end of the two-week period on account of the 
services rendered in the first week is not considered deferred 
compensation and is not subject to the special timing rule.
    The regulations also provide a rule of administrative convenience 
for ``short-term'' deferrals. Under this rule, an employer may choose 
to treat an amount that is deferred from one calendar year to a date 
that is no more than a brief period of time after the end of that 
calendar year as if it were subject to the general timing rule (i.e., 
treated as FICA wages when actually or constructively paid) instead of 
the special timing rule.
    Plans, arrangements, and benefits that do not provide for the 
deferral of compensation. Consistent with the legislative history 
relating to section 3121(v)(2), certain types of plans, arrangements, 
and benefits are not covered by the special timing rule of section 
3121(v)(2), even though they may be viewed in other contexts as 
providing for the deferral of compensation.
    The regulations provide that stock options, stock appreciation 
rights (described in Revenue Ruling 80-300, 1980-2 C.B. 165), and 
certain other stock-related rights do not provide for the deferral of 
compensation for FICA tax purposes, even though there may be no amount 
recognized for income tax 

[[Page 2196]]
purposes until after the calendar year of grant. In contrast, the 
regulations specify that a ``phantom'' stock plan that awards a right 
to a fixed payment equal to the value of a specified number of shares 
of employer stock may be treated as providing benefits that result from 
the deferral of compensation for purposes of section 3121(v)(2). Such a 
plan typically involves the employer's unfunded, unsecured promise to 
pay compensation in the future that is measured by the value of a 
specified number of shares of stock on the date of payment. A phantom 
stock plan is a nonqualified deferred compensation plan under which the 
earnings portion of the future compensation is based on the change in 
the value of the employer's stock, rather than, for example, an equity 
mutual fund or a specified rate of interest.
    The regulations provide that certain welfare benefits, including 
vacation benefits, sick leave, compensatory time, disability pay, 
severance pay, and death benefits, do not result from the deferral of 
compensation for FICA purposes. Neither section 3121(v) nor the 
legislative history relating to section 3121(v) indicates that Congress 
intended to modify the long- established FICA tax treatment of such 
benefits.
    Nothing in the regulations is intended to determine the amount or 
the timing of an employer's deduction for contributions to any type of 
welfare benefit plan, including a plan that provides severance 
benefits. Similarly, although the regulations include a severance pay 
plan under a heading titled ``certain welfare benefits,'' no inference 
is intended that a severance plan is treated as a welfare benefit plan 
under any other section of the Code.
    The regulations provide that certain other payments are not subject 
to the special timing rule of section 3121(v)(2). In describing the 
Senate Finance Committee proposal on golden parachutes, the Conference 
Report to DEFRA states that ``payments under golden parachute 
contracts, like termination pay, are to be subject to FICA taxes when 
paid.'' (Emphasis added.) Conf. Rpt. 98-861, p. 85. Consistent with 
this legislative history, the regulations provide that excess golden 
parachute payments and window benefits do not result from the deferral 
of compensation and, thus, are not subject to the special timing rule.
    Similarly, certain benefits established within 12 months prior to 
an employee's termination of employment are treated as termination pay 
that is not subject to the special timing rule. This provision is 
intended to ensure that termination pay is subject to FICA tax when it 
is paid, even where there is no explicit agreement to terminate 
employment. The regulations provide that a benefit established within 
12 months prior to an employee's termination of employment is treated 
as termination pay only if the facts and circumstances indicate that 
the benefit was provided in contemplation of the employee's impending 
termination of employment.
    Benefits established after termination of employment also do not 
result from the deferral of compensation. In addition, there is no 
deferral of compensation where the facts and circumstances indicate 
that the compensation is paid for current services.

Determination of the Amount Deferred

    The ``amount deferred'' under a nonqualified deferred compensation 
plan for a period is the amount that must be taken into account as 
wages for that period under the special timing rule of section 
3121(v)(2)(A). Under the regulations, the manner in which the amount 
deferred for a period is determined depends upon whether the 
nonqualified deferred compensation plan is an account balance plan or a 
nonaccount balance plan.
    Account balance plans. The regulations provide that, if benefits 
for an employee are provided under an account balance plan, the amount 
deferred equals the principal amount credited to the employee's account 
for the period, increased or decreased by any income attributable to 
that amount through the date such amount is required to be taken into 
account as FICA wages. For purposes of the regulations, a nonqualified 
deferred compensation plan is an ``account balance plan'' only if, 
under the terms of the plan, (1) principal amounts are credited to an 
individual account for an employee, (2) the income attributable to the 
principal amounts is credited (or debited) to the individual account, 
and (3) the benefits payable to the employee are based solely on the 
balance credited to the individual account.
    Nonaccount balance plans. If a nonqualified deferred compensation 
plan is not an account balance plan, the regulations provide that the 
amount deferred for a period equals the present value of the additional 
future payments to which the employee has obtained a legally binding 
right during that period. For purposes of determining present value, 
the regulations give employers the flexibility to use any reasonable 
actuarial assumptions and methods.

``Taken Into Account'' Defined

    An amount deferred is treated as ``taken into account'' when it is 
included in computing the amount of FICA wages, but only if any 
additional FICA tax for the year (including any interest and penalties 
due if the payment is late) that results from the inclusion is actually 
paid before the period of limitations is closed for the year. For years 
before 1994, the amount deferred is treated as taken into account even 
if its inclusion does not result in any additional FICA tax liability. 
For example, if, in 1993, an employee participating in a nonqualified 
deferred compensation plan had other wages that were at least equal to 
the applicable OASDI and HI wage bases for 1993, the inclusion in wages 
of an amount deferred would not have resulted in any additional FICA 
tax liability for that year. Nonetheless, the amount deferred would 
have been considered taken into account as wages for purposes of 
section 3121(v)(2).

Nonduplication Rule

    As noted above, under the nonduplication rule of section 
3121(v)(2)(B), if an amount deferred is taken into account as wages 
under the special timing rule, neither the amount deferred nor the 
related income is included in FICA wages when benefits attributable to 
that amount are paid.
    If an amount deferred is not taken into account as wages under the 
special timing rule, then benefits attributable to that amount are 
required to be included as wages when actually or constructively paid 
in accordance with the general timing rule. For this purpose, a Form W-
2 (Wage and Tax Statement) for an earlier (post-1993) year showing FICA 
wages in excess of taxable income for the year and an explanation 
showing that the payment is attributable to the excess could, for 
example, be used by a taxpayer to demonstrate that the payment is 
attributable to an amount deferred that was previously taken into 
account as wages under the special timing rule. If a payment is 
attributable to an amount deferred only a portion of which was 
previously taken into account, the portion of the payment that is 
excluded from wages pursuant to the nonduplication rule and the portion 
that is included in wages under the general timing rule are generally 
determined on a pro rata basis.

Income Attributable to an Amount Deferred

    Account balance plans. In the case of an account balance plan, the 
regulations 

[[Page 2197]]
define ``income attributable to the amount taken into account'' as any 
increase or decrease in the amount credited to an employee's account 
that, under the terms of the plan, is attributable to an amount 
previously taken into account, but only if the income is based on a 
rate of return that does not exceed either (1) the actual rate of 
return on a predetermined actual investment, or (2) if no predetermined 
actual investment has been specified, a reasonable rate of interest. If 
the rate of return credited under the plan is not reasonable, the 
income attributable to the amount taken into account is limited to the 
mid-term applicable federal rate (as defined in section 1274(d)) for 
the first day of the calendar year (the ``AFR''). However, in the case 
of a predetermined actual investment, if the actual rate of return on 
that investment is lower than the AFR, the income attributable to the 
amount taken into account is limited to the that actual rate of return. 
Any excess of the income credited under the plan over the income 
determined using the AFR (or the actual rate of return, if applicable) 
is considered an additional amount deferred in the year credited, and 
is required to be taken into account in that year under the special 
timing rule.
    Nonaccount balance plans. In the case of a nonaccount balance plan, 
the regulations define the ``income attributable to the amount taken 
into account'' as the increase, due solely to the passage of time, in 
the present value of any future payments to which the employee has 
obtained a legally binding right, determined using reasonable actuarial 
assumptions and methods. Thus, if an amount deferred for a period is 
determined using a reasonable interest rate and other reasonable 
actuarial assumptions and methods, and that amount is taken into 
account when required under the special timing rule, none of the future 
payments attributable to that amount will be subject to FICA tax when 
paid.
    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 the application of the AFR and, if 
applicable, the applicable mortality table under section 417(e) of the 
Code, both determined as of January 1 of the calendar year in which the 
amount was taken into account. If the present value of the future 
benefit payments (determined using the AFR and the section 417(e) 
mortality table) exceeds the amount taken into account plus 
attributable income (as limited by using those same assumptions), a 
portion of each benefit payment will be excluded from wages under the 
nonduplication rule and a portion will be included in wages under the 
general timing rule.

Time Amounts Deferred Are Taken Into Account

    Under the special timing rule, an amount deferred is required to be 
taken into account as FICA wages as of the later of when (1) the 
services are performed or (2) the right to the amount deferred is no 
longer subject to a substantial risk of forfeiture. However, the 
regulations allow an amount deferred to be taken into account at a 
later date if all or a portion of the amount deferred is not 
``reasonably ascertainable'' until that later date. In addition, 
consistent with Notice 94-96, 1994-2 C.B. 564, the regulations provide 
that no amount deferred under a nonqualified deferred compensation plan 
may be taken into account as FICA wages before the plan is established.
    Services creating the right to an amount deferred. The regulations 
provide that services creating the right to an amount deferred are 
considered performed when, under the terms of the plan and the relevant 
facts and circumstances, the employee has performed all of the services 
necessary to obtain a legally binding right to the amount deferred, 
disregarding any substantial risk of forfeiture.
    Substantial risk of forfeiture. In accordance with the legislative 
history relating to section 3121(v)(2), the regulations define a 
substantial risk of forfeiture for purposes of the special timing rule 
of section 3121(v)(2) in accordance with the principles of section 83. 
Thus, in general, whether or not a substantial risk of forfeiture 
exists will depend on the facts and circumstances. See Sec. 1.83-3(c) 
of the regulations.
    Amounts deferred that are not reasonably ascertainable. A number of 
commentators have emphasized the problems that would arise if certain 
amounts deferred were required to be taken into account while still 
highly uncertain and subject to fluctuation. For example, under a 
nonaccount balance plan, an amount deferred (and taken into account as 
wages) for a year might decrease, or even be eliminated, in a later 
year on account of changes in the limitations on contributions and 
benefits imposed on qualified plans under section 401(a)(17) or 415, 
the amount of an employee's future compensation, the date on which 
payments commence, or the form of benefit elected by an employee. (The 
possibility that benefits may decrease because of these contingencies 
does not, however, generally cause the benefits to be subject to a 
substantial risk of forfeiture within the meaning of section 83 or, 
therefore, section 3121(v)(2).)
    Because these types of contingencies generally cannot be predicted 
with a high degree of certainty for an individual employee, the 
regulations provide that an amount deferred under a nonaccount balance 
plan is not required to be taken into account as wages until the 
earliest date on which the amount deferred is reasonably ascertainable 
(the ``resolution date''). An amount deferred is ``reasonably 
ascertainable'' when there are no actuarial or other assumptions needed 
to determine the amount deferred, other than interest, mortality, or 
cost-of-living assumptions.
    Thus, for example, if assumptions relating to qualified plan offset 
variables, future pay, or the time or form of benefit payments are 
needed to determine the amount deferred at the time the services are 
performed (or, if applicable, when the benefit is no longer subject to 
a substantial risk of forfeiture), the employer may choose to delay 
taking the amount deferred into account until the only assumptions 
needed to determine the amount deferred are those relating to interest, 
mortality, and cost of living. An employer may choose to use this rule 
for all of an amount deferred, even if only a portion of the amount 
deferred is not reasonably ascertainable. For example, if the only 
portion of an amount deferred that is not reasonably ascertainable is 
an early retirement subsidy, no portion of the amount deferred is 
required to be taken into account until the contingency relating to 
early retirement has been resolved.
    On the resolution date, the amount deferred and the related income 
must be determined in accordance with the rules that generally apply to 
determine those amounts under a nonaccount balance plan. The rules that 
generally apply to determine whether an amount deferred is actually 
taken into account as wages, and the consequences if it is not so taken 
into account, also apply.
    An employer may choose to take an amount into account on a date 
(the ``early inclusion date'') that precedes the resolution date. 
However, if the amount taken into account at the early inclusion date 
(plus related income through the resolution date) is less than the 
resolution date amount, then the employer must ``true up'' by taking 
the balance of the resolution date amount into account as of the 
resolution date. If the amount taken into account at the early 
inclusion date (plus related income) exceeds the resolution date 

[[Page 2198]]
amount, the taxpayer may claim a refund or credit, in accordance with 
sections 6402 and 6413, for any overpayment of FICA tax in open years.
    Rule of administrative convenience. The regulations provide that an 
employer may treat an amount deferred as required to be taken into 
account on a 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. Thus, for example, if an employee obtains a 
legally binding right to an amount deferred mid-year, the employer may 
take the amount deferred into account on any later date within the same 
year (e.g., December 31).

Withholding

    For purposes of withholding and depositing FICA tax, 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 year by December 31 of 
that year. The regulations provide two alternative methods for 
withholding and depositing FICA tax in these situations.
    Under the ``estimated method,'' an employer may treat a reasonably 
estimated amount as wages paid on the last day of the calendar year 
(the ``first year''). 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 choose to 
treat the shortfall as wages either in the first year or in the first 
quarter of the next year. If the employer treats the shortfall as wages 
in the first year and the shortfall was not included on the employee's 
Form W-2, the employer must issue Form W-2c. In addition, the employer 
must correct the information on the Form 941 for the last quarter of 
the first year. In such a case, the shortfall will not be considered a 
late deposit subject to penalty if it is deposited by the employer's 
first regular deposit date following the first quarter of the next 
year. Conversely, if the employer overestimates the amount deferred 
that should have been taken into account as wages on the last day of 
the year, the employer may claim a refund or credit in accordance with 
sections 6402 and 6413.
    Under the second alternative method, the ``lag method,'' an 
employer may calculate the end-of-year amount deferred on any date in 
the first quarter of the next calendar year. The amount deferred will 
be treated as wages on that date, and the amount deferred that would 
otherwise have been taken into account on the last day of the year must 
be increased by income through the date on which the amount is taken 
into account.

Effective Date of the Regulations

    Proposed effective date. These regulations generally are proposed 
to be effective for amounts deferred and benefits paid on or after 
January 1, 1997.
    Consistent with Notice 94-96, the regulations confirm that, in 
determining FICA tax liability for amounts deferred and benefits paid 
before the effective date of the regulations, an employer may rely on a 
reasonable, good faith interpretation of section 3121(v)(2) (which, of 
course, includes a determination in accordance with the regulations). 
Thus, for any open year, an employer can choose to adjust its FICA tax 
determination in a manner consistent with the regulations. For example, 
if an employer took into account an amount deferred under a nonaccount 
balance plan in 1994, but that amount was not reasonably ascertainable 
within the meaning of these regulations, the employer may apply for a 
refund or credit for any FICA tax paid on that amount in 1994 and, 
instead, take the amount deferred into account when it becomes 
reasonably ascertainable. In addition, consistent with Notice 94-96, an 
employer's treatment of amounts deferred under a plan will not be 
considered to be in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if the employer treats the amounts 
as taken into account before the plan is established.
    Transition rules. The regulations provide four transition rules, 
which apply only if the taxpayer's determination of FICA tax treatment 
was based on a reasonable, good faith interpretation of section 
3121(v)(2).
    Under the first transition rule, if a plan is not a nonqualified 
deferred compensation plan under the regulations but was treated as 
such by the employer before the effective date of the regulations, no 
additional FICA tax will be owed on pre-effective date payments. 
However, on or after the regulatory effective date, benefits actually 
or constructively paid under the plan must be taken into account as 
FICA wages under the general timing rule. If FICA tax was actually paid 
on the amounts that were taken into account under section 3121(v)(2) 
before the regulatory effective date, the employer may claim a refund 
or credit for FICA tax paid for open years in accordance with sections 
6402 and 6413, to the extent that the FICA tax paid exceeds the FICA 
tax that would have been owed on benefit payments if those payments had 
been subject to FICA tax when paid.
    The second transition rule applies to a plan that is a nonqualified 
deferred compensation plan under the regulations but that was not 
treated as such before the regulatory effective date. Under this 
transition relief, post-effective date benefit payments will not be 
subject to FICA tax when paid if they are attributable to amounts that 
would have been required to be taken into account under section 
3121(v)(2)(A) in a year that is closed as of the regulatory effective 
date. This rule does not apply to amounts deferred that are required to 
be taken into account in years that are open as of the effective date. 
Amounts deferred in those open years will be treated as having been 
taken into account for purposes of applying the nonduplication rule to 
post-effective date benefit payments only if actually taken into 
account in accordance with these regulations.
    The third transition rule provides relief where the pre-effective 
date amount deferred under a nonaccount balance plan was determined in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2), but that amount was less than the amount deferred as 
determined under these regulations. In this case, no additional FICA 
tax will be owed for the pre- effective date period. In addition, when 
applying the nonduplication rule to the post-effective date benefit 
payments, the shortfall between the amount that was taken into account 
in a year closed as of the regulatory effective date and the amount 
that would have been required to be taken into account in that year 
under the regulations will be treated as if it had actually been taken 
into account under the special timing rule.
    The fourth transition rule applies to a situation in which an 
amount deferred was taken into account as FICA wages before the 
regulatory effective date, but, under the regulations, that amount 
deferred would have been taken into account on or after the effective 
date. In this case, for periods after the effective date, the employer 
must determine the amount deferred, and the time when the amount 
deferred should be taken into account as wages, in accordance with the 
regulations. However, the employer may claim a refund or credit, in 
accordance with sections 6402 and 6413, for any overpayment of FICA tax 
in open years. 

[[Page 2199]]


Statutory Effective Date

    Section 3121(v)(2) is generally effective for amounts deferred and 
benefits paid after December 31, 1983. However, the 1983 Amendments 
provide, in the case of an agreement in existence on March 24, 1983 
between a nonqualified deferred compensation plan and an individual, 
that the 1983 Amendments (and section 3121(v)(2)) apply only with 
respect to services performed after 1983. Accordingly, amounts deferred 
that relate to services performed before 1984 are subject to the 
general timing rule and the definition of wages in section 3121(a) as 
in effect on April 19, 1983 (including the retirement-related 
exclusions), and are not subject to the special timing rule. DEFRA 
amended the 1983 Amendments to provide further that amounts deferred 
under an agreement adopted after March 24, 1983 (but before 1984) that 
relate to pre-1984 services may, at the payor's election, be taken into 
account as wages either when paid or in accordance with section 
3121(v)(2).
    The regulations provide guidance on these statutory effective dates 
and rules for distinguishing benefits relating to pre-1984 services 
from those relating to post-1983 services. In determining the portion 
of total benefits that represents such pre-1984 benefits and the 
portion of each pre-regulatory-effective-date benefit payment that 
consists of such pre-1984 benefits, employers may use any reasonable 
allocation method that is consistent with the terms of the plan. 
Employers must treat payments made on or after the regulatory effective 
date as consisting of pro-rata portions of pre-1984 and post-1983 
benefits, unless such an allocation is inconsistent with the terms of 
the plan.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations and, therefore, a Regulatory Flexibility 
Analysis is not required. Pursuant to section 7805(f), this notice of 
proposed rulemaking will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by a person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these regulations is David N. Pardys, 
Office of the Associate Chief Counsel (Employee Benefits and Exempt 
Organizations), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social Security, 
Unemployment tax, Withholding.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 31 is proposed to be 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) of the Internal Revenue Code generally is taken into 
account for purposes of the Federal Insurance Contributions Act (FICA) 
taxes imposed under sections 3101 and 3111 of the Internal Revenue Code 
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 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 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).
    (v) Remuneration that does not constitute wages. If remuneration 
deferred 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 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 

[[Page 2200]]
example, benefits under a death benefit plan described in section 
3121(a)(13) of the Internal Revenue Code do not constitute wages for 
FICA 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--(i) 
Defined. For purposes of this section, the term ``nonqualified deferred 
compensation plan'' means any plan or other arrangement 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), other than a plan described in section 3121(a)(5). A 
nonqualified deferred compensation plan may be adopted unilaterally by 
the employer or may be negotiated between 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, as amended.
    (ii) Plan includes plan or other arrangement. 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, or the date on 
which the material terms of the plan are set forth in writing. For 
purposes of this section, a plan also 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, satisfies the requirements 
of paragraph (b)(2)(i) of this section.
    (iii) Transition rule. For purposes of this section, an unwritten 
plan that is 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 it is set forth in 
writing not later than [Date that is six months after the date of 
publication of final regulations in the Federal Register].
    (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 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. 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 a 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) of the Internal Revenue Code.
    (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 no 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. Amounts received as a result of a stock option, or as a result 
of a stock appreciation right or other stock value right, do not result 
from the deferral of compensation for purposes of section 3121(v)(2). 
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 

[[Page 2201]]
plan under which an employee obtains a legally binding right to receive 
property (whether or not the property is restricted property) in the 
future 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. 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). Benefits provided under a severance pay plan that 
is not an employee pension benefit plan pursuant to 29 CFR 2510.3-2(b) 
are considered ``severance pay'' for purposes of this paragraph 
(b)(4)(iv). If a plan is an employee pension benefit plan pursuant to 
29 CFR 2510.3-2(b), then whether benefits payable upon an employee's 
termination of employment are considered severance pay for purposes of 
this paragraph (b)(4)(iv) depends upon the relevant facts and 
circumstances. Notwithstanding the preceding sentence, a plan that is 
an employee pension benefit plan pursuant to 29 CFR 2510.3-2(b) is in 
all cases considered to provide severance pay for purposes of this 
paragraph (b)(4)(iv) if benefits payable under the plan upon an 
employee's termination of employment are payable only if that 
termination is involuntary.
    (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 
(b)(4)(v)(C) of this section do not result from a 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), 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.
    (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 benefit or the plan providing the benefit; 
and
    (2) The facts and circumstances indicate that the benefit or plan 
is established in contemplation of the employee's impending termination 
of employment.
    (vi) Benefits established after termination of employment. 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).
    (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) may be illustrated by the 
following examples:

    Example 1. (i) In December of 1997, Employer M tells Employee A 
that, if specified goals are satisfied for 1998, Employee A will 
receive a bonus on July 1, 1999 equal to a specified percentage of 
1998 compensation. Because Employee A meets the specified goals, 
Employer M pays the bonus to Employee A on July 1, 1999, 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) Employer N establishes a compensation arrangement 
for Employee B in 1997. Before the beginning of 1998, Employee B and 
Employer N enter into a legally binding salary reduction agreement 
to defer a specified percentage of Employee B's salary that would 
otherwise be payable in 1998. The amounts deferred remain a general 
asset of Employer N, and are payable in 2008.
    (ii) Employee B has a legally binding right during 1998 to an 
amount of compensation 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 O 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, 
1999 to increase benefits, and the amendment provides that the 
increase in benefits is on account of Employee C's performance of 
services for Employer O from 1985 through 1998.
    (ii) The additional benefits that resulted from the plan 
amendment cannot be taken into account as amounts deferred for 1985 
through 1998, 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 plan, as amended, 
is set forth in writing.
    Example 4. (i) In 1997, Employer P, 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)(i) 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 
P 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 

[[Page 2202]]
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 P is excluded from the definition of employment under 
section 3121(b)(7).
    Example 5. (i) In 1997, Employer Q establishes a plan that 
provides for bonuses to be paid to employees based on a specified 
formula that takes into account the employees' performance for 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 Q may choose, pursuant to paragraph (b)(3)(iii) 
of this section, to treat the bonuses as if they are not subject to 
the special timing rule of paragraph (a)(2)(ii) of this section.
    Example 6. (i) Employer R 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 a bonus until January of the year in which the bonus is paid, any 
bonus paid under the plan in that year will not be considered 
deferred from the preceding calendar year, and the plan will not be 
treated as providing for the deferral of compensation within the 
meaning of paragraph (b)(3)(i) of this section.
    Example 7. (i) Employer S 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 1997 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 2006. The 
options do not have a readily ascertainable fair market value for 
purposes of section 83 at the date of grant, and shares issued upon 
the exercise of the options are not subject to a substantial risk of 
forfeiture within the meaning of section 83. In 2002, when the fair 
market value of a share of employer stock is $100, Employee D 
exercises an option to acquire 1,000 shares.
    (ii) Under paragraph (b)(4)(ii) of this section, amounts 
received as a result of a stock option do not result from the 
deferral of compensation for purposes of section 3121(v)(2). Thus, 
the $50,000 spread between the amount paid for the shares ($50,000) 
and the fair market value of the shares on the date of exercise 
($100,000) is taken into account as wages for FICA 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 $55,000 
spread between the amount paid for the shares ($45,000) and the fair 
market value of the shares on the date of exercise ($100,000) would 
similarly be taken into account as wages for FICA 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, 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 plan which provides for 
payments solely upon an employee's dismissal from employment, death, 
or disability. 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) 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) On January 1, 1997, Employer V establishes a 
plan that covers only Employee E, 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 E's termination of employment at 
any time, he will receive $200,000 per year for each of the 
immediately succeeding five years. Employee E terminates employment 
on March 1, 1997.
    (ii) Because Employee E 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 11. (i) Employer W establishes a plan on January 1, 1998 
to supplement the qualified retirement benefits of recently hired 
55-year- old Employee F who forfeited retirement benefits with her 
former employer in order to accept employment with Employer W. The 
plan provides that Employee F will receive $50,000 per year for life 
beginning at age 65, regardless of when she terminates employment. 
On April 15, 1998, Employee F unexpectedly terminates employment.
    (ii) The facts and circumstances indicate that the plan was not 
established in contemplation of impending termination. Thus, even 
though Employee F 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 12. (i) Employer X 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 G is 
planning to (and actually does) retire within six months of the date 
on which the plan is established.
    (ii) Even though Employee G terminated employment within 12 
months of the establishment of the plan, the plan is not considered 
to have been established in connection with Employee G's impending 
termination within the meaning of paragraph (b)(4)(v) of this 
section because the facts and circumstances indicate otherwise.
    Example 13. (i) Employee H owns 100 percent of Employer Y, a 
corporation that provides consulting services. Substantially all of 
Employer Y's revenue is derived as a result of the services 
performed by Employee H. In each of 1997, 1998, and 1999, Employer Y 
has gross receipts of $180,000 and expenses (other than salary) of 
$80,000. In each of 1997 and 1998, Employer Y pays Employee H a 
salary of $100,000 for services performed in each of those years. On 
December 31, 1998, Employer Y establishes a plan to pay Employee H 
$80,000 in 1999. The plan recites that the payment is in recognition 
of prior services. In 1999, Employer Y pays Employee H 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 H in 1999 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 1999 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 

[[Page 2203]]
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. A 
nonqualified deferred compensation plan is an account balance plan for 
purposes of this section only if, under the terms of the plan, 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. 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.
    (ii) Income defined. 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.
    (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) Bifurcation permitted. An employer may treat a portion of a 
nonaccount balance plan as a separate account balance plan if that 
portion satisfies the requirements of paragraph (c)(1) of this section 
and the amount payable to employees under that portion is determined 
independently of the amount payable under the other portion of the 
plan.
    (iii) 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)(1) of this section using actuarial 
assumptions and methods that are reasonable as of that date. For this 
purpose, a discount for pre-retirement mortality is permitted, but only 
to the extent that benefits will be forfeited upon death. In addition, 
the present value cannot be discounted for the risk 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.
    (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)(A) of this section and 
the resolution date amount described in paragraph (e)(4)(ii) of this 
section are determined separately with respect to each amount deferred.
    (4) Examples. This paragraph (c) may be illustrated by the 
following examples:

    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 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 (a) 2 percent for each year of service and (b) Employee C's 
highest average annual compensation for a three-year period. The 
plan also provides that, if Employee C 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, 1998, Employee C has 25 years of service and high three-year 
average compensation of $100,000 (the average for the years 1996-
98). As of December 31, 1999, Employee C is age 61, has 26 years of 
service, and has high three-year average compensation of $104,000. 
As of December 31, 2000, Employee C is age 62, has 27 years of 
service, and has high three-year average compensation of $105,000. 
The assumptions that Employer O uses to determine the amount 
deferred for 1999 (a 7 percent interest rate and, for the period 
after commencement of benefits, the GAM 83 (male) mortality table) 
and for 2000 (a 7.5 percent interest rate and, for the period after 
commencement of benefits, the GAM 83 (male) mortality table) are 
assumed, solely for purposes of this example, to be reasonable 
actuarial assumptions.
    (ii) As of December 31, 1998, 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, 1999, 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 1999, 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 1999 is the present value, as of December 31, 1999, of 
these additional payments, which is $27,426 ($4,080 x the 

[[Page 2204]]
present value factor for a deferred annuity payable at age 65, using 
the specified actuarial assumptions). Similarly, during 2000, 
Employee C has earned a legally binding right to additional lifetime 
payments of $2,620 (2 percent x 27 years x $105,000-$54,080) per 
year beginning at age 65. The amount deferred for 2000 is the 
present value, as of December 31, 2000, of these additional 
payments, which is $18,149 ($2,620 x the present value factor for a 
deferred annuity payable at age 65, using the specified actuarial 
assumptions).

    (d) Amounts taken into account and income attributable thereto--(1) 
Taken into account--(i) Taken into account defined. 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 no later than the expiration of the 
applicable period of limitation for the year 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) or 
Hospital Insurance (HI) portions of FICA for the year, no portion of 
the amount deferred will actually result in additional OASDI or HI tax, 
respectively. 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 benefits 
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 on 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 only a portion of an amount deferred 
(as determined under paragraph (c) of this section) is taken into 
account, then a portion of each benefit payment attributable to that 
amount deferred 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 when the attributable 
benefits commence 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) and denominator of 
which is the present value of the future benefit payments attributable 
to the amount deferred. If the amount deferred was determined using 
reasonable actuarial assumptions, the present value is determined using 
those assumptions.
    (2) Income attributable to the amount taken into account--(i) 
Account balance plans. 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) 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 is based on a rate of return that does not exceed 
either the actual rate of return on a predetermined actual investment 
(whether or not assets associated with the plan or the employer are 
actually invested therein) or, if no predetermined actual investment 
has been specified for the period, a reasonable rate of interest. For 
purposes of this paragraph (d)(2)(i), 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). The actual rate of return includes 
any decrease as well as any increase in the value of the investment.
    (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, 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 current 
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. If, 
under an account balance plan, the rate of interest credited is not 
reasonable, as determined by the Commissioner, or the rate of return 
credited otherwise exceeds the applicable limitation in paragraph 
(d)(2)(i) of this section, then the income attributable to the amount 
taken into account is limited to the income that would result from 
application of the mid-term applicable federal rate (as defined 
pursuant to section 1274(d)) for January 1 of the calendar year, 
compounded annually (the ``AFR''). However, in the case of a 
predetermined actual investment, if the actual rate of return on that 
investment is lower than the AFR, then the income attributable to the 
amount taken into account is limited to the income that would result 
from application of that actual rate of return. Any excess of the 
income credited under the plan over the income determined using the AFR 
(or, if applicable, the actual rate of return) is considered an 
additional amount deferred in the year the income is credited, and is 
required to be taken into account under the special timing rule of 

[[Page 2205]]
paragraph (a)(2) of this section. If the excess is not taken into 
account as an additional amount deferred in the year credited, then, 
pursuant to paragraph (d)(1)(ii) of this section, the excess and any 
income attributable to the 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 that paragraph, 
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 the amount deferred was taken into account.
    (3) Examples. This paragraph (d) may be illustrated by the 
following examples:

     Example 1. (i) In 1997, Employer M establishes a nonqualified 
deferred compensation plan for Employee A under which all benefits 
are 100 percent vested. In 1998, 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 1998 is 
$20,000. Thus, Employee A has total wages for FICA purposes of 
$220,000. Because Employee A has other wages that exceed the OASDI 
wage base for 1998, no additional OASDI tax is owed 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 tax.
    (ii) Under paragraph (d)(1)(i) of this section, an amount 
deferred is considered taken into account as wages for FICA 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, benefits 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.
    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 limitation 
expires for 1998 (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 1998. 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 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 executive's 
account as of the preceding December 31. The interest rate specified 
in the plan results in an increase that is not based on the return 
on a predetermined actual investment within the meaning of paragraph 
(d)(2)(i) of this section, and that is greater than the increase 
that would result from application of a reasonable rate of interest 
within the meaning of paragraph (d)(2)(i) of this section.
    (ii) Pursuant to paragraph (d)(2)(iii)(A) of this section, the 
excess over the AFR is considered an additional amount deferred in 
the year credited and is required to be taken into account 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, 
it 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 equal to the greater of the 
rate of return on a specified aggressive growth mutual fund or the 
rate of return on a specified income-oriented mutual fund.
    (ii) Because the increase or decrease is based on the greater of 
the two investment returns and, thus, is not based on the actual 
rate of return on either specific investment, the increase is not 
based on the return on a predetermined actual investment within the 
meaning of paragraph (d)(2)(i) of this section. Thus, if the 
resulting increase exceeds 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 6. (i) The facts are the same as in Example 5, except 
that the annual increase or decrease with respect to 50 percent of 
the employee's account is equal to the rate of return on a 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 increase or decrease does not 
exceed a reasonable rate of return within the meaning of paragraph 
(d)(2)(i) of this section. Thus, 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 7. (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 1998, the board designates Company A stock as the 
investment for 1998. Before the beginning of 1999, the board 
designates Company B stock as the investment for 1999. At the end of 
1999, the board determines that the return on Company B stock was 
lower than expected and changes its designation for 1999 to a stock 
that had a higher return during 1999.
    (ii) The annual increase or decrease for 1998 is based on the 
return of a predetermined actual investment. Although the annual 
increase or decrease for 1999 is based on an actual investment, the 
actual investment is not predetermined since it was designated after 
its return was known. In addition, the increase or decrease for 1999 
is greater than the actual rate of return on the actual investment 
that was predetermined. Thus, pursuant to paragraph (d)(2)(iii)(A) 
of this section, the income attributable to the amount taken into 
account is limited to the AFR or, if lower, the actual rate of 
return on the predetermined actual investment that was designated 
for 1999.
    Example 8. (i) Employer O establishes a nonqualified deferred 
compensation plan for Employee B. Under the plan, if Employee B 
survives until payment is to be made, he has a fully vested right to 
receive a lump sum payment at age 65, equal to the product of (a) 10 
percent per year of service and (b) Employee B's highest average 
annual compensation for a three-year period. 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, 1998, Employee B has 25 years of 
service and Employee B's high three-year average compensation is 
$100,000 (the average for the years 1996-98). As of December 31, 
1998, 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, 1999, Employee B is age 63, has 26 years of service, 
and has high three-year average compensation of $104,000. As of 
December 31, 1999, Employer O 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 1999, Employee B has earned 

[[Page 2206]]
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 1999 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 1999 is the present value, as of December 
31, 1999, 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 1999 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 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 payments 
earned during 1999 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 falls within the definition of ``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 9. (i) The facts are the same as in Example 8, 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 (a) 2 percent for each 
year of service and (b) Employee B's highest average annual 
compensation for a three-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, 
1998, 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, 1999, 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 1999, 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 1999 is the present value, as of December 31, 1999, of these 
additional payments, determined using reasonable actuarial 
assumptions and methods. Employer O takes this amount into account 
by including it in Employee B's FICA wages for 1999 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 payment 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, the entire benefit stream of 
$4,080 attributable to the amount deferred in 1999 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 10. (i) The facts are the same as in Example 9, except 
that no amount is taken into account for 1999 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 benefits 
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 
payment will be included in wages when paid.
    Example 11. (i) Employer P establishes a nonqualified deferred 
compensation plan on January 1, 1998 under which all benefits are 
100 percent vested. The plan provides that amounts deferred will be 
credited annually with interest beginning in 1999 at a rate that is 
greater than a reasonable rate of interest. Pursuant to paragraph 
(d)(2)(iii)(A) of this section, Employer P treats the excess over 
the AFR as an additional amount deferred for 1999 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) Consequently, in accordance with paragraph (a)(2)(iii) of 
this section, the excess over the AFR and any income (at the AFR) 
attributable to the excess will not be treated as wages for FICA 
purposes in any subsequent year.
    Example 12. (i) The facts are the same as in Example 11, except 
that Employer P does not treat the excess over the AFR as an 
additional amount deferred and, accordingly, does not take the 
excess into account as FICA wages for 1999 and years thereafter.
    (ii) Because this excess was not taken into account as an 
additional amount deferred for 1999 and years thereafter, the excess 
and any amount attributable to the excess are subject to the general 
timing rule of paragraph (a)(1) of this section and will be included 
as wages for FICA purposes when actually or constructively paid.
    Example 13. (i) The facts are the same as in Example 8, except 
that, in determining the amount deferred, Employer P uses a 15 
percent interest rate, which, solely for purposes of this example, 
is assumed not to be a reasonable interest rate. Employer P 
determines that the amount deferred is the present value, as of 
December 31, 1999, of this payment, which is $15,023. Employer P 
includes this amount in wages and pays any resulting FICA tax. 
Assume that the AFR as of January 1, 1999, 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 deferred 
is $1,199 in the year 2000 and $1,313 in the year 2001. 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 benefits 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, the 
417(e) mortality table, and a reasonable assumption as to cost of 
living. All three 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 9, except that 
Employer O calculates the amount deferred for 1999 as $18,252 and 
takes that amount into account by including this 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 benefits, 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. Assume that the AFR as of January 1, 1999, 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 

[[Page 2207]]
income attributable to the $18,252 amount deferred is $1,278 in the 
year 2000 and $1,367 in the year 2001. Under paragraph (d)(1)(ii)(B) 
of this section, the portion of each of 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/$40,283, or .51875. Thus, $2,116 (.51875 x 
$4,080) of each year's benefit payment is excluded from 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 benefits 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, the 
417(e) mortality table, and a reasonable assumption as to cost of 
living. All three 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 $35,165, 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 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 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 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 purposes as of the 
date the plan is 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. 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 
deferred, determined as of the resolution date in accordance with 
paragraph (c)(2) of this section (the ``resolution date amount''), must 
be taken into account as of the resolution date. For purposes of this 
paragraph (e)(4), an amount deferred is considered reasonably 
ascertainable on the first date on which the only actuarial or other 
assumptions regarding future events or circumstances needed to 
determine the amount deferred are interest, mortality, and cost-of-
living assumptions. If these assumptions are the only assumptions 
regarding future events or circumstances that are needed to determine 
the amount deferred as of a particular date, then the amount deferred 
will not fail to be reasonably ascertainable merely because the exact 
amount deferred cannot be readily calculated as of that date.
    (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 a date (the ``early 
inclusion date'') before the resolution date (but not before the date 
otherwise described in paragraph (e)(1) of this section). If the amount 
taken into account at the early inclusion date with respect to an 
amount deferred for a period (plus income attributable to the amount 
taken into account through the resolution date) is less than the 
resolution date amount for that period, then the balance of the 
resolution date amount must be taken into account as of the resolution 
date. For purposes of determining the income attributable to an amount 
taken into account as of an early inclusion date, the employer must use 
an interest rate and, if applicable, a mortality assumption that would 
have been reasonable as of the early inclusion date.
    (B) 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, and the employer has 
previously taken an amount into account with respect to the amount 
deferred, 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 payment attributable to the amount taken 
into account. Under this first-in-first-out rule, the benefit payment 
is included as wages under the general timing rule of paragraph (a)(1) 
of this section only to the extent that it exceeds the amount 
previously taken into account plus income attributable to that amount. 
However, in determining the additional amount that must be taken into 
account on the resolution date (under paragraph (e)(4)(ii)(A) of this 
section), to the extent benefit payments were not included as wages 
when paid pursuant to the preceding sentence, those payments (plus 
income attributable to those payments) must be added to the resolution 
date amount. For purposes of determining the income attributable to 
such payments, the employer must use an interest rate and, if 
applicable, a mortality assumption that would have been reasonable as 
of the early inclusion date.
    (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 an 
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 


[[Page 2208]]
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.
    (6) Portions of an amount deferred required to be taken into 
account in more than one year. If different portions of an amount 
deferred are required to be taken into account under paragraph (e)(1) 
of this section in more than one year (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) may be illustrated by the 
following examples:

    Example 1. (i) Employer M establishes a nonqualified deferred 
compensation plan for Employee A on November 1, 1996. 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 1997, the principal amount credited 
to 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, 1997, 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, 1997, 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 the 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, 2002.
    (iii) December 31, 2002 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, 1997, plus the interest credited with respect to that 
principal amount through December 31, 2002) must be taken into 
account as of December 31, 2002.
    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 the attributable interest) becomes nonforfeitable 
according to a graded vesting schedule under which 20 percent is 
vested as of December 31, 1998; 40 percent is vested as of December 
31, 1999; 60 percent is vested as of December 31, 2000; 80 percent 
is vested as of December 31, 2001; and 100 percent is vested as of 
December 31, 2002. Because these dates are later than the date on 
which the services creating the right to the amount deferred are 
considered performed (December 31, 1997), 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 in more than one 
year, 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, 1998, is taken 
into account as an amount deferred on December 31, 1998; $5,000 of 
the principal amount, plus interest credited through December 31, 
1999, is taken into account as a separate amount deferred on 
December 31, 1999; etc.
    Example 4. (i) In 1997, 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 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.
    Example 5. (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 present value of the future benefit is 
contingent on when Employee B terminates employment, the 
determination of the amount deferred requires the use of assumptions 
other than interest, mortality, and cost-of-living assumptions. 
Thus, the amount deferred is not reasonably ascertainable within the 
meaning of paragraph (e)(4)(i) of this section.
    Example 6. (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) with a present 
value that is different than the amount payable under the lump sum 
option.
    (ii) Because the present value of the future benefit is 
contingent on the form of benefit elected by Employee B, the 
determination of the amount deferred requires the use of assumptions 
other than interest, mortality, and cost-of-living assumptions. 
Thus, the amount deferred is not reasonably ascertainable within the 
meaning of paragraph (e)(4)(i) of this section.
    Example 7. (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 straight life annuity payable 
monthly, beginning at age 65, equal to the excess of (a) 3 percent 
of Employee C's final three-year average pay for each year of 
participation up to 15 years, over (b) the amount payable to 
Employee C from Employer O's qualified pension plan. The amount 
payable under the qualified pension plan is equal to 1.5 percent of 
final three-year average pay for each year of employment, excluding 
pay in excess of the section 401(a)(17) compensation limit. Employee 
C becomes a participant in the SERP on January 1, 2001, at age 44. 
As permitted by paragraph (e)(5) of this section, any amount 
deferred under the SERP for the calendar year is taken into account 
as wages as of the last day of the year. However, the amount 
deferred under the SERP for any year is not reasonably ascertainable 
prior to termination of employment because the determination of such 
amount requires assumptions other than interest, mortality, and 
cost-of-living (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.
    (ii) As of the date Employee C terminates employment, the only 
actuarial or other assumptions needed to determine the amount 
deferred is an interest rate and 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. 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 an 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 the year 
2018. The resulting present value, $26,950, is taken into account in 
accordance with paragraph (d)(1) of this section.
    Example 8. (i) The facts are the same as in Example 7, 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 each year is reasonably ascertainable. For the year 
2001, Employer O chooses to assume that Employee C has earned a 
legally binding 

[[Page 2209]]
right to a benefit of $1,000 per year from the SERP. Employer O 
determines the present value of this benefit stream using an 8 
percent interest rate and the UP-84 mortality table, which, solely 
for purposes of this example, are assumed to be reasonable actuarial 
assumptions for the year 2001. The resulting present value, $1,853, 
is taken into account for 2001. 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 determines the additional amount required to be taken 
into in the year 2008 to be $20,212 (the excess of $26,950 present 
value of the stream of benefit payments to which Employee C obtained 
a legally binding right during 2001, determined as of the resolution 
date, over $6,738 (which is the sum of the $1,853 that was taken 
into account for 2001, and $4,885 in income attributable to that 
amount through the resolution date)).
    Example 9. (i) The facts are the same as in Example 8, except 
that Employer O determines that Employee C actually had obtained a 
legally binding right in 2001 to payments under the SERP that have a 
present value at the 2018 resolution date of $6,000.
    (ii) No additional amount is required to be taken into account 
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 and 6413.
    Example 10. (i) In 1997, Employer P establishes a nonqualified 
deferred compensation plan for Employee D. The plan provides that, 
in consideration of Employee D's services to be performed on Project 
X in 1998, Employee D will receive 1 percent per year of Employer 
P's net profits associated with Project X for each of the 
immediately succeeding three years. The 1 percent amount payable for 
net profits each year will be paid on March 31 of the immediately 
succeeding year. One percent of net profits associated with Project 
X is $750,000 in 1999, $400,000 in 2000, and $90,000 in 2001.
    (ii) Because the services creating the right to all or the 
amount deferred are performed in 1998, the benefit payments based on 
the 1999, 2000, and 2001 net profits are all attributable to the 
amount deferred in 1998. However, because the present value of D's 
future benefit is contingent on future profits, the determination of 
the amount deferred requires the use of assumptions other than 
interest, mortality, and cost-of-living. Thus, the amount deferred 
in 1998 will not be reasonably ascertainable within the meaning of 
paragraph (e)(4)(i) of this section until December 31, 2001 (which 
is the resolution date). Employer P does not choose to take any 
amount into account prior to the amount deferred becoming reasonably 
ascertainable.
    (iii) Paragraph (d)(1)(ii) of this section provides that a 
benefit attributable to an amount deferred under a nonqualified 
deferred compensation plan must be included as wages when actually 
or constructively paid if it is so paid before the amount deferred 
has been taken into account as wages under the special timing rule 
of paragraph (a)(2)(ii) of this section. Thus, the benefit payments 
in 2000 and 2001(on account of 1999 and 2000 net profits) must be 
included as wages when paid.
    (iv) As of December 31, 2001, the amount deferred under the plan 
becomes reasonably ascertainable. This is because the $90,000 future 
benefit payment is a knowable quantity, albeit not readily 
calculable, and the only assumption needed to determine the present 
value of the future benefits is interest. Thus, the present value of 
the payment to be made in 2002 is required to be taken into account 
as of the resolution date (December 31, 2001) under the special 
timing rule of paragraph (a)(2)(ii) of this section. Using an 
interest rate of 10 percent per year (which, solely for purposes of 
this example, is assumed to be reasonable), Employer P determines 
that the present value of the future benefits is $87,881, and 
Employer P includes that amount in wages for 2001. (Note that 
Employer P can choose to use the lag method of withholding described 
in paragraph (f)(3) of this section, which allows the resolution 
date amount to be taken into account in the first quarter of 2002, 
provided that an adjustment for income is made.)
    Example 11. (i) The facts are the same as in Example 10, except 
that Employer P chooses the early inclusion option permitted by 
paragraph (e)(4)(ii) of this section to take $1,000,000 into account 
on December 31, 1998, before the amount deferred for 1998 is 
reasonably ascertainable.
    (ii) Pursuant to paragraph (e)(4)(ii)(B) of this section, in 
applying the nonduplication rule of paragraph (a)(2)(iii) of this 
section, a first-in-first-out rule applies in determining the 
benefits that are attributable to amounts previously taken into 
account. Using the 10 percent interest rate, Employer P determines 
that the $750,000 benefit payment on March 31, 2000, and the March 
31, 2001 benefit payment of $400,000 are attributable to the 
$1,000,000 previously taken into account and, therefore, are not 
included in wages when paid.
    (iii) Under paragraph (e)(4)(ii) of this section, if an employer 
chooses to take an amount into account before the resolution date, 
the amount taken into account (plus income attributable to that 
amount) must be compared with the resolution date amount, and any 
shortfall must be taken into account as an additional amount 
deferred as of the resolution date. Pursuant to paragraph 
(e)(4)(ii)(B) of this section, the benefits paid in 2000 and 2001 
that were excluded from wages because they were attributable to the 
amount that was taken into account (plus income attributable to 
those payments) must be added to the resolution date amount for 
purposes of this computation. Thus, Employer P must compare the 
$1,000,000 taken into account in 1998 (plus income attributable to 
that amount) to the sum of the $87,881 resolution date amount and 
the two benefit payments ($750,000 and $400,000) excluded from wages 
(plus income attributable to each of those benefit payments). Using 
an interest rate of 10 percent, Employer P determines that the 
additional amount that is required to be taken into account as of 
December 31, 2001 is $72,653 ($1,331,000-($87,881 + $886,132 + 
$429,640)).

    (f) Withholding--(1) In general. Unless an employer applies an 
alternative method described in paragraph (f)(2) or (f)(3) of this 
section, an amount deferred under a nonqualified deferred compensation 
plan for any employee is treated, for purposes of withholding and 
depositing FICA tax, as wages paid by the employer and received by the 
employee at the time it is taken into account in accordance with 
paragraph (e) of this section. The alternative methods described in 
paragraphs (f)(2) and (f)(3) of this section may be used for a calendar 
year with respect to an amount deferred for an employee only if the 
amount deferred cannot be readily calculated by the last day of the 
year. An employer may, from year to year, change between the 
alternatives described in this paragraph (f).
    (2) Estimated method--(i) In general. Under the alternative method 
provided in this paragraph (f)(2), the employer may make a reasonable 
estimate of the amount deferred that cannot be readily calculated and 
take that estimated amount into account as wages paid by the employer 
and received by the employee on the last day of the calendar year (the 
``first year'').
    (ii) Underestimate of the amount deferred. If the employer 
underestimates the amount deferred (as determined after calculating the 
actual amount deferred that should have been taken into account by the 
last day of the first year), the employer may treat the shortfall as 
wages in the first year or in the first quarter of the next year (the 
``second year''). In either case, the shortfall does not include the 
income credited to the amount deferred after the first year. If the 
employer chooses to treat the shortfall as wages in the first year, the 
employer must reflect the shortfall on Form W-2 or Form W-2c for the 
first year, and must correct the information on the Form 941 for the 
last quarter of the first year. In addition, the shortfall will not be 
considered a late deposit if it is deposited no later than the 
employer's first regular deposit date after the close of the first 
quarter of the second year.
    (iii) Overestimate of the amount deferred. If the employer 
overestimates the amount deferred (as determined after calculating the 
actual amount deferred that should have been taken into account as of 
the last day of the calendar year) and deposits more than the amount 
required, the employer may claim a refund or credit in accordance with 
sections 6402 and 6413.
    (3) Lag method. Under the alternative method provided in this 
paragraph (f)(3), the amount deferred that is 

[[Page 2210]]
described in the last sentence of paragraph (f)(1) of this section may 
be calculated on any date in the first quarter of the succeeding 
calendar year and treated as wages paid by the employer and received by 
the employee on that date. For purposes of applying paragraph (c) of 
this section, the amount deferred includes income attributable to the 
amount deferred through the date on which that amount is taken into 
account under this paragraph (f)(3).
    (4) Examples. This paragraph (f) may be illustrated by the 
following examples:

    Example 1. (i) Employer M maintains a nonqualified deferred 
compensation plan that is an account balance plan. The plan provides 
for annual bonuses based on current year profits to be deferred 
until termination of employment. Employer M's profits for 1998, and 
thus the amount deferred, cannot be readily calculated until 
February 15, 1999.
    (ii) In accordance with the alternative method described in 
paragraph (f)(2) of this section, Employer M makes a reasonable 
estimate that the amount deferred that must be taken into account as 
of December 31, 1998 for Employee A is $20,000, and withholds and 
deposits FICA tax on that amount as if it were wages paid by 
Employer M and received by Employee A on that date. Employer M 
subsequently determines that the actual amount deferred that should 
have been taken into account on December 31, 1998 was $22,000.
    (iii) In accordance with the alternative method described in 
paragraph (f)(2)(ii) of this section, Employer M may treat the 
additional $2,000 as wages paid to and received by Employee A either 
in 1998 or in the first quarter of 1999. If Employer M chooses to 
treat the additional $2,000 as wages in 1998, Employer M must pay 
the FICA tax on the $2,000 difference no later than its first 
regular deposit date occurring after March 31, 1999. In addition, 
Employer M must file a Form W-2c for Employee A and must correct the 
information on Form 941 for the last quarter of 1998. If Employer M 
complies with these conditions, the FICA tax on the $2,000 
difference is not considered a late deposit.
    Example 2. (i) The facts are the same as in Example 1, except 
that Employer M subsequently determines that the actual amount 
deferred that should have been taken into account on December 31, 
1998 was $19,000.
    (ii) Under paragraph (f)(2)(iii) of this section, Employer M 
may, in accordance with sections 6402 and 6413, claim a refund or 
credit for the overpayment of tax resulting from the overestimate.
    Example 3. (i) The facts are the same as in Example 1, except 
that Employer M does not make a reasonable estimate of the amount 
deferred that must be taken into account as of December 31, 1998. 
Instead, Employer M withholds and deposits FICA tax on the amount 
deferred plus income on that amount (determined under the terms of 
the plan) as if it were wages paid by Employer M and received by 
Employee A on March 15, 1999.
    (ii) Under the alternative method described in paragraph (f)(3) 
of this section, the amount taken into account on March 15, 1999 
(including the income) will be treated as wages paid to and received 
by Employee A in 1999.

    (g) Effective date and transition rules--(1) General effective 
date--(i) Effective date. Except as otherwise provided in this 
paragraph (g) or in Sec. 31.3121(v)-2, this section is effective for 
amounts deferred and benefits paid on or after January 1, 1997.
    (ii) Reasonable, good faith interpretation--(A) in general. In 
determining FICA tax liability for amounts deferred and benefits paid 
before the effective date of this section, an employer may rely on a 
reasonable, good faith interpretation of section 3121(v)(2), taking 
into account pre-existing guidance. For example, an employer will be 
deemed to have determined FICA tax liability and satisfied FICA 
withholding requirements in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if that liability is determined in 
accordance with paragraphs (a) through (e) of this section, and the 
withholding method and timing comply with paragraph (f) of this 
section. 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.
    (B) Optional adjustment for open years. If an employer determined 
FICA tax liability for amounts deferred or benefits actually or 
constructively paid in any year before the effective date of this 
section for which the applicable period of limitation has not expired 
(``pre-effective-date open years''), in a manner that was not in 
accordance with this section, the employer may adjust its FICA tax 
determination for that year. In this case, any amount deferred that 
would have been taken into account (within the meaning of paragraph 
(d)(1) of this section) in that year under this section must actually 
be taken into account as if this section were effective for that year. 
Thus, for example, appropriate adjustments for the prior period must be 
reflected on Form 941, Employer's Quarterly Federal Tax Return, and 
Form 941c, Supporting Statement to Correct Information, and Form W-2c 
must be filed for any affected employee in order that the Social 
Security Administration may correctly post the amount deferred to the 
employee's earnings record. Similarly, if an amount was taken into 
account under a nonaccount balance plan for any pre-effective-date open 
year, but the amount deferred was not reasonably ascertainable (within 
the meaning of paragraph (e)(4)(i) of this section), the employer may 
claim a refund or credit for any FICA tax paid on that amount in 
accordance with Internal Revenue Code sections 6402 and 6413 and, 
thereafter, take the amount deferred into account when it first becomes 
reasonably ascertainable.
    (iii) Plan must be established or adopted. If amounts are deferred 
under a plan before the effective date of this section and benefits are 
paid on or after the effective date of this section, then in no event 
will an employer's treatment of amounts deferred under the plan be 
considered to be in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if the employer treats these 
amounts as taken into account as wages for FICA purposes prior to the 
establishment of the plan (within the meaning of paragraph (b)(2) of 
this section) providing for the deferred compensation (or, if later, 
the plan amendment providing for the deferred compensation). (If all 
amounts are deferred and all benefits are paid before the effective 
date of this section, ``adoption'' is substituted for ``establishment'' 
in the preceding sentence.) For example, awards, bonuses, raises, 
incentive payments, and other similar amounts granted under a plan as 
compensation for past services may not be taken into account under 
section 3121(v)(2) prior to the establishment (or, if applicable, the 
adoption) of the plan.
    (2) Transition rule for plans that are not subject to section 
3121(v)(2). If a plan is not a nonqualified deferred compensation plan 
within the meaning of paragraph (b)(1) of this section, but, for a 
period prior to the effective date of this section and pursuant to a 
reasonable, good faith interpretation of section 3121(v)(2)(A), an 
amount under the plan was taken into account (within the meaning of 
paragraph (d)(1) of this section) as an amount deferred under a 
nonqualified deferred compensation plan, then, pursuant to paragraph 
(g)(1) of this section, the following rules shall apply:
    (i) With respect to benefits actually or constructively paid before 
the effective date of this section that are attributable to amounts 
previously taken into account under the plan, no additional FICA tax 
will be owed;
    (ii) On or after the effective date of this section, benefits under 
the plan must be taken into account as wages when actually or 
constructively paid in accordance with paragraph (a)(1) of this 
section; and 

[[Page 2211]]

    (iii) To the extent FICA tax was actually paid on the amount taken 
into account prior to the effective date of this section, the employer 
may claim a refund or credit to the extent permitted by sections 6402 
and 6413. However, if any benefits were actually or constructively paid 
to an employee under the plan before the effective date of this section 
and these payments were not subject to FICA tax by reason of the 
employer's treatment of the plan as a nonqualified deferred 
compensation plan and the application of paragraph (g)(2)(i) of this 
section, then the employer may claim a refund or credit for pre-
effective-date open years only to the extent that the FICA tax paid on 
amounts deferred in those years exceeds the FICA tax that would have 
been owed on the benefits actually or constructively paid to the 
employee in those years if (notwithstanding paragraph (g)(2)(i) of this 
section) those benefits had been subject to FICA tax when paid.
    (3) Transition rules for plans that are subject to section 
3121(v)(2)--(i) Plans that were treated as not subject to section 
3121(v)(2)--closed years. If, for a period prior to the effective date 
of this section and in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2), an employer treated a plan as if 
it were not a nonqualified deferred compensation plan within the 
meaning of section 3121(v)(2), but that plan is a nonqualified deferred 
compensation plan within the meaning of paragraph (b)(1) of this 
section, then, for purposes of determining whether benefits actually or 
constructively paid on or after the effective date of this section were 
previously taken into account as wages for purposes of applying the 
nonduplication rule of section 3121(v)(2)(B), any amount deferred that 
would have been required to have been taken into account under this 
section in a year for which the applicable period of limitation has 
expired as of the effective date of this section (a ``section 3121(v) 
closed year'') will be treated as if it had been taken into account 
within the meaning of paragraph (d)(1) of this section. For purposes of 
this paragraph (g)(3)(i), an employer will be considered to have 
treated a plan as if it were not a nonqualified deferred compensation 
plan for a period prior to the effective date of this section only if 
the employer withheld and deposited any FICA tax due on any benefits 
actually or constructively paid under the plan during that period. The 
rule of this paragraph (g)(3)(i) does not apply to any amount deferred 
in a year that is not a section 3121(v) closed year that would have 
been required to have been taken into account under this section (if 
this section had been in effect for that year). Thus, such an amount 
deferred will be treated as having been taken into account for purposes 
of applying the nonduplication rule to benefits paid after the 
effective date of this section only if the amount deferred was actually 
taken into account within the meaning of paragraph (d)(1) of this 
section.
    (ii) Undervaluation of the amount deferred. If, for a period prior 
to the effective date of this section, an employer determined the 
amount deferred for an employee under a nonaccount balance plan in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2), but that amount is less than the amount that would have 
been considered the amount deferred under paragraph (c) of this 
section, the following rules shall apply:
    (A) No additional FICA tax will be owed for that period; and
    (B) The difference between the amount that was taken into account 
in a section 3121(v) closed year and the amount that would have been 
taken into account in that year had the amount deferred been determined 
under paragraph (c) of this section is treated as if it had been taken 
into account within the meaning of paragraph (d)(1) of this section. In 
the case of an amount deferred (in a section 3121(v) closed year) that 
was not reasonably ascertainable, the difference between the amount 
taken into account (if any) and the amount that would have been taken 
into account had the employer taken an amount into account using a 
method permitted in paragraph (c) of this section and actuarial 
assumptions that matched the actual experience is treated as if it had 
been taken into account within the meaning of paragraph (d)(1) of this 
section. Accordingly, with respect to such an amount deferred, the 
employer is not required to take any additional amount into account 
when the amount deferred becomes reasonably ascertainable, and no 
additional FICA tax will be owed when the benefits attributable to the 
amount deferred are actually or constructively paid. The rule of this 
paragraph (g)(3)(ii)(B) does not apply to any amount deferred that 
would have been required to have been taken into account under this 
section in a pre-effective-date open year.
    (iii) Overinclusion of the amount deferred. If an amount deferred 
for an employee under a nonaccount balance plan was taken into account 
before the effective date of this section in accordance with a 
reasonable, good faith interpretation of section 3121(v)(2), but, under 
this section, that amount would have been taken into account on or 
after the effective date of this section, the following rules apply:
    (A) The determination of an amount deferred for any period 
beginning on or after the effective date of this section must be made 
in accordance with paragraph (c) of this section, and the time when 
that amount deferred is required to be taken into account must be 
determined in accordance with paragraph (e) of this section, without 
regard to any amount deferred that was taken into account for any 
period before the effective date of this section; and
    (B) The employer may claim a refund or credit for an overpayment of 
tax caused by the pre-effective-date overinclusion of wages to the 
extent permitted by sections 6402 and 6413.
    (4) Examples. This paragraph (g) may be illustrated by the 
following examples:

    Example 1. (i) In 1994, Employer M establishes a nonqualified 
deferred compensation plan that is a nonaccount balance plan for 
Employee A. All benefits under the plan are 100 percent vested. In 
order to determine the amount deferred on behalf of Employee A under 
the plan for 1994 and 1995, Employer M must make assumptions as to 
the date on which Employee A will retire and the form of benefit 
Employee A will elect, in addition to interest, mortality, and cost-
of-living assumptions. Based on assumptions made with respect to all 
of these contingencies, Employer M determines that the amount 
deferred for 1994 is $50,000 and the amount deferred for 1995 is 
$55,000. No OASDI tax is owed with respect to those amounts 
deferred. However, Employer M withholds and deposits HI tax on those 
amounts. Because Employee B does not retire before the effective 
date of this section, Employer R will still need to make assumptions 
for the date of retirement and the form of benefit through the 
effective date. Employer M chooses to apply this section before its 
effective date to 1994 and 1995.
    (ii) Under the regulations in this section, the amounts deferred 
in 1994 and 1995 are not reasonably ascertainable (within the 
meaning of paragraph (e)(4)(i) of this section) before the effective 
date of this section. Thus, assuming the applicable period of 
limitation has not expired for 1994 and 1995, Employer M may, in 
accordance with paragraph (g)(1)(ii)(B) of this section, apply for a 
refund or credit for the HI tax paid on the amounts deferred for 
1994 and 1995 in accordance with sections 6402 and 6413 and, in 
accordance with paragraph (e)(4) of this section, take into account 
the amounts deferred when they become reasonably ascertainable.
    Example 2. (i) Employer N adopts a plan on January 1, 1994 that 
covers Employee B, who has 10 years of service as of that date. The 
plan provides that, in consideration of Employee B's outstanding 
services over the 

[[Page 2212]]
past 10 years, Employee B will be paid a $500,000 lump sum distribution 
upon termination of employment at any time. On January 15, 1996, 
Employee B terminates employment with Employer N. Employer N 
determines, based on a reasonable, good faith interpretation of 
section 3121(v)(2), that the plan is a nonqualified deferred 
compensation plan under that section. Employer N treats the $500,000 
as having been taken into account as an amount deferred in 1993 and 
earlier years.
    (ii) Under paragraph (g)(1)(iii) of this section, if all amounts 
are deferred and all benefits are paid under a plan before the 
effective date of this section, then in no event will an employer's 
treatment of amounts deferred under the plan be considered to be in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2) if the employer treats these amounts as taken into 
account as wages for FICA purposes prior to the adoption of the 
plan. Accordingly, Employer N's treatment is not in accordance with 
a reasonable, good faith interpretation of section 3121(v)(2) 
because Employer N treated amounts as taken into account in years 
before the adoption of the plan.
    Example 3. (i) Employer O adopts a bonus plan on December 1, 
1993 that becomes effective and legally binding on January 1, 1994. 
Under the plan, which is not set forth in writing, a specified bonus 
amount (which is 100 percent vested) is credited to Employee C's 
account each December 31. A reasonable rate of interest on Employee 
C's account balance is credited quarterly. Employee C's account 
balance will begin to be paid in equal annual installments over ten 
years beginning on January 1, 1999. Employer O determines, based on 
a reasonable, good faith interpretation of section 3121(v)(2), that 
the bonus plan is a nonqualified deferred compensation plan under 
that section and, therefore, treats the amounts credited on December 
31, 1994, 1995, and 1996 as amounts deferred and takes those amounts 
deferred into account as wages for FICA purposes as of those dates. 
The bonus plan is set forth in writing on February 1, 1997, which 
for purposes of this example is assumed to be prior to the date that 
is six months after the publication of the final regulations, and, 
thus, is treated as established as of January 1, 1994.
    (ii) Under paragraph (g)(1)(iii) of this section, if all amounts 
are deferred and all benefits are paid under a plan before the 
effective date of this section, then in no event will an employer's 
treatment of amounts deferred under the plan be considered to be in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2) if the employer treats these amounts as taken into 
account as wages for FICA purposes prior to the establishment of the 
plan (within the meaning of paragraph (b)(2) of this section. 
Because the bonus plan is treated as established on January 1, 1994 
(pursuant to the transition rule provided in paragraph (b)(2)(iii) 
of this section), the amounts deferred are not treated as having 
been taken into account prior to the establishment of the plan, even 
though the plan was not set forth in writing until February 1, 1997.
    Example 4. (i) In 1985, Employer P establishes a compensation 
arrangement for Employee D that provides annual payments over a 
number of years after termination of employment. Prior to the 
effective date of this section, and in accordance with a reasonable, 
good faith interpretation of section 3121(v)(2), Employer P treats 
the arrangement as a nonqualified deferred compensation plan under 
section 3121(v)(2). Each year, consistent with this treatment, 
Employer P determines the amount deferred that must be taken into 
account as FICA wages for the year. Employer P also determines that 
Employee D's total wages (without regard to the amount deferred) for 
each year from 1985 through 1993 exceed the applicable wage base for 
each of those years and, consequently, there is no FICA tax 
liability with respect to the amounts deferred for those years. In 
1994, Employee D's total wages (without regard to the amount 
deferred) exceed the OASDI wage base. However, because there is no 
limit on the HI wage base, the amount deferred for 1994 results in 
additional HI tax liability of $290, which is timely paid by 
Employer P.
    (ii) Employee D terminates employment with Employer P in 1995 
and receives a plan payment of $50,000. In that year, Employee D 
also receives wages of $60,000 from Employer P. In accordance with 
its treatment of the plan as a nonqualified deferred compensation 
plan under section 3121(v)(2), Employer P does not treat the payment 
in 1995 as wages for FICA purposes in that year. Although Employer P 
made a reasonable, good faith determination that the plan is a 
nonqualified deferred compensation plan under section 3121(v)(2), 
the plan is not a nonqualified deferred compensation plan within the 
meaning of paragraph (b)(1) of this section. Both 1994 and 1995 are 
pre- effective-date open years.
    (iii) Because amounts under a plan were taken into account 
(within the meaning of paragraph (d)(1) of this section) as amounts 
deferred under a nonqualified deferred compensation plan pursuant to 
a reasonable, good faith interpretation of section 3121(v)(2)(A), 
but that plan is not a nonqualified deferred compensation plan 
within the meaning of paragraph (b)(1) of this section, the 
transition rule provided in paragraph (g)(2) of this section 
applies. Thus, no additional FICA tax will be owed on benefits paid 
in 1995. However, on or after the effective date of this section, 
benefits under the plan must be taken into account as wages when 
actually or constructively paid in accordance with the general 
timing rule of paragraph (a)(1) of this section.
    (iv) Because $290 of HI tax was paid on the amount deferred in 
1994, Employer P is entitled to a refund or credit for that amount--
but only to the extent that $290 exceeds the FICA tax that would 
have been owed on the $50,000 annual payment in 1995 if those 
benefits had been subject to FICA tax when paid (i.e., if the 
regulation had been effective for those years). In 1995, Employee D 
had other wages of $60,000. Thus, only $1,200 (the $61,200 OASDI 
wage base, less the $60,000 of other wages) of the $50,000 payment 
would have been subject to OASDI; the full $50,000 would have been 
subject to HI. This would have resulted in $148.80 of OASDI tax 
($1,200  x  12.4 percent) and $1,450 of HI tax ($50,000  x  2.9 
percent). Employer P is not entitled to a refund or credit under the 
transition rule of paragraph (g)(2) because the $290 of HI tax paid 
in 1994 is less than the total $1,598.80 of FICA tax liability that 
would have resulted if this section had applied for 1995.
    Example 5. (i) In 1985, Employer Q establishes a compensation 
arrangement for Employee E that is a nonqualified deferred 
compensation plan within the meaning of paragraph (b)(1) of this 
section. However, prior to the effective date of this section, 
Employer Q determines, based on a reasonable, good faith 
interpretation of section 3121(v)(2), that the arrangement is not a 
nonqualified deferred compensation plan within the meaning of that 
section. Thus, when payments under the arrangement begin in 1995, 
Employer Q withholds and deposits FICA tax on the amounts paid to 
Employee E. Payments under the arrangement continue after the 
effective date of this section. Employer Q does not choose (under 
paragraph (g)(1)(ii)(B) of this section) to adjust its FICA tax 
determination for pre-effective-date open years by treating this 
section as in effect for all amounts deferred and benefits actually 
or constructively paid for those years.
    (ii) Under paragraph (g)(3)(i) of this section, for purposes of 
determining whether benefits actually or constructively paid on or 
after the effective date of this section were previously taken into 
account for purposes of applying the nonduplication rule of section 
3121(v)(2)(B), any amount that would have been required to have been 
taken into account in a section 3121(v) closed year will be treated 
as if it had been taken into account within the meaning of paragraph 
(d)(1) of this section. Under the nonduplication rule, benefits 
attributable to an amount that has been so taken into account is not 
treated as wages for FICA purposes at any later time (such as upon 
payment).
    (iii) Because Employer Q does not adjust its FICA tax 
determination for pre-effective-date open years by treating this 
section as in effect for all amounts deferred for those years, any 
benefits attributable to those amounts will be included in wages 
when actually or constructively paid in accordance with the general 
timing rule of paragraph (a)(1) of this section.
    Example 6. (i) The facts are the same as in Example 5, except 
that Employer Q chooses (in accordance with paragraph (g)(1)(ii)(B) 
of this section) to adjust its FICA tax determination for all pre-
effective-date open years by treating this section as in effect for 
all amounts deferred for those years.
    (ii) In accordance with the nonduplication rule of paragraph 
(a)(2)(iii) of this section, any benefits attributable to the 
amounts deferred that were taken into account for pre-effective-date 
open years in accordance with paragraph (d)(1) of this section will 
not be included as wages when actually or constructively paid.
    Example 7. (i) The facts are the same as in Example 5, except 
that Employer Q does not withhold and deposit the FICA tax due on 
benefits actually or constructively paid prior to the effective date 
of this section.
    (ii) Because Employer Q did not withhold and deposit the FICA 
tax due on benefits 

[[Page 2213]]
actually or constructively paid during that period, the transition rule 
provided in paragraph (g)(3)(i) of this section does not apply. 
Therefore, any amount that would have been required to have been 
taken into account under this section in a pre-effective-date closed 
year is not treated as if it had been so taken into account, and 
benefits attributable to any such amount are treated as FICA wages 
when actually or constructively paid in accordance with the general 
timing rule of paragraph (a)(1) of this section.
    Example 8. (i) In 1993, Employer R establishes a nonqualified 
deferred compensation plan for Employee F. In accordance with a 
reasonable, good faith interpretation of section 3121(v)(2), 
Employer R determines that, for 1993, there is an amount deferred of 
$2.5 million that must be taken into account as wages for FICA 
purposes. However, because Employee F has other wages in 1993 that 
exceed the applicable OASDI and HI wage bases for that year, no 
additional FICA tax is actually owed as a result of that amount 
deferred being taken into account for 1993. Under this section, $2 
million of the amount taken into account in 1993 would have been 
taken into account for years beginning on or after the effective 
date of this section because Employee F did not have a legally 
binding right to that amount until after that date.
    (ii) In accordance with paragraph (g)(3)(iii)(A) of this 
section, the determination of the amount deferred under the plan for 
any period beginning on or after the effective date of this section 
must be made in accordance with paragraph (c) of this section, and 
the time when that amount deferred is required to be taken into 
account must be determined in accordance with paragraph (e) of this 
section. In addition, these determinations must be made without 
regard to any amount deferred that was taken into account for any 
period before the effective date of this section. Thus, the $2 
million that, under this section, would have been taken into account 
for years beginning on or after the effective date of this section 
must be taken into account under this section for those years. 
Because no FICA tax was actually paid on that $2 million in 1993, no 
overpayment of tax was caused by the overinclusion of wages in 1993 
and, thus, Employer R is not entitled to a refund or credit.


Sec. 31.3121(v)(2)-2  Effective dates and transition rules.

    (a) General effective date. Except as otherwise provided in 
paragraphs (b) through (e) of this section, section 3121(v)(2) and the 
amendments made to section 3121(a)(2), (3), and (13) by the Social 
Security Amendments of 1983 (Pub. L. 98-21, 97 Stat. 65 (1983)), as 
amended by section 2662(f)(2) of the Deficit Reduction Act of 1984 
(Pub. L. 98-369, 98 Stat. 494 (1984)), apply to amounts deferred and 
benefits paid after December 31, 1983.
    (b) Definitions. For purposes of Sec. 31.3121(v)(2)-1 and 
paragraphs (a) through (e) of this section, the following definitions 
apply:
    FICA. FICA means the Federal Insurance Contributions Act (26 U.S.C. 
3101 et seq.).
    457(a) plan. A 457(a) plan means an eligible deferred compensation 
plan of a State or local government or of a tax- exempt organization to 
which section 457(a) of the Internal Revenue Code applies.
    Gap agreement. Gap agreement means an agreement adopted after March 
24, 1983, and on or before December 31, 1983.
    March 24, 1983 agreement. March 24, 1983 agreement means an 
agreement in existence on March 24, 1983 between an individual and a 
nonqualified deferred compensation plan within the meaning of 
Sec. 31.3121(v)-1(b). For this purpose only, any plan (or agreement) to 
make payments that qualify for one of the retirement payment exclusions 
is treated as a nonqualified deferred compensation plan, regardless of 
whether the plan (or agreement) is treated as a nonqualified deferred 
compensation plan within the meaning of Sec. 31.3121(v)-1(b). For 
example, Sec. 31.3121(v)-1(b)(4)(v) provides that certain benefits 
established in connection with impending termination do not result from 
the deferral of compensation and thus are not considered deferred under 
a nonqualified deferred compensation plan. However, a plan that 
provides such benefits and that was in existence on March 24, 1983 is 
treated as a nonqualified deferred compensation plan for purposes of 
this paragraph (b) to the extent it provides benefits that would have 
satisfied one of the retirement payment exclusions had the benefits 
been paid on April 19, 1983.
    Post-amendment. Post-amendment means after December 31, 1983.
    Pre-amendment. Pre-amendment means on or before December 31, 1983.
    Retirement payment exclusions. Retirement payment exclusions are 
the exclusions from wages (for FICA tax purposes) for retirement 
payments under sections 3121(a)(2)(A), (a)(3), and (a)(13)(A)(iii), as 
in effect on April 19, 1983.
    Transition benefits. Transition benefits are post-amendment 
payments attributable to pre-amendment services.
    (c) Transition rules--(1) In general. The general effective date 
described in paragraph (a) of this section applies to post-amendment 
payments attributable solely to post-amendment services, whether or not 
paid under a March 24, 1983 agreement or a gap agreement. Thus, section 
3121(v)(2) applies, and the retirement payment exclusions do not apply, 
to these benefits. Special effective dates apply to transition benefits 
under a March 24, 1983 agreement and transition benefits under a gap 
agreement. These special effective dates are set forth in paragraphs 
(c)(2) and (c)(3) of this section, respectively.
    (2) Transition benefits under a March 24, 1983 agreement. 
Transition benefits under a March 24, 1983 agreement (except for those 
under a 457(a) plan) are not subject to the special timing rule of 
section 3121(v)(2) and remain subject to section 3121(a) as in effect 
on April 19, 1983. Thus, transition benefits under a March 24, 1983 
agreement (except for those under a 457(a) plan) are excluded from 
wages (for FICA tax purposes) only if they qualify for any of the 
retirement payment exclusions (or any other exclusion provided under 
section 3121(a) as in effect on April 19, 1983).
    (3) Transition benefits under a gap agreement. The payor of 
transition benefits under a gap agreement must choose to either--
    (i) Take the transition benefits into account as wages when paid; 
or
    (ii) Take the amount deferred (within the meaning of 
Sec. 31.3121(v)-1(c)) with respect to the transition benefits into 
account as wages under section 3121(v)(2) (as if section 3121(v)(2) had 
applied before its general effective date).
    (d) Determining transition benefit portion. For purposes of 
determining the portion of total benefits under a nonqualified deferred 
compensation plan that represents transition benefits, if, under the 
terms of the plan, benefits are not attributed to specific years of 
service, the employer may use any reasonable method. For example, if a 
plan provides that the employee will receive benefits equal to two 
percent of high three-year average compensation multiplied by years of 
service, and the employee retires after 25 years of service, nine of 
which are before 1984, the employer may determine that 9/25 of the 
total benefits to be received beginning in 2000 are transition benefits 
attributable to services performed before 1984.
    (e) Order of payment. If an employer determines, in accordance with 
paragraph (d) of this section, that a portion of the total benefits 
under a nonqualified deferred compensation plan constitutes transition 
benefits, then, for purposes of determining the portion of each benefit 
payment that constitutes transition benefits--
    (1) For a payment made before the effective date of this section, 
the employer may use any reasonable allocation method to determine the 
portion of a payment that consists of transition benefits, provided 
that the 

[[Page 2214]]
allocation method is consistent with the terms of the plan; and
    (2) For a payment made on or after the effective date of this 
section, the employer must treat each payment as consisting of 
transition benefits in the same proportion as the transition benefits 
that have not been paid (as of the effective date of this section) bear 
to total benefits that have not been paid (as of the effective date of 
this section), unless such allocation is inconsistent with the terms of 
the plan.
Margaret Milner Richrdson,
Commissioner of Internal Revenue.
[FR Doc. 96-715 Filed 1-19-96; 12:52 pm]
BILLING CODE 4830-01-U