[Federal Register Volume 64, Number 19 (Friday, January 29, 1999)]
[Rules and Regulations]
[Pages 4542-4568]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1663]



[[Page 4542]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 31 and 602

[TD 8814]
RIN 1545-AT27


Federal Insurance Contributions Act (FICA) Taxation of Amounts 
Under Employee Benefit Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 
3121(v)(2) of the Internal Revenue Code (Code) that provide guidance as 
to when amounts deferred under or paid from a nonqualified deferred 
compensation plan are taken into account as wages for purposes of the 
employment taxes imposed by the Federal Insurance Contributions Act 
(FICA). Section 3121(v)(2), relating to treatment of certain 
nonqualified deferred compensation, was added to the Code by section 
324 of the Social Security Amendments of 1983. These regulations 
provide guidance to employers who maintain nonqualified deferred 
compensation plans and to participants in those plans.

DATES: Effective Date: These regulations are effective January 29, 
1999.
    Applicability Date: These regulations are applicable on and after 
January 1, 2000. In addition, these regulations provide certain 
transition rules for amounts deferred and benefits paid before January 
1, 2000, including allowing employers to use a reasonable, good faith 
interpretation of section 3121(v)(2).

FOR FURTHER INFORMATION CONTACT: Janine Cook, Linda E. Alsalihi, or 
Margaret A. Owens, (202) 622-6040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this final rule has been 
reviewed and, pending receipt and evaluation of public comments, 
approved by the Office of Management and Budget (OMB) under 44 U.S.C. 
3507 and assigned control number 1545-1643.
    The collection of information in this regulation is in 
Sec. 31.3121(v)(2)-1(b)(2). This information is required to implement 
Code section 3121(v). This information will be used to identify the 
material terms of a plan. The collection of information is required to 
obtain a benefit. The likely recordkeepers are business or other for-
profit institutions.
    Comments on the collection of information should be sent to the 
Office of Management and Budget, Attn: Desk Officer for the Department 
of the Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224. 
Comments on the collection of information should be received by March 
30, 1999.
    Comments are specifically requested concerning:
    Whether the collection of information is necessary for the proper 
performance of the functions of the IRS, including whether the 
information will have practical utility;
    The accuracy of the estimated burden associated with the collection 
of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the collection of information may 
be minimized, including through the application of automated collection 
techniques or other forms of information technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The estimated total annual recordkeeping burden for 
Sec. 31.3121(v)(2)-1(b)(2) is 12,500 hours. The annual estimated burden 
per recordkeeper varies from 2 hours to 10 hours, depending on the 
individual circumstances, with an estimated average of 5 hours. The 
estimated number of recordkeepers is 2,500.
    Estimates of the reporting burden in Sec. 31.3121(v)(2)-1(f) and 
(g) are reflected in the burden estimates of Form 941, Employer's 
Quarterly Federal Tax Return, Form 941c, Supporting Statement To 
Correct Information, Form W-2, Wage and Tax Statement, and Form W-2c, 
Corrected Wage and Tax Statement.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    These regulations amend the Employment Tax Regulations (26 CFR part 
31) under section 3121(v)(2). Section 3121(v)(2) was added to the 
Internal Revenue Code (Code) by section 324 of the Social Security 
Amendments of 1983 (1983 Amendments). Section 2662(f)(2) of the Deficit 
Reduction Act of 1984 (DEFRA) amended section 324 of the 1983 
Amendments.
    Notice 94-96 (1994-2 C.B. 564) provides that until final 
regulations are issued, the IRS will not challenge an employer's 
determination of FICA tax liability with respect to a nonqualified 
deferred compensation plan for periods before the effective date of any 
final regulations if the determination is based on a reasonable, good 
faith interpretation of section 3121(v)(2). On January 25, 1996, a 
notice of proposed rulemaking (EE-142-87) under section 3121(v)(2) was 
published in the Federal Register (61 FR 2194), providing guidance 
related to the Federal Insurance Contributions Act (FICA) tax treatment 
of amounts deferred under or paid from certain nonqualified deferred 
compensation plans. On December 24, 1997, a notice of proposed 
rulemaking (REG-209484-87 and REG-209807-95) under section 3121(v)(2) 
extending the proposed general effective date of the regulations to 
January 1, 1998, was published in the Federal Register (62 FR 67304).
    Comments regarding the 1996 proposed regulations were received from 
the public, and on June 24, 1996, the IRS held a public hearing 
concerning the proposed amendments. After consideration of the public 
comments received and the statements made at the public hearing, the 
proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

    Sections 3101 and 3111 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. 
Generally, FICA tax 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. Section 31.3121(a)-2(a) provides that FICA tax is imposed 
at the time the remuneration is actually or constructively paid.

1983 Amendments

    Prior to the 1983 Amendments, benefits under a nonqualified 
deferred

[[Page 4543]]

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

Repeal of Wage Based Limitation

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

Application of these Regulations to Taxes Imposed by the Railroad 
Retirement Tax Act

    In accordance with the cross-reference in section 3231(e)(8)(B), 
the provisions of section 3121(v)(2) and these final regulations also 
apply for purposes of the taxes imposed by the Railroad Retirement Tax 
Act under sections 3201 through 3231.

Overview of Final Regulations

    In general, comments received on the proposed regulations were 
favorable and, accordingly, the final regulations retain the general 
structure and substance of the proposed regulations, including a wide 
variety of examples illustrating the substance of the final 
regulations. However, commentators made a number of specific 
recommendations for modifications and clarifications of the 
regulations. In response to these comments, the final regulations 
incorporate the modifications and clarifications described below.
     The proposed regulations provided that certain types of 
benefits do not result from the deferral of compensation and, 
accordingly, are not subject to the special timing rule under section 
3121(v)(2). The final regulations generally retain these rules. 
However, in response to comments, the final regulations allow certain 
cost-of-living adjustments provided to former employees to be treated 
as deferred compensation for purposes of section 3121(v)(2) and provide 
transition relief for window programs that begin before the effective 
date of the final regulations. The final regulations also clarify the 
rules under which stock options, death benefits, disability benefits, 
and severance pay are excluded from the special timing rule.
     The final regulations retain the distinction between the 
method of calculating the amount deferred (and the income on that 
amount) for account balance plans and the method for nonaccount balance 
plans, but provide additional guidance simplifying those calculations. 
The final regulations provide that a plan that bases benefits on an 
account balance but permits optional forms (such as annuities) can use 
the simple methodology that applies to account balance plans if the 
plan terms preclude a subsidized optional form. Also, a nonaccount 
balance plan that provides multiple benefit distribution options or 
commencement dates under plan terms that preclude subsidized optional 
forms and commencement dates can determine the amount deferred by 
assuming that a participant elects to receive the normal form of 
payment (regardless of which option is actually elected).
     The final regulations clarify the rules governing when 
income under an account balance plan is excluded from FICA wages. The 
final regulations also provide that, while the determination of whether 
an account balance plan is using a reasonable interest rate generally 
is made annually, a rate that is specified for a fixed period of up to 
five years is treated as reasonable for that period if it was 
reasonable when it was specified (even if it ceases to be reasonable 
during the period for which it is specified).
     The final regulations retain the structure of the rules in 
the proposed regulations under which FICA tax payments are not required 
to be made on amounts that are not reasonably ascertainable until 
certain uncertainties related to benefit payments are resolved. Those 
rules permit earlier inclusion with a true-up at the resolution date, 
when those uncertainties are resolved. However, the final regulations 
modify the calculation of the true-up to eliminate the risk that 
additional amounts will have to be taken into account at the resolution 
date because of changes in interest rates between the early inclusion 
date and the resolution date.
     The final regulations permit an employer to choose how the 
amounts deferred under a plan over a series of years can be allocated 
among those years when the plan formula does not do so by its terms 
(for example, where the plan has a benefit formula that includes an 
offset of another plan's benefit).
     The final regulations retain the flexibility provided in 
the proposed regulations permitting an employer to delay the date on 
which amounts deferred are taken into account to a later date within 
the year, and also broaden and simplify two options that provide 
additional time to calculate the amount deferred. The first option 
permits an employer to estimate the amount deferred and then adjust it 
at any time within three months. Alternatively, FICA tax payment can be 
postponed by treating the entire amount deferred as if it were deferred 
on a date that is within

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three months of the date the amount is otherwise required to be taken 
into account, provided that the amount deferred is increased by 
interest at the applicable federal rate \2\ (AFR) until it is included 
in wages.
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    \2\ The regulations define the applicable federal rate as the 
mid-term applicable federal rate, as defined pursuant to section 
1274(d), for January 1 of the calendar year, compounded annually.
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     The final regulations include a number of special 
transition rules that provide relief to employers that, prior to the 
effective date of the regulations, followed a reasonable, good faith 
interpretation of section 3121(v)(2). Under the final regulations, 
amounts deferred for 1994 and 1995 can be taken into account, without 
interest, as late as March 31, 2000. Further, the final regulations 
reflect the transition rule in the proposed regulations under which 
amounts deferred that would have been required or permitted to be taken 
into account before 1994 are treated as having been correctly taken 
into account before 1994.

Summary of Comments Received and Changes Made

a. Application of the Special Timing Rule
    The special timing rule provided under section 3121(v)(2) is set 
forth in paragraph (a) of the regulations. The special timing rule 
imposes FICA tax on amounts deferred under nonqualified deferred 
compensation plans at the later of the date when the services creating 
the right to the amount deferred are performed and the date on which 
the right to that amount is no longer subject to a substantial risk of 
forfeiture. This date usually is earlier than when any benefit is paid. 
Several commentators requested clarification as to whether the special 
timing rule is elective and whether failure to comply with the special 
timing rule may lead to the imposition of interest or penalties. The 
special timing rule is not elective and, if an employer does not take 
an amount deferred into account (including payment of any resulting 
FICA tax) when required by section 3121(v)(2), interest and penalties 
may be imposed. Moreover, to the extent that the amount deferred is not 
taken into account in accordance with the special timing rule, the 
nonduplication rule, under which amounts deferred that are properly 
taken into account under the special timing rule are excluded from FICA 
wages upon payment, does not apply.
b. Amounts or Benefits That Do Not Result From the Deferral of 
Compensation
    The definition of a nonqualified deferred compensation plan for 
purposes of section 3121(v)(2) is set forth in paragraph (b) of the 
regulations. A number of comments were received on the rules in the 
proposed regulations for determining whether an amount or benefit 
results from the deferral of compensation subject to the special timing 
rule of section 3121(v)(2). The final regulations make several 
clarifications and changes to reflect these comments. The regulations 
clarify that the grant (as well as the exercise) of stock options, 
stock appreciation rights, and other stock value rights generally is 
not subject to section 3121(v)(2). Thus, FICA tax is not imposed at the 
time of grant, but is generally imposed at the time of exercise. No 
inference is intended as to whether or not these options and rights are 
deferred compensation for any tax purposes other than section 
3121(v)(2).
    The final regulations retain the rule in the proposed regulations 
that benefits established after termination of employment are not 
subject to section 3121(v)(2). However, in response to comments, the 
final regulations provide an exception under which certain payments to 
which the employee obtains a legally binding right after termination of 
employment that are in the nature of cost-of-living adjustments are 
nonetheless subject to section 3121(v)(2).
    The final regulations retain the rule in the proposed regulations 
that window benefits do not result from the deferral of compensation. 
However, the final regulations include a transition rule under which 
window benefits can be treated as subject to section 3121(v)(2) if the 
window program commences prior to January 1, 2000 (the general 
effective date of the final regulations). Payments made pursuant to a 
window program that qualifies for the transition rule are not subject 
to FICA tax under the general timing rule at the time payment is made, 
provided that the present value of the window benefits has been taken 
into account under section 3121(v)(2) on a timely basis.
c. Account Balance Plans
    Paragraph (c) of the regulations defines account balance plan and 
provides that, for purposes of section 3121(v)(2), the amount deferred 
under an account balance plan generally is based on the amount of 
principal credited to the account. Commentators asked whether a plan 
that permits optional forms of benefit can be treated as an account 
balance plan. The final regulations provide that if the plan's terms 
preclude subsidies of optional forms of benefit (for example, if, under 
the terms of the plan at the time the amount is deferred, alternative 
forms of payment will be actuarially equivalent to the account balance 
based on a rate of interest that will be reasonable at the time the 
optional form is elected), the plan does not fail to be an account 
balance plan merely because of the availability of optional forms of 
benefit.
 d. Income and Reasonable Rate of Interest
    Under paragraph (d) of the proposed regulations, if an account 
balance plan credits income based on a reasonable rate of interest or a 
rate of return that does not exceed the rate of return on a 
predetermined actual investment specified under the plan, FICA tax 
would not be imposed on that income. A number of commentators requested 
clarification as to whether a rate of interest that was fixed for an 
extended period could be reasonable for this purpose. The final 
regulations clarify that the determination of whether interest credited 
under an account balance plan is reasonable is generally made annually. 
However, a rate that is specified for a fixed period of up to five 
years and that was reasonable when it was specified is treated as 
continuing to be reasonable (even if it subsequently ceases to be 
reasonable during the period for which it is specified).
    The final regulations also clarify what constitutes a predetermined 
actual investment and provide rules for determining the amount deferred 
in cases in which income is credited under a plan that uses neither a 
predetermined actual investment nor a reasonable interest rate. In 
these cases, the final regulations generally provide for the income 
credited in excess of AFR to be treated as an additional amount 
deferred. However, the final regulations provide that if the employer 
takes into account as an additional amount deferred the income credited 
to the extent it exceeds a reasonable rate of interest calculated by 
the employer, the remaining income (which is no greater than a 
reasonable rate of interest) is excluded from FICA wages.
    Some commentators suggested that the employer's creditworthiness 
should be permitted to be considered in determining whether the 
interest rate credited under a plan of the employer is reasonable. The 
final regulations, like the proposed regulations, permit the amount 
deferred to be calculated after application of a discount to reflect 
the

[[Page 4545]]

time value of money and the risk that benefits will not be paid due to 
death. However, no discount is permitted for the risk that the amount 
deferred will not be paid by the employer. Permitting employers to 
implicitly achieve the same result through the interest rate credited 
under an account balance plan would be inconsistent with this 
restriction. Accordingly, the final regulations do not permit the 
employer's creditworthiness to be considered in determining whether the 
interest rate credited under a plan of the employer is reasonable.
e. Treatment of Amounts Deferred That Are Not Reasonably Ascertainable
    Paragraph (e) of the final regulations retains the rule in the 
proposed regulations that the amount deferred need not be taken into 
account until it is reasonably ascertainable. This rule addresses the 
difficulty of determining the appropriate amount to be taken into 
account for a plan that provides benefits that are not fixed until 
certain future events occur, such as a nonaccount balance plan with 
subsidized optional forms or a long-term incentive plan that depends on 
subsequent corporate performance. The final regulations retain the rule 
in the proposed regulations that allows optional inclusion of these 
amounts at an earlier date with a true-up at the resolution date when 
the amount deferred becomes reasonably ascertainable.
    Under the proposed regulations, the early inclusion amount was to 
be accumulated to the resolution date at an interest rate (and with a 
mortality assumption, if appropriate) that was reasonable at the early 
inclusion date. That accumulated amount was then compared to the 
present value of payments using actuarial assumptions that were 
reasonable at the resolution date. This methodology exposes the 
employer to the risk that an additional amount could be required to be 
taken into account at the resolution date solely as a result of changes 
in interest rates between the early inclusion date and the resolution 
date. In response to comments, this true-up methodology has been 
modified.
    Under the final regulations, in performing the true-up, the amount 
taken into account at the early inclusion date is converted to an 
actuarially equivalent benefit payment stream in the form, and with the 
commencement date, in which benefits are actually paid. The conversion 
is done using actuarial assumptions that were reasonable as of the 
early inclusion date. The benefit payment stream thus derived is 
compared to the benefits actually payable. To the extent the benefit 
payment stream actually payable exceeds the benefit payment stream that 
is actuarially equivalent to the amount taken into account at the early 
inclusion date, the present value of the excess (determined using 
actuarial assumptions that are reasonable as of the resolution date) 
must be taken into account on the resolution date. If the benefit 
payment stream that is actuarially equivalent to the amount taken into 
account at the early inclusion date equals (or exceeds) the actual 
benefit payment stream, no additional amount is required to be taken 
into account at the resolution date, regardless of any changes in 
interest rates between the early inclusion date and the resolution 
date. This method--an annuity purchase model--eliminates the risk that 
the employer will be required to take additional amounts into account 
merely because of interest rate changes between the early inclusion 
date and the resolution date.
    In addition, the final regulations provide that an amount deferred 
under certain nonaccount balance plans that permit optional forms of 
benefit or alternative commencement dates will not fail to be 
reasonably ascertainable merely because the form or commencement date 
has not been selected. If the terms of a nonaccount balance plan, at 
the time an amount is deferred, provide that the amount payable under 
each optional form and commencement date will be equivalent using 
actuarial assumptions that are reasonable at the resolution date 
(generally, the time the optional form and commencement date are 
selected) the amount deferred can be calculated based solely on the 
normal form of payment commencing at normal commencement date 
(regardless of which optional form or commencement date is ultimately 
selected). For this purpose, the normal form of benefit commencing at 
normal commencement date is the form and date of commencement under 
which the payments due to an employee under the plan are expressed, 
before adjustments for form or timing of commencement of payments.
    The final regulations clarify how to allocate amounts deferred 
among periods for purposes of the early inclusion rules, including a 
rule requested by commentators concerning plan offsets. For example, 
the final regulations provide a rule to determine how amounts deferred 
are to be allocated among years in cases in which an employee obtains a 
legally binding right in each of several years to receive payments from 
a nonqualified deferred compensation plan that provides a specified 
gross benefit for the years which is to be offset by the benefits 
payable under a qualified plan. Under this rule, the amount deferred in 
the first year may be treated as equal to the gross benefit for the 
year, reduced by the offset applicable at the end of the first year 
(even if the offset increases after the end of that year). The same 
method applies to subsequent years, with adjustments for amounts 
allocated to an earlier year.
    The regulations also retain the rule of administrative convenience 
that was in the proposed regulations under which the amount deferred 
during a year can be treated as required to be taken into account at 
any later date during the year, provided that income attributable to 
the amount deferred through that date is included. Thus, in a 
nonaccount balance plan this rule permits the present value of amounts 
deferred throughout a year to be determined as of the end of the year 
based on the employee's age and appropriate actuarial assumptions at 
the end of the year.
f. Withholding Rules
    For purposes of withholding and depositing FICA tax, paragraph (f) 
of the final regulations provides that 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 given year by December 31 of that 
year. The proposed regulations provided relief in these situations by 
allowing employers to use either of two alternative methods, the 
estimated method and the lag method, for withholding and depositing 
FICA tax.
    The final regulations provide broader relief by permitting these 
methods to be used as of any date during the year and for the methods 
to be available without regard to whether the amount deferred can be 
readily calculated. Thus, the final regulations provide that, under the 
estimated method, an employer may make a reasonable estimate of the 
amount deferred as of the date the amount deferred is required to be 
taken into account. 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 treat the shortfall as 
wages either on the estimate date or on any date that is within three 
months thereafter. If the

[[Page 4546]]

employer overestimates the amount deferred that should have been taken 
into account as wages on the estimate date, the employer may claim a 
refund or credit in accordance with sections 6402, 6413, and 6511. If 
the employer treats any shortfall as wages on the estimate date or 
overestimates the amount deferred on the estimate date, the employer 
must correct any previously-reported wage information.
    Further, the final regulations provide that, under the second 
alternative method, the lag method, an employer may treat the amount 
deferred on any date as wages paid on any date that is no later than 
three months following the date the amount deferred is required to be 
taken into account. In addition, in response to comments, the final 
regulations simplify use of the lag method by permitting the FICA tax 
due to be calculated using a fixed rate of interest, not less than AFR, 
rather than on the basis of income under the plan.

Effective Dates

    These final regulations are applicable on and after January 1, 
2000. However, the final regulations include certain special transition 
provisions for periods before January 1, 2000.
    For amounts deferred and benefits paid before the January 1, 2000 
general effective date, an employer may rely on a reasonable, good 
faith interpretation of section 3121(v)(2), taking into account Notice 
94-96. The final regulations specifically provide that an employer will 
be deemed to have determined FICA tax liability and satisfied FICA tax 
withholding requirements in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if that liability is determined in 
accordance with the final regulations and the withholding method and 
timing comply with the final regulations. An employer will also be 
deemed to have determined FICA tax liability and satisfied FICA tax 
withholding requirements in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if that liability is determined in 
accordance with the proposed regulations and the withholding method and 
timing comply with the proposed regulations. 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 and the extent to which the 
employer has resolved unclear issues in its favor.
    The regulations address consistency in the treatment of stock 
options, stock appreciation rights, or other stock value rights that 
are exercised before the January 1, 2000 general effective date. Under 
the final regulations, the grant of these options and rights cannot be 
treated as subject to section 3121(v)(2) after December 31, 1999, and 
FICA tax generally applies at exercise. For periods before January 1, 
2000, an employer that treats the grant of such an option or right as 
subject to section 3121(v)(2) has not acted in accordance with a 
reasonable, good faith interpretation of section 3121(v)(2) if the 
employer has not treated that grant and all earlier grants as subject 
to section 3121(v)(2).
    The final regulations include a transition rule for periods 
3 before 1994 that applies if the employer acted in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2). Under this rule, an amount deferred that would be required 
or permitted to be taken into account in any period that ends prior to 
January 1, 1994, under the final regulations, is treated as if it had 
been taken into account in accordance with the final 
regulations.4 For example, in the case of an amount deferred 
before 1994 that was not reasonably ascertainable, the employer is 
treated as having taken the amount deferred into account at an early 
inclusion date before 1994 using a method permitted in the final 
regulations, including anticipation of the actual form in which the 
benefit payments attributable to the amount deferred are paid and the 
actual date of commencement. Thus, the employer is not required to pay 
any additional FICA tax when the amount deferred becomes reasonably 
ascertainable or when the benefit payments attributable to the amount 
deferred are actually or constructively paid.
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    \3\ For purposes of FICA tax, the period of limitations is 
generally based on calendar quarters (whereas, for purposes of the 
Federal Unemployment Tax Act (FUTA) tax, the period of limitations 
is based on calendar years). See section 6501.
    \4\ The proposed regulations (as amended in 1997) included a 
similar rule applicable to periods that were closed as of January 1, 
1998 (which generally would have been periods before 1994). 
Commentators recommended that this rule apply even if the period is 
kept open beyond the normal period of limitations, such as by 
agreement with the IRS or by a claim for refund. In response to 
those comments, the final regulations provide that this rule applies 
to all periods prior to 1994 regardless of whether the period 
remains open.
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    The final regulations include a new transition rule for amounts 
deferred that were required to be taken into account in 1994 or 1995. 
Under the final regulations, an employer will be treated as taking the 
amount deferred into account under the final regulations to the extent 
the employer takes the amount into account by treating it as wages paid 
by the employer and received by the employee as of any date prior to 
April 1, 2000. The amount taken into account before April 1, 2000, is 
not required to be increased by attributable income or interest.
    These and the other transition provisions of the final regulations 
are in addition to the interest-free adjustment procedures that are 
available under section 6205 at any time before the period of 
limitations has expired. Thus, for example, with respect to a FICA tax 
return (Form 941) for a period before the effective date, an employer 
may make an adjustment to take an amount deferred under a nonqualified 
deferred compensation plan into account in accordance with the final 
regulations if the period is still open.
    Section 31.3121(v)(2)-2 of the final regulations provides special 
rules relating to a March 24, 1983 agreement and certain agreements 
adopted after March 24, 1983, and before January 1, 1984. The final 
regulations also include certain clarifications to the transition rules 
that have been made in response to comments on the proposed 
regulations, including clarification of the effect of post-1983 
amendments.

Special Analyses

    It has been determined that this Treasury decision 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) 
does not apply to these regulations, and because the notice of proposed 
rulemaking was issued prior to March 29, 1996, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact on small business.

Drafting Information

    The principal authors of these regulations are Janine Cook, Linda 
E. Alsalihi, and Margaret A. Owens, Office of the Associate Chief 
Counsel (Employee Benefits and Exempt Organizations). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects

26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement,

[[Page 4547]]

 Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 31 and 602 are 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) generally is taken into account for purposes of the 
Federal Insurance Contributions Act (FICA) taxes imposed under sections 
3101 and 3111 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 tax 
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 tax 
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). For example, if a nonqualified 
deferred compensation plan provides retirement benefits which result 
from the deferral of compensation and disability pay (within the 
meaning of paragraph (b)(4)(iv)(C) of this section) which does not 
result from the deferral of compensation, the retirement benefits 
provided under the plan are subject to the special timing rule in this 
paragraph (a)(2) and the disability pay is not.
    (v) Remuneration that does not constitute wages. If remuneration 
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 tax 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 
example, benefits under a death benefit plan described in section 
3121(a)(13) do not constitute wages for FICA tax 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. For 
purposes of this section, the term nonqualified deferred compensation 
plan means any plan or other arrangement, other than a plan described 
in section 3121(a)(5), 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). A nonqualified 
deferred compensation plan may be adopted unilaterally by the employer 
or may be negotiated among 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 (ERISA), as amended (29 U.S.C. 1002(3)). 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, and the date on 
which the material terms of the plan are set forth in writing. For 
purposes of this section, a plan 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, is established in 
accordance with paragraph (b)(2)(i) of this section.
    (iii) Transition rule for written plan requirement. For purposes of 
this section, an unwritten plan that was 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 the material

[[Page 4548]]

terms of the plan are set forth in writing before January 1, 2000.
    (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 to (or on behalf of) the employee 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 after the services creating the right to the 
compensation have been performed. 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 an objective 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), or because benefits are reduced due to investment losses or, in 
a final average pay plan, subsequent decreases in compensation.
    (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 not 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. The grant of a stock option, stock appreciation right, or 
other stock value right does not constitute the deferral of 
compensation for purposes of section 3121(v)(2). In addition, amounts 
received as a result of the exercise of a stock option, stock 
appreciation right, or other stock value right do not result from the 
deferral of compensation for purposes of section 3121(v)(2) if such 
amounts are actually or constructively received in the calendar year of 
the exercise. 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 plan under which an employee obtains a legally binding right 
to receive property (whether or not the property is restricted 
property) in a future year 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--(A) In general. 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).
    (B) Severance pay. Benefits that are provided under a severance pay 
arrangement (within the meaning of section 3(2)(B)(i) of ERISA) that 
satisfies the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii) are 
considered severance pay for purposes of this paragraph (b)(4)(iv). If 
benefits are provided under a severance pay arrangement (within the 
meaning of section 3(2)(B)(i) of ERISA), but do not satisfy one or more 
of the conditions in 29 CFR 2510.3-2(b)(1)(i) through (iii), then 
whether those benefits are severance pay within the meaning of this 
paragraph (b)(4)(iv) depends upon the relevant facts and circumstances. 
For this purpose, relevant facts and circumstances include whether the 
benefits are provided over a short period of time commencing 
immediately after (or shortly after) termination of employment or for a 
substantial period of time following termination of employment and 
whether the benefits are provided after any termination or only after 
retirement (or another specified type of termination). Benefits 
provided under a severance pay arrangement (within the meaning of 
section 3(2)(B)(i) of ERISA) are in all cases severance pay within the 
meaning of this paragraph (b)(4)(iv) if the benefits payable under the 
plan upon an employee's termination of employment are payable only if 
that termination is involuntary.
    (C) Death benefits and disability pay--(1) General definition. 
Payments made under a nonqualified deferred compensation plan in the 
event of death are death benefits within the meaning of this paragraph 
(b)(4)(iv), but only to the extent the total benefits payable under the 
plan exceed the lifetime benefits payable under the plan. Similarly, 
payments made under a nonqualified deferred compensation plan in the 
event of disability are disability pay within the meaning of this 
paragraph (b)(4)(iv), but only to the extent the disability benefits 
payable under the plan exceed the lifetime benefits payable under the 
plan. Accordingly, any benefits that a nonqualified deferred 
compensation plan provides in the event of death or disability that are 
associated with an amount deferred under this section are

[[Page 4549]]

disregarded in applying this section to the extent the benefits payable 
under the plan in the event of death or in the event of disability have 
a value in excess of the lifetime benefits payable under the plan.
    (2) Total benefits payable defined. For purposes of paragraph 
(b)(4)(iv)(C)(1) of this section, the term total benefits payable under 
a plan means the present value of the total benefits payable to or on 
behalf of the employee (including benefits payable in the event of the 
employee's death) under the plan, disregarding any benefits that are 
payable only in the event of disability and determined separately with 
respect to each form of distribution or other election that may apply 
with respect to the employee.
    (3) Disability benefits payable defined. For purposes of paragraph 
(b)(4)(iv)(C)(1) of this section, the term disability benefits payable 
under a plan means the present value of the benefits payable to or on 
behalf of the employee under the plan, including benefits payable in 
the event of the employee's disability but excluding death benefits 
within the meaning of this paragraph (b)(4)(iv).
    (4) Lifetime benefits payable defined. For purposes of paragraph 
(b)(4)(iv)(C)(1) of this section, the term lifetime benefits payable 
under a plan means the present value of the benefits that could be 
payable to the employee under the plan during the employee's lifetime, 
determined under the plan's optional form of distribution or other 
election that is or was available to the employee at any time with 
respect to the amount deferred and that provides the largest present 
value to the employee during the employee's lifetime of any such form 
or election so available.
    (5) Rules of application. For purposes of determining present value 
under this paragraph (b)(4)(iv)(C), present value is determined as of 
the time immediately preceding the time the amount deferred under a 
nonqualified deferred compensation plan is required to be taken into 
account under paragraph (e) of this section, using actuarial 
assumptions that are reasonable as of that date but taking into 
consideration only benefits that result from the deferral of 
compensation, as determined under this paragraph (b), and benefits 
payable in the event of death or disability. In addition, for purposes 
of paragraph (b)(4)(iv)(C)(4) of this section, present value must be 
determined without any discount for the probability that the employee 
may die before benefit payments commence and without regard to any 
benefits payable solely in the event of disability.
    (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 (C) 
of this section do not result from the 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), except as provided in paragraph (b)(4)(v)(B)(3) of this 
section, 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.
    (3) Transition rule for window benefits. In the case of a window 
benefit that is made available for a period of time that begins before 
January 1, 2000, an employer may choose to treat the window benefit as 
a benefit that results from the deferral of compensation if the sole 
reason the window benefit would otherwise fail to be provided pursuant 
to a nonqualified deferred compensation plan is the application of 
paragraph (b)(4)(v)(B)(1) of this section.
    (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 plan (or amendment) providing the benefit; 
and
    (2) The facts and circumstances indicate that the plan (or 
amendment) is established in contemplation of the employee's impending 
termination of employment.
    (vi) Benefits established after termination. 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). However, cost-of-living adjustments on 
benefit payments under a nonqualified deferred compensation plan 
(within the meaning of paragraph (b) of this section) shall not be 
considered benefits established after the employee's termination of 
employment for purposes of this paragraph (b)(4)(vi) merely because the 
employee does not obtain the right to the adjustment until after the 
employee's termination of employment. For purposes of the preceding 
sentence, cost-of-living adjustments are payments that satisfy 
conditions similar to those of 29 CFR 2510.3-2(g)(1)(ii) and (iii).
    (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) is illustrated by the following 
examples:

    Example 1. (i) In December of 2001, Employer L tells Employee A 
that, if specified goals are satisfied for 2002, Employee A will 
receive a bonus on July 1, 2003, equal to a specified percentage of 
2002 compensation. Because Employee A meets the specified goals, 
Employer L pays the bonus to Employee A on July 1, 2003, 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) In 2004, Employer M establishes a compensation 
arrangement for Employee B under which Employer M agrees to pay 
Employee B a specified amount based on a percentage of his salary 
for 2004. The amount due is to be paid out of the general assets of 
Employer M and is payable in 2008.
    (ii) Employee B has a legally binding right during 2004 to an 
amount of compensation

[[Page 4550]]

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 N 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, 
2001, to increase benefits, and the amendment provides that the 
increase in benefits is on account of Employee C's performance of 
services for Employer N from 1985 through 2000.
    (ii) The additional benefits that resulted from the plan 
amendment cannot be taken into account as amounts deferred for 1985 
through 2000, 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 material terms of 
the plan, as amended, are set forth in writing.
    Example 4. (i) In 2002, Employer O, 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) 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 O 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 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 O is excluded from the definition of 
employment under section 3121(b)(7).
    Example 5. (i) In 2000, Employer P establishes a plan that 
provides for bonuses to be paid to employees based on an objective 
formula that takes into account the employees' performance for the 
year. Employer P does not have the discretion to reduce the amount 
of any employee's bonus after the end of 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 P may choose, pursuant to paragraph (b)(3)(iii) 
of this section, to treat all the bonuses as if they are not subject 
to the special timing rule of paragraph (a)(2) of this section.
    (iii) If the employer uses the special timing rule, the amount 
deferred would be taken into account as wages on December 31, 2000. 
If the employer chooses not to use the special timing rule, the 
amount of the bonus is wages on the date it is actually or 
constructively paid, March 15, 2000.
    Example 6. (i) Employer Q 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 any bonus until January of the year in which the bonus is paid, 
any bonus paid under the plan in that year is not deferred from the 
preceding calendar year, and the plan does not provide for the 
deferral of compensation within the meaning of paragraph (b)(3)(i) 
of this section.
    Example 7. (i) Employer R 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 2001 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 2010. The 
options do not have a readily ascertainable fair market value for 
purposes of section 83 at the date of grant, and shares are issued 
upon the exercise of the options without being subject to a 
substantial risk of forfeiture within the meaning of section 83. In 
2005, when the fair market value of a share of employer stock is 
$80, Employee D exercises an option to acquire 1,000 shares.
    (ii) Under paragraph (b)(4)(ii) of this section, neither the 
grant of a stock option nor amounts received currently as a result 
of the exercise of a stock option result from the deferral of 
compensation for purposes of section 3121(v)(2). Thus, under the 
general timing rule of paragraph (a)(1) of this section, the $30,000 
spread between the amount paid for the shares ($50,000) and the fair 
market value of the shares on the date of exercise ($80,000) is 
taken into account as wages for FICA tax 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 $35,000 
spread between the amount paid for the shares ($45,000) and the fair 
market value of the shares on the date of exercise ($80,000) would 
similarly be taken into account as wages for FICA tax 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 on the date of termination, 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 severance pay 
arrangement (within the meaning of section 3(2)(b)(i) of ERISA) 
which provides for payments solely upon an employee's death, 
disability, or dismissal from employment. 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)(B) 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) Employer V establishes a nonqualified deferred 
compensation plan under which employees will receive benefit 
payments commencing at age 65 as a life annuity or in one of several 
actuarially equivalent annuity forms. If an employee dies before 
benefit payments commence under the plan, a benefit is payable to 
the employee's designated beneficiary in a single sum payment equal 
to the present value of the employee's annuity benefit. This benefit 
(sometimes called a full reserve death benefit) is calculated using 
the applicable interest rate specified in section 417(e) and, for 
the period after age 65, the applicable mortality table specified in 
section 417(e), both of which are reasonable actuarial assumptions. 
During 2002, Employee E obtains a legally binding right to an 
annuity benefit under the plan, payable at age 65. This annuity 
benefit has a present value of $10,000 at the end of 2002, 
determined using the same assumptions as are used under the plan to 
calculate the full reserve death benefit.
    (ii) The present value, at the end of 2002, of the total 
benefits payable to or on behalf of Employee E (i.e., the sum of the 
present

[[Page 4551]]

value of the annuity benefit commencing at age 65, and the present 
value of the full reserve death benefit, with both determined using 
the actuarial assumptions described in paragraph (i) of this Example 
10, except also taking into account the probability of death prior 
to age 65) is $10,000. This present value does not exceed the 
present value of the annuity benefits that could be payable to 
Employee E under the plan during Employee E's lifetime determined 
without a discount for the possibility that Employee E might die 
before age 65 (also $10,000). Thus, the benefit payable in the event 
of the Employee E's death is not a death benefit for purposes of 
paragraph (b)(4)(iv) of this section.
    (iii) The same result would apply in the case of a plan that 
bases benefits on an interest bearing account balance and pays the 
account balance at termination of employment or death (because the 
sum of the deferred benefits payable in the future if the employee 
terminates employment before death with a discount for the 
probability of death before that date plus the present value of the 
benefit payable in the event of death necessarily equals the present 
value of the deferred benefits payable with no discount for the 
probability of death).
    Example 11. (i) The facts are the same as in Example 10, except 
that, in lieu of the full reserve death benefit, the plan provides a 
monthly life annuity benefit to an employee's spouse in the event of 
the employee's death before benefit payments commence equal to 100 
percent of the monthly annuity that would be payable to the employee 
at age 65 under the life annuity form. Employee E is age 63 and has 
a spouse who is age 51. The sum of the present value of Employee E's 
annuity benefit commencing at age 65 determined with a discount for 
the possibility that Employee E might die before age 65 and the 
present value of the 100 percent annuity death benefit for Employee 
E's spouse exceeds $10,000.
    (ii) The amount deferred for 2002 is $10,000 (because the 100 
percent annuity death benefit for Employee E's spouse is disregarded 
to the extent that the total benefits payable to or on behalf of 
Employee E exceeds the present value of the annuity benefits that 
could be payable to Employee E under the plan during the Employee 
E's lifetime without a discount for the probability of Employee E's 
death before benefit payments commence).
    Example 12. (i) On January 1, 2001, Employer W establishes a 
plan that covers only Employee F, 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 F's termination of employment at 
any time, he will receive $200,000 per year for each of the 
immediately succeeding five years. Employee F terminates employment 
on March 1, 2001.
    (ii) Because Employee F 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 13. (i) Employer X establishes a plan on January 1, 
2004, to supplement the qualified retirement benefits of recently 
hired 55-year old Employee G, who forfeited retirement benefits with 
her former employer in order to accept employment with Employer X. 
The plan provides that Employee G will receive $50,000 per year for 
life beginning at age 65, regardless of when she terminates 
employment. On April 15, 2004, Employee G unexpectedly terminates 
employment.
    (ii) The facts and circumstances indicate that the plan was not 
established in contemplation of impending termination. Thus, even 
though Employee G 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 14. (i) Employer Y 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 H is 
planning to (and actually does) retire within six months of the date 
on which the plan is established.
    (ii) Even though Employee H terminated employment within 12 
months of the establishment of the plan, the plan is not considered 
to have been established in connection with Employee H's impending 
termination within the meaning of paragraph (b)(4)(v) of this 
section because the facts and circumstances indicate otherwise.
    Example 15. (i) Employee J owns 100 percent of Employer Z, a 
corporation that provides consulting services. Substantially all of 
Employer Z's revenue is derived as a result of the services 
performed by Employee J. In each of 2001, 2002, and 2003, Employer Z 
has gross receipts of $180,000 and expenses (other than salary) of 
$80,000. In each of 2001 and 2002, Employer Z pays Employee J a 
salary of $100,000 for services performed in each of those years. On 
December 31, 2002, Employer Z establishes a plan to pay Employee J 
$80,000 in 2003. The plan recites that the payment is in recognition 
of prior services. In 2003, Employer Z pays Employee J 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 J in 2003 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 2003 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 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.
    (ii) Definitions--(A) Account balance plan. For purposes of this 
section, an account balance plan is a nonqualified deferred 
compensation plan under the terms of which 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.
    (B) Income. 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.
    (iii) Additional rules--(A) Commingled accounts. 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.
    (B) Bifurcation permitted. An employer may treat a portion of a 
nonqualified deferred compensation plan as a separate account balance 
plan if that portion satisfies the requirements of this paragraph 
(c)(1) and the amount payable to employees under that portion is 
determined independently of the amount payable under the other portion 
of the plan.
    (C) Actuarial equivalents. A plan does not fail to be an account 
balance plan merely because the plan permits employees to elect to 
receive their benefits under the plan in a form of benefit other than 
payment of the account balance, provided the amount of benefit payable 
in that other form is actuarially equivalent to payment of the account 
balance using actuarial assumptions that are reasonable. Conversely, a 
plan is not an account

[[Page 4552]]

balance plan if it provides an optional form of benefit that is not 
actuarially equivalent to the account balance using actuarial 
assumptions that are reasonable. For this purpose, the determination of 
whether forms are actuarially equivalent using actuarial assumptions 
that are reasonable is determined under the rules applicable to 
nonaccount balance plans under paragraph (c)(2)(iii) of this section.
    (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) 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) of this section using actuarial assumptions 
and methods that are reasonable as of that date. For this purpose, a 
discount for the probability that an employee will die before 
commencement of benefit payments is permitted, but only to the extent 
that benefits will be forfeited upon death. In addition, the present 
value cannot be discounted for the probability 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. Nor is the 
present value affected by the possibility that some of the payments due 
under the plan will be eligible for one of the exclusions from wages in 
section 3121(a).
    (iii) Treatment of actuarially equivalent benefits--(A) In general. 
In the case of a nonaccount balance plan that permits employees to 
receive their benefits in more than one form or commencing at more than 
one date, the amount deferred is determined by assuming that payments 
are made in the normal form of benefit commencing at normal 
commencement date if the requirements of paragraph (c)(2)(iii)(B) of 
this section are satisfied. Accordingly, in the case of a nonaccount 
balance plan that permits employees to receive their benefits in more 
than one form or commencing at more than one date, unless the 
requirements of paragraph (c)(2)(iii)(B) of this section are satisfied, 
the amount deferred is treated as not reasonably ascertainable under 
the rules of paragraph (e)(4)(i)(B) of this section until a form of 
benefit and a time of commencement are selected.
    (B) Use of normal form commencing at normal commencement date. The 
requirements of this paragraph (c)(2)(iii)(B) are satisfied by a 
nonaccount balance plan if the plan has a single normal form of benefit 
commencing at normal commencement date for the amount deferred and each 
other optional form is actuarially equivalent to the normal form of 
benefit commencing at normal commencement date using actuarial 
assumptions that are reasonable. For this purpose, each form of benefit 
for payment of the amount deferred commencing at a date is a separate 
optional form. For purposes of this paragraph (c)(2)(iii)(B), each 
optional form is actuarially equivalent to the normal form of benefit 
commencing at normal commencement date only if the terms of the plan in 
effect when the amount is deferred provide for every optional form to 
be actuarially equivalent and further provide for actuarial assumptions 
to determine actuarial equivalency that will be reasonable at the time 
the optional form is selected, without regard to whether market 
interest rates are higher or lower at the time the optional form is 
selected than at the time the amount is deferred. Thus, a plan that 
provides for every optional form to be actuarially equivalent satisfies 
this paragraph (c)(2)(iii)(B) if it provides for actuarial equivalence 
to be determined--
    (1) When an optional form is selected or when benefit payments 
under the optional form commence, based on assumptions that are 
reasonable then;
    (2) Based on an index that reflects market rates of interest from 
time to time (for example, the plan specifies that all benefits will be 
actuarially equivalent using the applicable interest rate and 
applicable mortality table specified in section 417(e)); or
    (3) Based on actuarial assumptions specified in the plan and 
provides for those assumptions to be revised to be reasonable 
assumptions if they cease to be reasonable assumptions.
    (C) Fixed mortality assumptions permitted. A plan does not fail to 
satisfy paragraph (c)(2)(iii)(B) of this section merely because the 
plan specifies a fixed mortality assumption that is reasonable at the 
time the amount is deferred, even if that assumption is not reasonable 
at the time the optional form is selected. (But see paragraph 
(c)(2)(iii)(E) of this section for additional rules that apply if the 
mortality assumption is not reasonable at the time the optional form is 
selected.)
    (D) Normal form of benefit commencing at normal commencement date 
defined. For purposes of this paragraph (c)(2)(iii), the normal form of 
benefit commencing at normal commencement date under the plan is the 
form, and date of commencement, under which the payments due to the 
employee under the plan are expressed, prior to adjustments for form or 
timing of commencement of payments.
    (E) Rule applicable if actuarial assumptions cease to be 
reasonable. If the terms of the plan in effect when an amount is 
deferred provide for actuarial assumptions to determine actuarial 
equivalency that will be reasonable at the time the optional form is 
selected or payments commence as provided in paragraph (c)(2)(iii)(B) 
of this section, but, at that time, the actuarial assumptions used 
under the plan are not reasonable, the employee will be treated as 
obtaining a legally binding right at that time (or, if earlier, at the 
date on which the plan is amended to provide actuarial assumptions that 
are not reasonable) to any additional benefits that result from the use 
of an unreasonable actuarial assumption. This might occur, for example, 
if the plan specifies that the actuarial assumptions will be reasonable 
assumptions to be set at the time the optional form is selected and the 
assumptions used are in fact not reasonable at that time.
    (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)(B) of this section and 
the amount of the true-up at the resolution date described in paragraph 
(e)(4)(ii)(B) of this section are determined separately with respect to 
each amount deferred. See paragraph (e)(4)(ii)(D) of this section

[[Page 4553]]

for special rules for allocating amounts deferred over more than one 
year.
    (4) Examples. This paragraph (c) is illustrated by the following 
examples. (The examples illustrate the rules in this paragraph (c) and 
include various interest rate and mortality table assumptions, 
including the applicable section 417(e) mortality table, the GAM 83 
(male) mortality table, and UP-84 mortality table. These tables can be 
obtained from the Society of Actuaries at its internet site at http://
www.soa.org.) The examples are as follows:

    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 five employees. Under the plan, a 
specified sum is credited to an account for the benefit of the group 
of employees on July 31 of each year. Income on the balance of the 
account is credited annually at a rate that is reasonable for each 
year. The benefit payable to an employee is equal to one-fifth of 
the account balance and is payable, at the employee's option, in a 
lump sum or in 10 annual installments that reflect income on the 
balance.
    (ii) The plan is an account balance plan notwithstanding the 
fact that the employee's benefit is equal to a specified percentage 
of an account maintained for a group of employees.
    Example 4. (i) The facts are the same as in Example 3, except 
that the plan also permits an employee to elect a life annuity that 
is actuarially equivalent to the account balance based on the 
applicable interest rate and applicable mortality table specified in 
section 417(e) at the time the benefit is elected by the employee.
    (ii) Under paragraphs (c)(1)(iii)(C) and (c)(2)(iii) of this 
section, the plan does not fail to be an account balance plan merely 
because the plan permits employees to elect to receive their 
benefits under the plan in a form that is actuarially equivalent to 
payment of the account balance using actuarial assumptions that are 
reasonable at the time the form is selected.
    Example 5. (i) Employer P 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 2 percent for each year of service and the employee's highest 
average annual compensation for any 3-year period. The plan also 
provides that, if an employee 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, 2002, 
Employee C is age 60, has 25 years of service, and high 3-year 
average compensation of $100,000 (the average for the years 2000 
through 2002). As of December 31, 2003, Employee C is age 61, has 26 
years of service, and has high 3-year average compensation of 
$104,000. As of December 31, 2004, Employee C is age 62, has 27 
years of service, and has high 3-year average compensation of 
$105,000. The assumptions that Employer P uses to determine the 
amount deferred for 2003 (a 7 percent interest rate and, for the 
period after commencement of benefit payments, the GAM 83 (male) 
mortality table) and for 2004 (a 7.5 percent interest rate and, for 
the period after commencement of benefit payments, the GAM 83 (male) 
mortality table) are assumed, solely for purposes of this example, 
to be reasonable actuarial assumptions.
    (ii) As of December 31, 2002, 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, 2003, 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 2003, 
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 2003 is the present value, as of December 
31, 2003, of these additional payments, which is $28,767 ($4,080  x  
the present value factor for a deferred annuity payable at age 65, 
using the specified actuarial assumptions for 2003). Similarly, 
during 2004, Employee C has earned a legally binding right to 
additional lifetime payments of $2,620 (2 percent  x  27 years  x  
$105,000, minus $54,080) per year beginning at age 65. The amount 
deferred for 2004 is the present value, as of December 31, 2004, of 
these additional payments, which is $18,845 ($2,620  x  the present 
value factor for a deferred annuity payable at age 65, using the 
specified actuarial assumptions for 2004).
    Example 6. (i) Employer Q establishes a nonqualified deferred 
compensation plan for Employee D on January 1, 2001, when Employee D 
is age 63. During 2001, Employee D obtains a fully vested right to 
receive a life annuity under the nonqualified deferred compensation 
plan equal to the excess of $200,000 over the life annuity benefits 
payable to Employee D under a qualified defined benefit pension plan 
sponsored by Employer Q. The life annuity benefit payable annually 
under the qualified plan is the lesser of $200,000 and the section 
415(b)(1)(A) limitation in effect for the year, where the section 
415(b)(1)(A) limitation is automatically adjusted to reflect changes 
in the cost of living. Benefits under both the qualified and 
nonqualified plan are payable monthly beginning at age 65. For 
purposes of this example, the section 415(b)(1)(A) limit for 2001 is 
assumed to be $140,000. The nonqualified plan provides no benefits 
in the event Employee D dies prior to commencement of benefit 
payments. 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. The 
assumptions that Employer Q uses to determine the amount deferred 
for 2001 (a 7 percent interest rate, a 3 percent increase in the 
cost of living and the GAM 83 (male) mortality table) are assumed, 
solely for purposes of this example, to be reasonable actuarial 
assumptions. As of December 31, 2001, Employee D has a legally 
binding right to receive lifetime payments as set forth in the 
following table:

[[Page 4554]]



----------------------------------------------------------------------------------------------------------------
                                                                                      Assumed
                                                                                  qualified plan    Net annual
                              Year                                 Annual gross   annual payment   payment under
                                                                      amount      (based on cost   nonqualified
                                                                                    of  living)        plan
----------------------------------------------------------------------------------------------------------------
2003............................................................        $200,000        $145,000         $55,000
2004............................................................         200,000         150,000          50,000
2005............................................................         200,000         155,000          45,000
2006............................................................         200,000         160,000          40,000
2007............................................................         200,000         165,000          35,000
2008............................................................         200,000         170,000          30,000
2009............................................................         200,000         175,000          25,000
2010............................................................         200,000         180,000          20,000
2011............................................................         200,000         185,000          15,000
2012............................................................         200,000         190,000          10,000
2013............................................................         200,000         195,000           5,000
2014 and thereafter.............................................         200,000      205,000 or
                                                                                         greater               0
----------------------------------------------------------------------------------------------------------------

    (ii) The amount deferred for 2001 is the present value, as of 
December 31, 2001, of the net lifetime payments under the 
nonqualified plan, or $223,753.

    (d) Amounts taken into account and income attributable thereto--(1) 
Amounts taken into account--(i) In general. 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 before the expiration of the applicable period of limitations for 
the period 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) portion (or, in the case of years before 1994, the 
Hospital Insurance (HI) portion) of FICA for the year, no portion of 
the amount deferred will actually result in additional OASDI (or HI) 
tax. 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 benefit 
payments 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 resulting from 
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, as of the date an amount deferred is 
required to be taken into account, only a portion of the amount 
deferred (as determined under paragraph (c) of this section) has been 
taken into account, then a portion of each subsequent benefit payment 
that is attributable to that amount 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 
immediately before the attributable benefit payments commence (or, if 
later, the date the amount deferred is required to be taken into 
account) 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 determined under 
paragraph (d)(2) of this section through the date the portion is fixed) 
and the denominator of which is the present value of the future benefit 
payments attributable to the amount deferred, determined as of the date 
the portion is fixed. For this purpose, if the requirements of 
paragraph (c)(2)(iii)(B) of this section are satisfied, the present 
value is determined by assuming that payments are made in the normal 
form of benefit commencing at normal commencement date. In addition, if 
the employer demonstrates that the amount deferred was determined using 
reasonable actuarial assumptions as determined by the Commissioner, the 
present value of the future benefit payments attributable to the amount 
deferred is determined using those assumptions. In any other case, see 
paragraph (d)(2)(iii) of this section.
    (2) Income attributable to the amount taken into account--(i) 
Account balance plans--(A) In general. 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)(ii)(B) 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 reflects a rate of return that 
does not exceed either the rate of return on a predetermined actual 
investment (as determined in accordance with paragraph (d)(2)(i)(B) of 
this section) or, if the income does not reflect the rate of return on 
a predetermined actual investment (as so determined), a reasonable rate 
of interest (as

[[Page 4555]]

determined in accordance with paragraph (d)(2)(i)(C) of this section).
    (B) Rules relating to actual investment--(1) In general. For 
purposes of this paragraph (d)(2)(i), the rate of return on a 
predetermined actual investment for any period means the rate of total 
return (including increases or decreases in fair market value) that 
would apply if the account balance were, during the applicable period, 
actually invested in one or more investments that are identified in 
accordance with the plan before the beginning of the period. For this 
purpose, an account balance plan can determine income based on the rate 
of return of a predetermined actual investment regardless of whether 
assets associated with the plan or the employer are actually invested 
therein and regardless of whether that investment is generally 
available to the public. For example, an account balance plan could 
provide that income on the account balance is determined based on an 
employee's prospective election among various investment alternatives 
that are available under the employer's section 401(k) plan, even if 
one of those investment alternatives is not generally available to the 
public. In addition, 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).
    (2) Certain rates of return not based on predetermined actual 
investment. A rate of return will not be treated as the rate of return 
on a predetermined actual investment within the meaning of this 
paragraph (d)(2)(i)(B) if the rate of return (to any extent or under 
any conditions) is based on the greater of the rate of return of two or 
more actual investments, is based on the greater of the rate of return 
on an actual investment and a rate of interest (whether or not the rate 
of interest would otherwise be reasonable under paragraph (d)(2)(i)(C) 
of this section), or is based on the rate of return on an actual 
investment that is not predetermined. For example, if a plan bases the 
rate of return on the greater of the rate of return on a predetermined 
actual investment (such as the value of the employer's stock), and a 0 
percent interest rate (i.e., without regard to decreases in the value 
of that investment), the plan is using a rate of return that is not a 
rate of return on a predetermined actual investment within the meaning 
of this paragraph (d)(2)(i)(B).
    (C) Rules relating to reasonable interest rates--(1) In general. If 
income for a period is credited to an account balance plan on a basis 
other than the rate of return on a predetermined actual investment (as 
determined in accordance with paragraph (d)(2)(i)(B) of this section), 
then, except as otherwise provided in this paragraph (d)(2)(i)(C), the 
determination of whether the income for the period is based on a 
reasonable rate of interest will be made at the time the amount 
deferred is required to be taken into account and annually thereafter.
    (2) Fixed rates permitted. If, with respect to an amount deferred 
for a period, an account balance plan provides for a fixed rate of 
interest to be credited, and the rate is to be reset under the plan at 
a specified future date that is not later than the end of the fifth 
calendar year that begins after the beginning of the period, the rate 
is reasonable at the beginning of the period, and the rate is not 
changed before the reset date, then the rate will be treated as 
reasonable in all future periods before the reset date.
    (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, for 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 
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. This 
paragraph (d)(2)(iii)(A) applies to an account balance plan under which 
the income credited is based on neither a predetermined actual 
investment, within the meaning of paragraph (d)(2)(i)(B) of this 
section, nor a rate of interest that is reasonable, within the meaning 
of paragraph (d)(2)(i)(C) of this section, as determined by the 
Commissioner. In that event, the employer must calculate the amount 
that would be credited as income under a reasonable rate of interest, 
determine the excess (if any) of the amount credited under the plan 
over the income that would be credited using the reasonable rate of 
interest, and take that excess into account as an additional amount 
deferred in the year the income is credited. If the employer fails to 
calculate the amount that would be credited as income under a 
reasonable rate of interest and to take the excess into account as an 
additional amount deferred in the year the income is credited, or the 
employer otherwise fails to take the full amount deferred into account, 
then the excess of the income credited under the plan over the income 
that would be credited using AFR will be treated as an amount deferred 
in the year the income is credited. For purposes of this section, AFR 
means the mid-term applicable federal rate (as defined pursuant to 
section 1274(d)) for January 1 of the calendar year, compounded 
annually. In addition, pursuant to paragraph (d)(1)(ii) of this 
section, the excess over the income that would result from the 
application of AFR and any income attributable to that 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 paragraph (d)(1)(ii)(B) 
of this section (at the date specified in paragraph (d)(1)(ii)(B) of 
this section), 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

[[Page 4556]]

the amount deferred was required to be taken into account.
    (3) Examples. This paragraph (d) is illustrated by the following 
examples:

    Example 1. (i) In 2001, Employer M establishes a nonqualified 
deferred compensation plan for Employee A under which all benefits 
are 100 percent vested. In 2002, 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 2002 is 
$20,000. Thus, Employee A has total wages for FICA tax purposes of 
$220,000. Because Employee A has other wages that exceed the OASDI 
wage base for 2002, no additional OASDI tax is due 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 HI tax.
    (ii) Under paragraph (d)(1)(i) of this section, an amount 
deferred is considered taken into account as wages for FICA tax 
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, benefit payments 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 and will 
be subject to the HI portion of FICA tax when actually or 
constructively paid (and the OASDI portion of FICA tax to the extent 
Employee A's wages do not exceed the OASDI wage base limitation).
    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 
limitations expires for 2002 (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 2002. 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 tax 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 employee's 
account as of the preceding December 31. The interest rate specified 
in the plan results in income credits that are not based on the rate 
of return on a predetermined actual investment within the meaning of 
paragraph (d)(2)(i)(B) of this section, and that are greater than 
the income that would result from application of a reasonable rate 
of interest within the meaning of paragraph (d)(2)(i)(C) of this 
section. Employer N fails to take into account an additional amount 
for the excess of the income credited under the plan over a 
reasonable rate of interest.
    (ii) Pursuant to paragraph (d)(2)(iii)(A) of this section, the 
income credits in excess of the income that would be credited using 
the AFR are considered additional amounts deferred 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, 
the income credited under the plan 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 based on the rate of total 
return on Employer N's publicly traded common stock.
    (ii) Because the income credited under the plan does not exceed 
the actual rate of return on a predetermined actual investment, the 
income credited is considered income attributable to the amount 
taken into account within the meaning of paragraph (d)(2)(i) of this 
section.
    Example 6. (i) The facts are the same as in Example 3, except 
that the annual rate of increase or decrease is equal to the greater 
of the rate of total return on a specified aggressive growth mutual 
fund or the rate of return on a specified income-oriented mutual 
fund. Employer N fails to take into account an additional amount for 
the excess of the income credited under the plan over a reasonable 
rate of interest.
    (ii) Because the rate of increase or decrease is based on the 
greater of two rates of returns, the increase is not based on the 
return on a predetermined actual investment within the meaning of 
paragraph (d)(2)(i)(B) of this section. Thus, if the rate of return 
credited under the plan (i.e., the greater of the rates of return of 
the two mutual funds) exceeds the income that would be credited 
using 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 7. (i) The facts are the same as in Example 6, except 
that the annual increase or decrease with respect to 50 percent of 
the employee's account is equal to the rate of total return on the 
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 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 8. (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 2004, the board designates Company A stock as the 
investment for 2004. Before the beginning of 2005, the board 
designates Company B stock as the investment for 2005. At the end of 
2005, the board determines that the return on Company B stock was 
lower than expected and changes its designation for 2005 to the rate 
of return on Company C stock, which had a higher return during 2005. 
Employer N fails to take into account an additional amount for the 
excess of the income credited under the plan over a reasonable rate 
of interest.
    (ii) The annual increase or decrease for 2004 is based on the 
return of a predetermined actual investment. Although the annual 
increase or decrease for 2005 is based on an actual investment, the 
actual investment is not predetermined since it was not designated 
before the beginning of 2005. Pursuant to paragraph (d)(2)(iii)(A) 
of this section, the excess of the income credited under the plan 
over the income determined using AFR is an additional amount 
deferred for 2005.
    Example 9. (i) Employer O establishes a nonqualified deferred 
compensation plan for Employee B. Under the plan, if Employee B 
survives until age 65, he has a fully vested right to receive a lump 
sum payment at that age, equal to the product of 10 percent per year 
of service and Employee B's highest average annual compensation for 
any 3-year period, but no benefits are payable in the event Employee 
B dies prior to age 65. 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, 2002, Employee B has 25 years of service and Employee 
B's high 3-year average compensation is $100,000 (the average for 
the years 2000 through 2002). As of December 31, 2002, 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, 
2003, Employee B is age 63, has 26 years of service, and has high 3-
year average compensation of $104,000. As of December 31, 2003, 
Employee B 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 
2003, Employee B has earned 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 2003 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 2003 is 
the present value, as of December 31, 2003, 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 2003 and paying the 
additional FICA tax.

[[Page 4557]]

    (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 payment 
earned during 2003 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 constitutes 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 10. (i) The facts are the same as in Example 9, 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 2 percent for each year 
of service and Employee B's highest average annual compensation for 
any 3-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, 2002, 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, 
2003, 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 2003, 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 2003 is $32,935, which 
is the present value, as of December 31, 2003, of these additional 
payments, determined using the same actuarial assumptions and 
methods used in Example 9, except that there is no discount for the 
probability of death prior to age 65. Employer O takes this amount 
into account by including it in Employee B's FICA wages for 2003 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 payments 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, each annual payment of 
$4,080 attributable to the amount deferred in 2003 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 11. (i) The facts are the same as in Example 10, except 
that no amount is taken into account for 2003 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 benefit 
payments 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 payments will be included in wages when actually or 
constructively paid, in accordance with the general timing rule.
    Example 12. (i) Employer P establishes an account balance plan 
on January 1, 2002, under which all benefits are 100 percent vested. 
The plan provides that amounts deferred will be credited annually 
with interest beginning in 2002 at a rate that is greater than a 
reasonable rate of interest. Employer P treats the excess over the 
applicable interest rate in section 417(e) as an additional amount 
deferred for 2002 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) Under the nonduplication rule in paragraph (a)(2)(iii) of 
this section, the benefits paid under the plan will be excluded from 
wages for FICA tax purposes.
    Example 13. (i) The facts are the same as in Example 9, except 
that, in determining the amount deferred, Employer O uses a 15 
percent interest rate, which, solely for purposes of this example, 
is assumed not to be a reasonable interest rate. Employer O 
determines that the amount deferred for 2003 is the present value, 
as of December 31, 2003, of the $20,400 payment, which is $15,023. 
Employer O includes $15,023 in wages and pays any resulting FICA 
tax. Solely for purposes of this example, it is assumed that the AFR 
as of January 1, 2003, 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 taken 
into account for 2003 is $1,199 in 2004 and $1,313 in 2005. 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 benefit payments 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 and 
the 417(e) mortality table. These 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 10, except 
that Employer O calculates the amount deferred for 2003 as $18,252 
and takes that amount into account by including that 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 benefit payments, 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. Solely for purposes of this example, it is 
assumed that the AFR as of January 1, 2003, 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 income attributable to the 
$18,252 amount taken into account for 2003 is $1,278 in 2004 and 
$1,367 in 2005. Under paragraph (d)(1)(ii)(B) of this section, the 
portion of each 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 
divided by $40,283, or .51875. Thus, $2,116 (.51875  x  $4,080) of 
each year's benefit payment is excluded from

[[Page 4558]]

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 benefit payments 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 and 
the 417(e) mortality table. These 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 $35,185, 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 required to be 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 tax 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 tax 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 tax purposes as of the date the material terms of the plan are 
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--(A) Date required to be taken 
into account. 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 required to be taken into account as of the 
resolution date is determined in accordance with paragraph (c)(2) of 
this section.
    (B) Definition of reasonably ascertainable. For purposes of this 
paragraph (e)(4), an amount deferred is considered reasonably 
ascertainable on the first date on which the amount, form, and 
commencement date of the benefit payments attributable to the amount 
deferred are known, and the only actuarial or other assumptions 
regarding future events or circumstances needed to determine the amount 
deferred are interest and mortality. For this purpose, the form and 
commencement date of the benefit payments attributable to the amount 
deferred are treated as known if the requirements of paragraph 
(c)(2)(iii)(B) of this section (under which payments are treated as 
being made in the normal form of benefit commencing at normal 
commencement date) are satisfied. In addition, an amount deferred does 
not fail to be reasonably ascertainable on a date merely because the 
exact amount of the benefit payable cannot readily be calculated on 
that date or merely because the exact amount of the benefit payable 
depends on future changes in the cost of living. If the exact amount of 
the benefit payable depends on future changes in the cost of living, 
the amount deferred must be determined using a reasonable assumption as 
to the future changes in the cost of living. For example, the amount of 
a benefit is treated as known even if the exact amount of the benefit 
payable cannot be determined until future changes in the cost of living 
are reflected in the section 415 limitation on benefits payable under a 
qualified retirement plan.
    (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 any date or dates (an 
early inclusion date or dates) before the resolution date (but not 
before the date described in paragraph (e)(1) of this section with 
respect to the amount deferred). Thus, for example, with respect to an 
amount deferred under a nonaccount balance plan that is not reasonably 
ascertainable because the plan permits employees to receive their 
benefits in more than one form or commencing at more than one date (and 
the requirements of paragraph (c)(2)(iii) of this section are not 
satisfied), an employer may choose to take an amount into account on 
the date otherwise described in paragraph (e)(1) of this section before 
the form and commencement date are selected (based on assumptions as to 
the form and commencement date for the benefit payments) or may choose 
to wait until the form and commencement date of the benefit payments 
are selected. An employer that chooses to take an amount into account 
at an early inclusion date under this paragraph (e)(4)(ii) for an 
employee under a plan is not required until the resolution date to 
identify the period to which the amount taken into account relates.
    (B) True-up at resolution date. If, with respect to an amount 
deferred for a period, an employer chooses to take an amount into 
account as of an early inclusion date in accordance with this paragraph 
(e)(4)(ii) and the benefit payments attributable to the amount deferred 
exceed the benefit payments that are actuarially equivalent to the 
amount taken into account at the early inclusion date (payable in the 
same form and using the same commencement date as the benefit payments 
attributable to the amount deferred), then the present value of the 
difference in the benefits, determined in accordance with paragraph 
(c)(2) of this section, must be taken into account as of the resolution 
date.
    (C) Actuarial assumptions. For purposes of determining the benefits 
that are actuarially equivalent to the amount taken into account as of 
an early inclusion date, the amount taken into account is converted to 
an actuarially equivalent benefit payable in the same form and 
commencing on the same date as the actual benefit payments attributable 
to the amount deferred using an interest rate, and, if applicable, 
mortality and cost-of-living assumptions, that were reasonable as of 
the early inclusion date. Thus, with respect to an amount deferred for 
a

[[Page 4559]]

period, the amount required to be taken into account as of the 
resolution date is the present value (determined using an interest 
rate, and, if applicable, mortality and cost-of-living assumptions, 
that are reasonable as of the resolution date) of the excess, if any, 
of the future benefit payments attributable to the amount deferred over 
the future benefits payable in the same form and commencing on the same 
date that are actuarially equivalent to the portion of the amount 
deferred that was taken into account as of the early inclusion date 
(where actuarial equivalence is determined using an interest rate, and, 
if applicable, mortality and cost-of-living assumptions, that were 
reasonable as of the early inclusion date).
    (D) Allocation rules for amounts deferred over more than one 
period--(1) General rule. The rules of this paragraph (e)(4)(ii)(D) 
apply for purposes of determining whether an amount has been included 
under this paragraph (e)(4) before the earliest date permitted under 
paragraph (e)(1) of this section.
    (2) Future compensation increases. Increases in an employee's 
compensation after the early inclusion date must be disregarded.
    (3) Early retirement subsidies. An early retirement subsidy that 
the employee ultimately receives may be taken into account at an early 
inclusion date if the employee would have a legally binding right to 
the subsidy at the early inclusion date but for any condition that the 
employee continue to render services. Accordingly, an employer may take 
into account at an early inclusion date any early retirement subsidy 
that the employee ultimately receives to the extent that elimination or 
reduction of that subsidy would violate section 411(d)(6)(B)(i) if that 
section applied to the plan.
    (4) Allocation with respect to offsets. In any case in which a 
series of amounts are deferred over more than one period, the amounts 
deferred are not reasonably ascertainable until a single resolution 
date and the benefit payments attributable to the entire series are 
determined under a formula that provides a gross benefit that in the 
aggregate is subject to an objective reduction for future events under 
the terms of the plan, such as an offset for the aggregate benefits 
payable under a plan qualified under section 401(a), the attribution of 
benefit payments to the amount deferred in each period is determined 
under the rules of this paragraph (e)(4)(ii)(D)(4). In a case described 
in the preceding sentence, the benefit payments made as a result of the 
series of amounts deferred may be treated as attributable to the amount 
deferred as of the earliest period in which the employee obtained a 
legally binding right to a benefit under the plan equal to the excess, 
if any, of the amount of the gross benefit attributable to that period 
(determined at the resolution date), over the amount of the reduction 
determined as of the end of that period. Thus, for example, if an 
employee obtains a legally binding right in each of several years to 
benefit payments from a nonqualified deferred compensation plan that 
provides for a specified gross benefit for the years to be offset by 
the benefits payable under a qualified plan, the amount deferred in the 
first year may be treated as equal to the gross benefit for the year, 
reduced by the offset applicable at the end of the year (even if the 
offset increases after the end of the year).
    (E) 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 (or is paid before the 
date selected under paragraph (e)(5) of this section), and the employer 
has previously taken an amount into account with respect to the amount 
deferred under the early inclusion rule of this paragraph (e)(4), 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 benefit payment attributable to the amount taken into 
account. Under this first-in-first-out rule, the benefit payment is 
compared to the sum of the amount taken into account at the early 
inclusion date and the income attributable to that amount. If the 
benefit payment equals or exceeds the amount taken into account at the 
early inclusion date and the income attributable to that amount as of 
the date of the benefit payment, the benefit payment is included as 
wages under the general timing rule of paragraph (a)(1) of this section 
to the extent of any excess, and the amount taken into account at the 
early inclusion date (and income attributable to that amount) is 
disregarded thereafter with respect to the amount deferred. If the 
amount taken into account at the early inclusion date and the income 
attributable to that amount as of the date of the benefit payment 
exceeds the benefit payment, the benefit payment is not included as 
wages under the general timing rule of paragraph (a)(1) of this section 
and, in determining the amount that must be taken into account 
thereafter with respect to the amount deferred, the amount taken into 
account at the early inclusion date, plus attributable income as of the 
date of the benefit payment, is reduced by the amount of the benefit 
payment, and only the excess plus future income attributable to the 
excess (credited using assumptions that were reasonable on the early 
inclusion date) is taken into consideration. If amounts have been taken 
into account at more than one early inclusion date, this paragraph 
(e)(4)(ii)(E) applies on a first-in-first-out basis, beginning with the 
amount taken into account at the earliest early inclusion date 
(including income attributable thereto).
    (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 
the 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 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. If an employer uses 
the rule of administrative convenience described in this paragraph 
(e)(5), any determination of whether the income attributable to an 
amount deferred under an account balance plan is based on a reasonable 
rate of interest or whether the actuarial assumptions used to determine 
the present value of an amount deferred in a nonaccount balance plan 
are reasonable will be made as of the date the employer selects to take 
the amount into account.
    (6) Portions of an amount deferred required to be taken into 
account on more than one date. If different portions of an amount 
deferred are required to be taken into account under paragraph (e)(1) 
of this section on more than one date (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) is illustrated by the following 
examples:

    Example 1. (i) Employer M establishes a nonqualified deferred 
compensation plan for Employee A on November 1, 2005. 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 2006, the principal amount credited 
to

[[Page 4560]]

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, 2006, 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, 2006, 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 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, 2011.
    (iii) December 31, 2011, 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, 2006, plus the interest credited with respect to that 
principal amount through December 31, 2011) must be taken into 
account as of December 31, 2011.
    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 attributable interest) becomes nonforfeitable 
according to a graded vesting schedule under which 20 percent is 
vested as of December 31, 2007; 40 percent is vested as of December 
31, 2008; 60 percent is vested as of December 31, 2009; 80 percent 
is vested as of December 31, 2010; and 100 percent is vested as of 
December 31, 2011. Because these dates are later than the date on 
which the services creating the right to the amount deferred are 
considered performed (December 31, 2006), 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 on more than one 
date, 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, 2007, is taken 
into account as an amount deferred on December 31, 2007; $5,000 of 
the principal amount, plus interest credited through December 31, 
2008, is taken into account as a separate amount deferred on 
December 31, 2008; etc.
    Example 4. (i) On November 21, 2001, 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 amount, form, and commencement date of the 
benefit are known, and 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 on November 21, 2001.
    Example 5. (i) The facts are the same as in Example 4, except 
that plan provides that the lump sum will be paid at the later of 
age 65 or termination of employment and provides that the $500,000 
payable to Employee B is increased by 5 percent per year for each 
year that payment is deferred beyond age 65.
    (ii) Because the commencement date of the benefit payment is 
contingent on when Employee B terminates employment, the 
commencement date of the benefit payment is not known. Thus, the 
amount deferred is not reasonably ascertainable within the meaning 
of paragraph (e)(4)(i) of this section, unless the plan satisfies 
the requirements of paragraph (c)(2)(iii)(B) of this section. 
Because the fixed 5 percent factor may not be reasonable at the time 
benefit payments commence (i.e., 5 percent might be higher or lower 
than a reasonable interest rate when payments commence), the plan 
fails to satisfy paragraph (c)(2)(iii)(B) of this section and 
accordingly the amount deferred is not reasonably ascertainable 
until termination of employment.
    Example 6. (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 commencement date of the benefit payment is 
contingent on when Employee B terminates employment, the 
commencement date of the benefit payment is not known. Thus, the 
amount deferred is not reasonably ascertainable until termination of 
employment.
    Example 7. (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).
    (ii) Because the plan permits employees to elect to receive 
benefits in more than one form and the alternative forms may not 
have the same value when Employee B makes his election, the plan 
fails to satisfy the requirements of paragraph (c)(2)(iii)(B) of 
this section until a form of benefit is selected. Thus, the amount 
deferred is not reasonably ascertainable until then.
    Example 8. (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 life annuity payable monthly, 
beginning at age 65, equal to the excess of 3 percent of Employee 
C's final 3-year average pay for each year of participation up to 15 
years, over the amount payable to Employee C from Employer O's 
qualified pension plan. The amount payable under the qualified 
pension plan is a life annuity payable monthly, beginning at age 65, 
equal to 1.5 percent of final 3-year average pay for each year of 
employment, excluding pay in excess of the section 401(a)(17) 
compensation limit. No benefits are payable under the SERP if 
Employee C dies before age 65. Employee C becomes a participant in 
the SERP on January 1, 2001, at age 44. The amount deferred under 
the SERP for any year is not reasonably ascertainable prior to 
termination of employment because the amount of the benefit is not 
known and the determination of the amount deferred requires 
assumptions other than interest and mortality (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 when he is age 62.
    (ii) As of the date Employee C terminates employment, the amount 
of the benefit is known and the only actuarial or other assumptions 
needed to determine the amount deferred are an interest rate 
assumption and a 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 beginning 
in 2021 when Employee C is age 65. 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 a 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 
December 31, 2018. The special timing rule will be satisfied if the 
resulting present value, $26,950, is taken into account on that date 
in accordance with paragraph (d)(1) of this section.
    Example 9. (i) The facts are the same as in Example 8, except 
that the plan provides that Employee C may choose to receive early 
retirement benefits on an unreduced basis at any time after age 60 
if Employee C has completed 15 years of service by that date.
    (ii) As of the date Employee C terminates employment, the amount 
of the benefit is known and the only actuarial or other assumptions 
needed to determine the amount deferred are an interest rate 
assumption and a 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 beginning 
on

[[Page 4561]]

December 31, 2018 when Employee C is age 62. 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 a 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 December 31, 2018. The special timing rule will be 
satisfied if the resulting present value, $37,576, is taken into 
account on that date in accordance with paragraph (d)(1) of this 
section.
    Example 10. (i) The facts are the same as in Example 9, 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 2001 is reasonably ascertainable. The amount that 
Employer O takes into account on December 31, 2001, is $13,043 (the 
present value of a life annuity of $4,000 per year, payable at age 
62, using a 6 percent interest rate and the UP-84 mortality table). 
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 must determine any additional amount required to be taken 
into account in 2018. If the $4,000 payable in the form of a life 
annuity beginning at age 62 exceeds the life annuity which is 
actuarially equivalent to the $13,043 previously taken into account, 
the present value of the excess must be taken into account. In this 
Example 10, the $13,043 previously taken into account is actuarially 
equivalent to a $4,000 annuity commencing at age 62 using a 6 
percent interest rate and the UP-84 mortality table ( which, solely 
for purposes of this example, are assumed to be reasonable actuarial 
assumptions for December 31, 2001). Accordingly, no additional 
amount need be taken into account in 2018, regardless of any changes 
in market rates of interest between 2001 and 2018.
    Example 11. (i) The facts are the same as in Example 9, 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 2001 is reasonably ascertainable. The amount that 
Employer O takes into account on December 31, 2001, is $9,569 (the 
present value of a life annuity of $4,000 per year, payable at age 
65, using a 6 percent interest rate and the UP-84 mortality table). 
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 must determine any additional amount required to be taken 
into account in 2018. If the $4,000 payable in the form of a life 
annuity beginning in 2018 at age 62 exceeds the life annuity which 
is actuarially equivalent to the $9,569 previously taken into 
account, the present value of the excess must be taken into account. 
In this case, the $9,569 previously taken into account is 
actuarially equivalent to a $2,935 annuity commencing at age 62 
using a 6 percent interest rate and the UP-84 mortality table 
(which, solely for purposes of this example, are assumed to be 
reasonable actuarial assumptions for December 31, 2001). 
Accordingly, an additional amount needs to be taken into account in 
2018 equal to the present value of the excess of the $4,000 annual 
stream of benefit payments to which Employee C obtained a legally 
binding right during 2001 over the $2,935 annual stream of benefit 
payments which is actuarially equivalent to the amount previously 
taken into account. This present value (i.e., the present value of a 
life annuity equal to $4,000 minus $2,935, or $1,065 annually) is 
determined by Employer O to be $10,005 as of the resolution date 
using a 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 December 31, 2018).
    Example 12. (i) The facts are the same as in Example 9, except 
that the amount that Employer O takes into account on December 31, 
2001, is $15,834 (the present value of $4,000, payable at age 60, 
using a 6 percent interest rate and the UP-84 mortality table). 
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 must determine any additional amount required to be taken 
into account in 2018. If the $4,000 payable in the form of a life 
annuity beginning at age 62 exceeds the life annuity which is 
actuarially equivalent to the $15,834 previously taken into account, 
the present value of the excess must be taken into account. In this 
case, the $15,834 previously taken into account is actuarially 
equivalent to a $4,856 annuity commencing at age 62 using a 6 
percent interest rate and the UP-84 mortality table (which, solely 
for purposes of this example, are assumed to be reasonable actuarial 
assumptions for December 31, 2001). Because the life annuity of 
$4,856 per year (which is equivalent to the amount taken into 
account at the early inclusion date) exceeds the $4,000 annuity 
attributable to the amount deferred in 2001, no additional amount is 
required to be taken into account for that amount deferred 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, 6413, and 6511.
    Example 13. (i) The facts are the same as in Example 12, except 
that Employee C became a participant in the SERP on January 1, 2000. 
In addition, Employer O determines in 2018 that during 2000 Employee 
C earned a legally binding right to a life annuity of $1,500 per 
year beginning on December 31, 2018.
    (ii) Employer O may allocate the $15,834 previously taken into 
account among any amounts deferred on or before the early inclusion 
date. At the resolution date, Employer O will have to take into 
account the present value of an annuity equal to the excess of the 
life annuity attributable to the amounts deferred for 2000 and 2001 
over a life annuity of $4,856 per year.
    Example 14. (i) In 2003, 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 2004, Employee D will have a nonforfeitable right to receive 1 
percent per year of Employer P's net profits associated with Project 
X for each of the immediately succeeding three years. No services 
beyond 2004 are required. The 1 percent of net profits payable 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 
2005, $400,000 in 2006, and $90,000 in 2007. Employee D receives 
$750,000 on March 31, 2006, $400,000 on March 31, 2007, and $90,000 
on March 31, 2008.
    (ii) Because the services creating the right to all of the 
amount deferred are performed in 2004, the benefit payments based on 
the 2005, 2006, and 2007 net profits are all attributable to the 
amount deferred in 2004. However, because the present value of 
Employee 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, all of the 
amount deferred in 2004 will not be reasonably ascertainable within 
the meaning of paragraph (e)(4)(i) of this section until December 
31, 2007 (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) However, paragraph (d)(1)(ii)(A) of this section provides 
that a benefit payment attributable to an amount deferred under a 
nonqualified deferred compensation plan must be included as wages 
when actually or constructively paid if the amount deferred has not 
been taken into account as wages under the special timing rule of 
paragraph (a)(2) of this section. Thus, the benefit payments in 2006 
and 2007 must be included as wages when paid.
    (iv) As of December 31, 2007, all of the amount deferred under 
the plan becomes reasonably ascertainable because the amount of the 
benefit payable attributable to the amount deferred is treated as 
known under paragraph (e)(4)(i)(B) of this section, and the only 
assumption needed to determine the present value of the future 
benefits is interest. However, since Employer P was required to 
treat the payments in 2006 and 2007 as wages when paid under the 
general timing rule of paragraph (a)(1) of this section, only the 
present value of the payment to be made in 2008 is required to be 
taken into account as of the resolution date (December 31, 2007) 
under the special timing rule of paragraph (a)(2) of this section. 
Using an interest rate of 10 percent per year (which, solely for 
purposes of this Example 14, is assumed to be reasonable), Employer 
P determines that on December 31, 2007, the present value of the 
future benefits is $87,881, and Employer P includes that additional 
amount in wages for 2007. (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 no later than March 31, 2008, provided that the amount 
deferred is increased by interest using the AFR for January of 
2008.)
    Example 15. (i) The facts are the same as in Example 14, except 
that Employer P

[[Page 4562]]

chooses the early inclusion option permitted by paragraph (e)(4)(ii) 
of this section to take $1,000,000 into account on December 31, 
2004, before the amount deferred for 2004 is reasonably 
ascertainable.
    (ii) Pursuant to paragraph (e)(4)(ii)(E) 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 
benefit payments 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, 2006, and 
the March 31, 2007, benefit payment of $400,000 are less than the 
$1,000,000 taken into account at the early inclusion date, plus 
attributable income, and, therefore, are not included in wages when 
paid.
    (iii) Under paragraph (e)(4)(ii)(E) 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) is disregarded to the extent the amount 
is attributed to benefit payments made before the resolution date. 
Thus, Employer P must reduce the $1,000,000 taken into account in 
2004 (plus income attributable to that amount) based upon the two 
benefit payments ($750,000 and $400,000) that were excluded from 
wages. Using an interest rate of 10 percent, Employer P determines 
that the amount taken into account in 2004 plus interest to the 
resolution date and reduced based upon the two benefit payments is 
$15,228 and the additional amount that is required to be taken into 
account as of December 31, 2007, is $72,653 ($87,881-$15,228).
    Example 16. (i) Employee E obtains a fully vested, legally 
binding right during 2002, 2003, and 2004 to payments from a 
nonqualified deferred compensation plan of Employer Q under which 
the benefits are based on a formula that includes an actuarial 
offset by the account balance under a qualified defined contribution 
plan of Employer Q as of December 31, 2004. The payments from the 
nonqualified deferred compensation plan are to commence on December 
31, 2005. At the resolution date for the amounts earned during 2002, 
2003, and 2004, which is December 31, 2004, Employee E has a legally 
binding right to a net annual benefit of $100,000 payable for life 
to commence on December 31, 2005. On the resolution date, Employer Q 
determines that on December 31, 2002, Employee E had a legally 
binding right to receive $100,000 annually for life beginning on 
December 31, 2005 (as a result of the gross benefit under the 
nonqualified plan being $120,000 annually for life, and the offset 
being $20,000 annually for life, as of December 31, 2002). On 
December 31, 2003, Employee E had a legally binding right to receive 
$95,000 annually for life beginning on December 31, 2005 (as a 
result of the gross benefit under the nonqualified plan being 
$135,000 annually for life, and the offset being $40,000 annually 
for life, as of December 31, 2003). On December 31, 2004, Employee E 
had a legally binding right to receive $100,000 annually for life 
beginning on December 31, 2005 (as a result of the gross benefit 
under the nonqualified plan being $145,000 annually for life, and 
the offset being $45,000 annually for life, as of December 31, 
2004).
    (ii) In this case, pursuant to paragraph (e)(4)(ii)(D)(4) of 
this section, Employer Q can attribute the entire $100,000 life 
annuity to the amount deferred for 2002, even though Employee E's 
benefit under the nonqualified deferred compensation plan is reduced 
to $95,000 in 2003.
    Example 17. (i) In 2010, Employee F performs services for which 
she earns a right to 10 percent of the proceeds from the sale of a 
motion picture. In 2011, Employee F performs services for which she 
earns a right to 10 percent of the proceeds from the sale of another 
motion picture. These proceeds are calculated by subtracting the 
total advertising expenses for both movies. Payment is to be made in 
the year following the date on which both pictures have been sold, 
but not later than 2018. At the end of 2010, the advertising 
expenses for both pictures totaled $300,000. The first motion 
picture is sold for $10,000,000 in 2014. The second motion picture 
is sold for $17,000,000 in 2017. At the end of 2017, the advertising 
expenses totaled $1,700,000. In 2018, Employee F is paid $2,530,000 
(10 percent of the sum of $10,000,000 and $17,000,000 minus 
$1,700,000).
    (ii) Pursuant to paragraph (e)(4)(ii)(D)(4) of this section, 
$970,000 (10 percent of the excess of the gross proceeds from the 
sale of the first motion picture at the resolution date in 2017 over 
the advertising expenses incurred at the end of 2010) of the payment 
made in 2018 can be attributed to the amount deferred in 2010 (and 
with the remaining payment of $1,560,000 to be attributed to the 
amount deferred in 2011).

    (f) Withholding--(1) In general. Unless an employer applies an 
alternative method described in paragraph (f)(2) or (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. However, paragraphs (f)(2) and (3) of 
this section provide alternative methods which may be used with respect 
to an amount deferred for an employee. An employer is not required to 
be consistent in applying the alternatives described in this paragraph 
(f) with respect to different employees or amounts deferred.
    (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 on the date on which the amount is 
taken into account in accordance with paragraph (e) of this section and 
take that estimated amount into account as wages paid by the employer 
and received by the employee on that date (the estimate date), for 
purposes of withholding and depositing FICA tax.
    (ii) Underestimate of the amount deferred--(A) General rule. If the 
employer underestimates the amount deferred (as determined after 
calculating the actual amount deferred that should have been taken into 
account as of the date on which the amount was taken into account in 
accordance with paragraph (e) of this section, using an interest rate 
and other actuarial assumptions that are reasonable as of that date), 
the employer may treat the shortfall as wages paid as of the estimate 
date or as of any date that is no later than three months after the 
estimate date. In either case, the shortfall does not include the 
income credited to the amount deferred after the amount is taken into 
account in accordance with paragraph (e) of this section.
    (B) Shortfall is treated as wages paid on a date after the estimate 
date. If the employer chooses to treat the shortfall as wages paid on a 
date that is no later than three months after the estimate date, the 
employer must take that shortfall into account as wages paid by the 
employer and received by the employee on that date, for purposes of 
withholding and depositing FICA tax.
    (C) Shortfall is treated as wages paid on the estimate date. If the 
employer chooses to treat the shortfall as wages paid as of the 
estimate date, the shortfall is treated as an error for purposes of 
withholding and depositing FICA tax. Appropriate adjustments may be 
made in accordance with section 6205(a) and the regulations thereunder; 
however, for purposes of Sec. 31.6205-1(b), the error need not be 
treated as ascertained before the date that is three months after the 
estimate date.
    (D) Reporting. The employer must report the shortfall as wages on 
Form 941, Employer's Quarterly Federal Tax Return (and, if applicable, 
Form 941c, Supporting Statement to Correct Information) and Form W-2, 
Wage and Tax Statement (or, if applicable, Form W-2c, Corrected Wage 
and Tax Statement) in accordance with its treatment of the shortfall 
under paragraph (f)(2)(ii) (B) or (C) of this section.
    (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 date on which the amount was taken into account in accordance with 
paragraph (e) of this section, using an interest rate and actuarial 
assumptions that are reasonable as of that date) and deposits

[[Page 4563]]

more than the amount required, the employer may claim a refund or 
credit in accordance with sections 6402, 6413, and 6511. A Form 941c, 
or an equivalent statement, must accompany each claim for refund. In 
addition, Form W-2 or, if applicable, Form W-2c must also reflect the 
actual amount deferred that should have been taken into account.
    (3) Lag method. Under the alternative method provided in this 
paragraph (f)(3), an amount deferred, plus interest, may be treated as 
wages paid by the employer and received by the employee, for purposes 
of withholding and depositing FICA tax, on any date that is no later 
than three months after the date the amount is required to be taken 
into account in accordance with paragraph (e) of this section. For 
purposes of this paragraph (f)(3), the amount deferred must be 
increased by interest through the date on which the wages are treated 
as paid, at a rate that is not less than AFR. If the employer withholds 
and deposits FICA tax in accordance with this paragraph (f)(3), the 
employer will be treated as having taken into account the amount 
deferred plus income to the date on which the wages are treated as 
paid.
    (4) Examples. This paragraph (f) is 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 2003, and 
thus the amount deferred, is reasonably ascertainable, but Employer 
M calculates the amount deferred on March 3, 2004, when the relevant 
data is available.
    (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, 2003, 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. In January of 
2004, Employer M files and furnishes Form W-2 for Employee A 
including the $20,000 in FICA wages. On March 3, 2004, Employer M 
determines that the actual amount deferred that should have been 
taken into account on December 31, 2003, 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 on 
December 31, 2003, the estimate date. Employer M may treat the 
$2,000 shortfall as an error ascertained on March 3, 2004, and 
withhold and deposit FICA tax on that amount. Form W-2c for Employee 
A for 2003 must include the $2,000 shortfall in FICA wages. Employer 
M must also correct the information on Form 941 for the last quarter 
of 2003, reporting the adjustment on Form 941 for the first quarter 
of 2004, accompanied by Form 941c for the last quarter of 2003.
    (iv) Instead, Employer M may treat the $2,000 shortfall as wages 
paid on March 31, 2004, and withhold and deposit FICA tax on that 
amount as if it were wages paid by Employer M and received by 
Employee A on that date. Form W-2 for Employee A for 2004 and Form 
941 for the first quarter of 2004 must include the $2,000 shortfall 
in FICA wages.
    Example 2. (i) The facts are the same as in Example 1, except 
that on March 3, 2004, Employer M determines that the actual amount 
deferred that should have been taken into account on December 31, 
2003, was $19,000.
    (ii) Under paragraph (f)(2)(iii) of this section, Employer M 
may, in accordance with sections 6402, 6413, and 6511, claim a 
refund or credit for the overpayment of tax resulting from the 
overestimate. In addition, Employer M must file and furnish a Form 
W-2c for Employee A and must correct the information on Form 941 for 
the last quarter of 2003.
    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, 2003. 
Instead, Employer M withholds and deposits FICA tax on the amount 
deferred plus interest on that amount using AFR (for January 2004) 
as if it were wages paid by Employer M and received by Employee A on 
March 15, 2004.
    (ii) Under the alternative method described in paragraph (f)(3) 
of this section, the amount taken into account on March 15, 2004 
(including the interest), will be treated as FICA wages paid to and 
received by Employee A on March 15, 2004.
    Example 4. (i) The facts are the same as in Example 1, except 
that an amount is also deferred for Employee B which is required to 
be taken into account on October 15, 2003, and Employer M chooses to 
use the lag method in paragraph (f)(3) of this section in order to 
provide time to calculate the amount deferred.
    (ii) Employer M may use any date not later than January 15, 
2004, to take the amount deferred into account (provided that the 
amount deferred includes interest, at AFR for January 1, 2003, 
through December 31, 2003, and at AFR for January 1, 2004, through 
January 15, 2004).

    (g) Effective date and transition rules--(1) General effective 
date. Except for paragraphs (g)(2) through (4) of this section, this 
section is applicable on and after January 1, 2000. Thus, paragraphs 
(a) through (f) of this section apply to amounts deferred on or after 
January 1, 2000; to amounts deferred before January 1, 2000, which 
cease to be subject to a substantial risk of forfeiture on or after 
January 1, 2000, or for which a resolution date occurs on or after 
January 1, 2000; and to benefits actually or constructively paid on or 
after January 1, 2000.
    (2) Reasonable, good faith interpretation for amounts deferred and 
benefits paid before January 1, 2000--(i) In general. For periods 
before January 1, 2000 (including amounts deferred before January 1, 
2000, and any benefits actually or constructively paid before January 
1, 2000, that are attributable to those amounts deferred), an employer 
may rely on a reasonable, good faith interpretation of section 
3121(v)(2), taking into account pre-existing guidance. 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 the employer has complied with 
paragraphs (a) through (f) of this section. For purposes of paragraphs 
(g)(2) through (4) of this section, and subject to paragraphs 
(g)(2)(ii) and (iii) of this section, whether an employer that has not 
complied with paragraphs (a) through (f) of this section has determined 
FICA tax liability and satisfied FICA withholding requirements in 
accordance with 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 and 
the extent to which the employer has resolved unclear issues in its 
favor.
    (ii) Plan must be established or adopted. If an amount is deferred 
under a plan before January 1, 2000, and benefit payments attributable 
to that amount are actually or constructively paid on or after January 
1, 2000, then in no event will an employer's treatment of the amount 
deferred be considered to be in accordance with a reasonable, good 
faith interpretation of section 3121(v)(2) if the employer treats that 
amount as taken into account as wages for FICA tax 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 establishment of the plan as amended to provide for the deferred 
compensation, as provided in paragraph (b)(2)(ii) of this section). If 
an amount is deferred under a plan before January 1, 2000, and benefit 
payments attributable to that amount are actually or constructively 
paid before January 1, 2000, then in no event will the employer's 
treatment of that amount deferred be considered to be in accordance 
with a reasonable, good faith interpretation of section 3121(v)(2) if 
the employer treats that amount as taken into account as wages for FICA 
tax purposes prior to the adoption of the plan providing for the 
deferred

[[Page 4564]]

compensation (or, if later, the adoption of the plan amendment 
providing the deferred compensation). 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.
    (iii) Certain changes in position for stock options, stock 
appreciation rights, and other stock value rights not reasonable, good 
faith interpretation. In the case of a stock option, stock appreciation 
right, or other stock value right (as defined in paragraph (b)(4)(ii) 
of this section) that is exercised before January 1, 2000, an employer 
that treats the exercise as not subject to FICA tax as a result of the 
nonduplication rule of section 3121(v)(2)(B) is not acting in 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2) if the employer has not treated that grant and all earlier 
grants as subject to section 3121(v)(2) by reporting the current value 
of such options and rights as FICA wages on Form 941 filed for the 
quarter during which each grant was made (or, if later, for the quarter 
during which each grant ceased to be subject to a substantial risk of 
forfeiture).
    (3) Optional adjustments to conform with this section for pre-
effective-date open periods--(i) General rule. If an employer 
determined FICA tax liability with respect to section 3121(v)(2) in any 
period ending before January 1, 2000, for which the applicable period 
of limitations has not expired on January 1, 2000 (pre-effective-date 
open periods), in a manner that was not in accordance with this 
section, the employer may adjust its FICA tax determination for that 
period to conform to this section. Thus, if an amount deferred was 
taken into account in a pre-effective-date open period when it was not 
required to be taken into account (e.g., an amount taken into account 
before it became reasonably ascertainable), the employer may claim a 
refund or credit for any FICA tax paid on that amount to the extent 
permitted by sections 6402, 6413, and 6511.
    (ii) Consistency required. In the case of a plan that is not a 
nonqualified deferred compensation plan (within the meaning of 
paragraph (b)(1) of this section), if any payment was actually or 
constructively paid to an employee under the plan in a pre-effective-
date open period and that payment was not included in FICA wages by 
reason of the employer's treatment of the plan as a nonqualified 
deferred compensation plan, then the employer may claim a refund or 
credit for FICA tax paid on amounts treated as amounts deferred under 
the plan (in accordance with the employer's treatment of the plan as a 
nonqualified deferred compensation plan) for that employee for pre-
effective-date open periods only to the extent that the FICA tax paid 
on all amounts treated as amounts deferred for the employee in all pre-
effective-date open periods under the plan exceeds the FICA tax that 
would have been due on the benefits actually or constructively paid to 
the employee in those periods under the plan if those benefits were 
included in FICA wages when paid. If any benefit payments attributable 
to amounts deferred after December 31, 1993, were actually or 
constructively paid to an employee under a nonqualified deferred 
compensation plan (within the meaning of paragraph (b)(1) of this 
section) in a pre-effective-date open period, but these payments were 
treated as subject to FICA tax because the employer treated the plan as 
not being a nonqualified deferred compensation plan, then the employer 
may claim a refund or credit for the FICA tax paid on those benefit 
payments only to the extent that the FICA tax paid on those benefit 
payments exceeds the FICA tax that would have been due on the amounts 
deferred to which those benefit payments are attributable if those 
amounts deferred had been taken into account when they would have been 
required to have been taken into account under this section (if this 
section had been in effect then).
    (iii) Reporting. Any employer that adjusts its FICA tax 
determination in accordance with paragraphs (g)(3)(i) and (ii) of this 
section must make appropriate adjustments on Form 941 and Form 941c for 
the affected periods, and, in addition, must file and furnish Form W-2, 
or, if applicable, Form W-2c, for any affected employee so that the 
Social Security Administration may correctly post the amount deferred 
to the employee's earnings record. The adjustments may be made in 
accordance with section 6205(a) and the regulations thereunder; 
however, for purposes of Sec. 31.6205-1(b), the error is not required 
to be treated as ascertained before March 31, 2000.
    (4) Application of reasonable, good faith standard--(i) 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 ending prior to January 1, 2000, and, 
pursuant to a reasonable, good faith interpretation of section 
3121(v)(2), 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)(2) of this section, the following rules shall apply--
    (A) With respect to benefit payments actually or constructively 
paid before January 1, 2000, that are attributable to amounts 
previously taken into account under the plan, no additional FICA tax 
will be due;
    (B) On or after January 1, 2000, benefit payments 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
    (C) To the extent permitted by paragraph (g)(3) of this section, 
the employer may claim a refund or credit for FICA tax actually paid on 
amounts taken into account prior to January 1, 2000.
    (ii) Plans that are subject to section 3121(v)(2) for which the 
amount deferred has not been fully taken into account--(A) In general. 
The rules of paragraphs (g)(4)(ii)(B) through (E) of this section apply 
if a plan is a nonqualified deferred compensation plan (within the 
meaning of paragraph (b)(1) of this section) and, with respect to an 
amount deferred under the plan for an employee prior to January 1, 
2000, the employer, in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2), either took into account an 
amount that is less than the amount that would have been required to be 
taken into account if paragraphs (a) through (f) of this section had 
been in effect for that period or took no amount into account. Thus, 
paragraphs (g)(4)(ii)(B) through (E) of this section apply both to an 
employer that treated the plan as if it were not a nonqualified 
deferred compensation plan within the meaning of section 3121(v)(2) (by 
withholding and paying FICA tax due on benefits actually or 
constructively paid under the plan during that period, if any) and to 
an employer that treated the plan as a nonqualified deferred 
compensation plan within the meaning of section 3121(v)(2).
    (B) No additional tax required. Pursuant to paragraph (g)(2) of 
this section, no additional FICA tax will be due for any period ending 
prior to January 1, 2000.
    (C) General timing rule applicable. In accordance with paragraph 
(d)(1)(ii) of this section, except as provided in paragraphs (g)(4)(ii) 
(D) and (E), the general timing rule described in paragraph (a)(1) of 
this section applies to benefits actually or constructively paid on or 
after January 1, 2000, attributable to an amount deferred in a period 
before January 1, 2000, to the

[[Page 4565]]

extent the amount taken into account was less than the amount that 
would have been required to be taken into account if paragraphs (a) 
through (f) of this section had been in effect before January 1, 2000.
    (D) Special rule for amounts deferred before 1994. The difference 
between the amount that was taken into account in any period ending 
prior to January 1, 1994, and the amount that would have been required 
or permitted to be taken into account in that period if paragraphs (a) 
through (f) of this section had been in effect is treated as if it had 
been taken into account within the meaning of paragraph (d)(1) of this 
section. For example, in the case of an amount deferred before 1994 
that was not reasonably ascertainable (and which was not subject to a 
substantial risk of forfeiture), the employer is treated as if it had 
anticipated the actual amount, form, and commencement date for the 
benefit payments attributable to the amount deferred and had taken the 
amount deferred into account at an early inclusion date before 1994 
using a method permitted under this section. Thus, 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 due when the benefit 
payments attributable to the amount deferred are actually or 
constructively paid.
    (E) Special rule for amounts required to be taken into account in 
1994 or 1995. In the case of an amount deferred that would have been 
required to be taken into account in 1994 or 1995 if paragraphs (a) 
through (f) of this section had been in effect, an employer will be 
treated as taking the amount deferred into account under paragraph 
(d)(1) of this section to the extent the employer takes the amount into 
account by treating it as wages paid by the employer and received by 
the employee as of any date prior to April 1, 2000.
    (iii) Plans that are subject to section 3121(v)(2) for which more 
than the amount deferred has been taken into account. If a plan is a 
nonqualified deferred compensation plan (within the meaning of 
paragraph (b)(1) of this section) and an amount was taken into account 
under the plan for an employee before January 1, 2000, in accordance 
with a reasonable, good faith interpretation of section 3121(v)(2), but 
that amount could not have been taken into account before January 1, 
2000, if paragraphs (a) through (f) of this section had been in effect 
then, the following rules apply--
    (A) The determination of the amount deferred for any period 
beginning on or after January 1, 2000, must be made in accordance with 
paragraph (c) of this section, and the time when amounts deferred under 
the plan are required to be taken into account must be determined in 
accordance with paragraph (e) of this section, without regard to any 
such amount that was taken into account for any period ending before 
January 1, 2000; and
    (B) To the extent permitted by sections 6402, 6413, and 6511, the 
employer may claim a refund or credit for an overpayment of tax caused 
by the overinclusion of wages that occurred before January 1, 2000.
    (5) Examples. This paragraph (g) is illustrated by the following 
examples:

    Example 1. (i) In 1996, 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 1996 and 1997, 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 1996 is $50,000 and the amount deferred for 1997 is 
$55,000. In 1996 and 1997, Employee A's total wages (without regard 
to the amounts deferred) exceed the OASDI wage bases. Employer M 
withholds and deposits HI tax on the $50,000 and $55,000 amounts. 
Employee A does not retire before January 1, 2000. Employer M 
chooses under paragraph (g)(3) of this section to apply this section 
to 1996 and 1997 before the January 1, 2000, general effective date.
    (ii) Under this section, the amounts deferred in 1996 and 1997 
are not reasonably ascertainable (within the meaning of paragraph 
(e)(4)(i) of this section) before January 1, 2000. Thus, as long as 
the applicable period of limitations has not expired for the periods 
in 1996 and 1997, Employer M may, to the extent permitted under 
paragraph (g)(3) of this section, apply for a refund or credit for 
the HI tax paid on the amounts deferred for 1996 and 1997 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 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)(2)(ii) of this section, if all amounts 
are deferred and all benefits are paid under a plan before January 
1, 2000, 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 tax 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. As a result, the payment made to Employee B in 1996 was 
subject to both the OASDI and HI portions of FICA tax when paid.
    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 10 
years beginning on January 1, 2000. 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 from 
January 1, 1994, through December 31, 1999, as amounts deferred and, 
in accordance with a reasonable, good faith interpretation of 
section 3121(v)(2), takes those amounts deferred into account as 
wages for FICA tax purposes as of those dates. The bonus plan is set 
forth in writing on May 1, 1999, and, thus, is treated as 
established as of January 1, 1994.
    (ii) Under paragraph (g)(2)(ii) of this section, if an amount is 
deferred before January 1, 2000, and the attributable benefit is 
paid on or after January 1, 2000, then in no event will an 
employer's treatment of the amount deferred under a plan be 
considered to be in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2) if the employer treats the 
amount deferred as taken into account as wages for FICA tax 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 
for unwritten plans in paragraph (b)(2)(iii) of this section), and 
because Employer O, in accordance with a reasonable, good faith 
interpretation of section 3121(v)(2), took amounts deferred into 
account in 1994 through 1999, the amounts paid to Employee C 
attributable to those amounts deferred will not be subject to FICA 
tax when paid.
    Example 4. (i) In 1985, Employer P establishes a compensation 
arrangement for Employee D that provides for a lump sum

[[Page 4566]]

payment to be made after termination of employment but the 
arrangement is not a nonqualified deferred compensation plan (within 
the meaning of paragraph (b)(1) of this section). However, prior to 
January 1, 2000, 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). Employer P determines that Employee D's total 
wages (without regard to the amount deferred) for each year from 
1985 through 1993 exceed the applicable OASDI and HI wage bases 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 $50,000 
payment in 1995 as wages for FICA tax purposes in that year.
    (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 rules provided in paragraph (g)(4)(i) of this section 
apply. Thus, no additional FICA tax will be due on the benefits paid 
in 1995.
    (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 
to the extent permitted under sections 6402, 6413, and 6511--but 
only to the extent that $290 exceeds the FICA tax that would have 
been due on the $50,000 payment in 1995 if that payment had been 
subject to FICA tax when paid (i.e., if paragraphs (a) through (f) 
of this section 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 consistency rule of paragraph (g)(3)(ii) 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.
    (v) However, if the benefit payment is instead actually or 
constructively paid on or after January 1, 2000, the benefit payment 
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 (and paragraph (g)(4)(i)(B) of this section).
    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 January 1, 2000, 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 
Employee E retires at the end of 1996 and benefit payments under the 
arrangement begin in 1997, Employer Q withholds and deposits FICA 
tax on the amounts paid to Employee E. Payments under the 
arrangement continue on or after January 1, 2000. Employer Q does 
not choose (under paragraph (g)(3) of this section) to adjust its 
FICA tax determination for a pre-effective-date open period by 
treating this section as in effect for all amounts deferred and 
benefits actually or constructively paid for any such period. The 
periods in 1994 and 1995 are not pre-effective-date open periods for 
Employer Q.
    (ii) Under paragraph (g)(4)(ii) of this section, for purposes of 
determining whether benefits actually or constructively paid on or 
after January 1, 2000, 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 before 1994 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, benefit payments 
attributable to an amount that has been so treated as taken into 
account is not treated as wages for FICA tax purposes at any later 
time (such as upon payment).
    (iii) Because Employer Q does not adjust its FICA tax 
determination by treating this section as in effect for all amounts 
deferred for periods ending after December 31, 1993, any benefit 
payments attributable to amounts deferred in periods ending after 
December 31, 1993, 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)(3) of this 
section) to adjust its FICA tax determination for all pre-effective-
date open periods by treating this section as in effect for all 
amounts deferred for those periods. In addition, Employer Q chooses 
(in accordance with paragraph (g)(4)(ii)(E) of this section) to take 
the amounts deferred for 1994 and 1995 into account by treating 
these amounts as FICA wages paid and received by Employee E on 
January 15, 2000.
    (ii) In accordance with the nonduplication rule of paragraph 
(a)(2)(iii) of this section, because all amounts deferred for 
Employee E under the plan were taken into account (or treated as 
taken into account), any benefit payments made to Employee E under 
the plan will not be included as FICA 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 before January 1, 2000.
    (ii) Because Employer Q did not withhold and deposit the FICA 
tax due on benefits actually or constructively paid before January 
1, 2000, Employer Q did not determine FICA tax liability and satisfy 
FICA tax withholding requirements in accordance with a reasonable, 
good faith interpretation of section 3121(v)(2). Thus, the 
transition rules provided in paragraphs (g)(3) and (4) of this 
section do not apply. As a result, any amount that would have been 
required to have been taken into account under this section before 
1994 is not treated as if it had been so taken into account under 
paragraph (g)(4)(ii)(D) of this section, and benefit payments 
attributable to amounts deferred before January 1, 2000, 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 under which Employee F 
will have a fully vested right to receive a lump sum payment in 2000 
equal to 50 percent of Employee F's highest rate of salary. On 
December 31, 1993, Employee F's highest salary is $1 million. In 
accordance with a reasonable, good faith interpretation of section 
3121(v)(2), Employer R determines that, for 1993, there is an amount 
deferred that must be taken into account as wages for FICA tax 
purposes. Based Employer R's estimate that Employee F's highest 
salary will be $3 million in 2000, Employer R determines that the 
amount deferred is equal to the present value in 1993 of $1.5 
million payable in 2000. 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 paid as a result of that amount 
deferred being taken into account for 1993. In addition, Employer R 
takes no amounts into account under the plan after 1993 for Employee 
F. Under paragraphs (e)(1) and (4)(ii)(D)(2) of this section, the 
largest amount that could have been taken into account in 1993 is 
the present value of a lump sum payment of $500,000, payable in 
2000, because that is the maximum amount to which Employee R has a 
legally binding right as of December 31, 1993. Employee F's highest 
salary is, in fact, $3 million in 2000 and Employee F receives $1.5 
million under the plan on December 31, 2000.
    (ii) In accordance with paragraphs (g)(1) and (4)(iii)(A) of 
this section, the determination of the amount deferred under the 
plan for any period beginning on or after January 1, 2000, and the 
time when that amount deferred is required to be taken into account 
must be determined in accordance with this section. In addition, 
these determinations must be made without regard to any amount 
deferred that was taken into account for any period ending before 
January 1, 2000, that could not be taken into account before January 
1, 2000, if paragraphs (a) through (f) of this section had been in 
effect. Because no FICA tax was actually paid on

[[Page 4567]]

that $1 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 (even assuming that the period of limitations 
has been kept open for periods in 1993). In addition, because the 
difference between the present value of the $1.5 million payment and 
the present value of a $500,000 payment was not taken into account 
for periods beginning on or after January 1, 1994, $1 million must 
be included in FICA wages under the general timing rule when paid.


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

    (a) General statutory 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), (a)(3), and (a)(13) by the 
Social Security Amendments of 1983 (Pub. L. 98-21, 97 Stat. 65), as 
amended by section 2662(f)(2) of the Deficit Reduction Act of 1984 
(Pub. L. 98-369, 98 Stat. 494), apply to amounts deferred and benefits 
paid after December 31, 1983.
    (b) Definitions. For purposes of Sec. 31.3121(v)(2)-1 and this 
section, the following definitions apply:
    (1) FICA. FICA means the Federal Insurance Contributions Act (26 
U.S.C. 3101 et seq.).
    (2) 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) applies.
    (3) Gap agreement. Gap agreement means an agreement adopted after 
March 24, 1983, and on or before December 31, 1983, between an 
individual and a nonqualified deferred compensation plan within the 
meaning of Sec. 31.3121(v)(2)-1(b). Such an agreement does not fail to 
be a gap agreement merely because the terms of the plan are changed 
after December 31,1983.
    (4) Individual party to a gap agreement. Individual party to a gap 
agreement means an individual who was eligible to participate in a gap 
agreement on December 31, 1983, under the terms of the agreement on 
that date. An individual will be treated as an individual party to a 
gap agreement even if the individual has not accrued any benefits under 
the plan by December 31, 1983, and regardless of whether the individual 
has taken any specific action to become a party to the agreement. 
However, an individual who becomes eligible to participate in a gap 
agreement after December 31, 1983, is not an individual party to a gap 
agreement.
    (5) Individual party to a March 24, 1983 agreement. Individual 
party to a March 24, 1983 agreement means an individual who was 
eligible to participate in a March 24, 1983 agreement under the terms 
of the agreement on March 24, 1983. An individual will be treated as an 
individual party to a March 24, 1983 agreement even if the individual 
has not accrued any benefits under the plan by March 24, 1983, and 
regardless of whether the individual has taken any specific action to 
become a party to the agreement. However, an individual who becomes 
eligible to participate in a March 24, 1983 agreement after March 24, 
1983, is not an individual party to a March 24, 1983 agreement.
    (6) 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)(2)-1(b). Such an agreement does not fail to be a March 
24, 1983 agreement merely because the terms of the plan are changed 
after March 24, 1983. In addition, for purposes of this paragraph 
(b)(6) only, any plan (or agreement) that provides for payments that 
qualify for one of the retirement payment exclusions is treated as a 
nonqualified deferred compensation plan. For example, 
Sec. 31.3121(v)(2)-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.
    (7) Retirement payment exclusions. Retirement payment exclusions 
are the exclusions from wages (for FICA tax purposes) for retirement 
payments under section 3121(a)(2)(A), (a)(3), and (a)(13)(A)(iii), as 
in effect on April 19, 1983 (the day before enactment of the Social 
Security Amendments of 1983).
    (8) Transition benefits. Transition benefits are payments made 
after December 31, 1983, attributable to services rendered before 
January 1, 1984. For this purpose, transition benefits are determined 
without regard to any changes made in the terms of the plan after March 
24, 1983, in the case of a March 24, 1983 agreement or after December 
31, 1983, in the case of a gap agreement.
    (c) Transition rules--(1) In general. Except as provided in 
paragraph (c)(2) or (3) of this section, the general statutory 
effective date described in paragraph (a) of this section applies to 
benefit payments after December 31, 1983. Thus, except as provided in 
paragraph (c)(2) or (3) of this section, section 3121(v)(2) applies, 
and the retirement payment exclusions do not apply, to benefit payments 
made after December 31, 1983, even if the benefit payments are made 
under a March 24, 1983 agreement or a gap agreement.
    (2) Transition benefits under a March 24, 1983 agreement. With 
respect to an individual party to a March 24, 1983 agreement, 
transition benefits paid under that March 24, 1983 agreement (except 
for those paid under a 457(a) plan) are not subject to the special 
timing rule of section 3121(v)(2) and are 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) to an 
individual party to a March 24, 1983 agreement 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. With respect to an 
individual party to a gap agreement, the payor of transition benefits 
under the 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)(2)-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 statutory 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, benefit payments 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 2 percent of high 3-year average compensation multiplied by 
years of service, and the employee retires after 25 years of service, 9 
of which are before 1984, the employer may determine that 9/25 of the 
total benefit payments 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

[[Page 4568]]

nonqualified deferred compensation plan constitutes transition 
benefits, then, for purposes of determining the portion of each benefit 
payment that constitutes transition benefits, the employer must treat 
each benefit payment as consisting of transition benefits in the same 
proportion as the transition benefits that have not been paid (as of 
January 1, 2000) bear to total benefits that have not been paid (as of 
January 1, 2000), unless such allocation is inconsistent with the terms 
of the plan. However, for a benefit payment made before January 1, 
2000, the employer may use any reasonable allocation method to 
determine the portion of a payment that consists of transition 
benefits, provided that the allocation method is consistent with the 
terms of the plan.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 4. In Sec. 602.101, paragraph (c) is amended by adding the 
following entry in the table in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
                                                                Current
                                                                  OMB
     CFR part or section where identified and described         control
                                                                  No.
------------------------------------------------------------------------
 
                *         *         *         *         *
31.3121(v)(2)-1.............................................   1545-1643
 
                *         *         *         *         *
------------------------------------------------------------------------

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.

    Approved: December 23, 1998.

Donald C. Lubick,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 99-1663 Filed 1-28-99; 8:45 am]
BILLING CODE 4830-01-P