Nonqualified Deferred Compensation

Nonqualified Deferred Compensation

In the United States, the question whether any compensation plan is qualified or non-qualified is primarily a question of taxation under the Internal Revenue Code (IRC). Any business prefers to deduct its expenses from its income, which will reduce the income subject to taxation. Expenses which are deductible ("qualified") have satisfied tests required by the IRC. Expenses which do not satisfy those tests ("non-qualified") are not deductible; even though the business has spent the money, the amount of that expenditure remains as part of taxable income. In most situations, any business will attempt to satisfy the requirements so that its expenditures are deductible business expenses.

A non-qualified deferred compensation plan or agreement simply defers the payment of a portion of the employee’s compensation to a future date. The amounts are held back (deferred) while the employee is working for the company, and are paid out to the employee when he or she separates from service, becomes disabled, dies, etc. As will be discussed later, one of the keys in designing a non-qualified deferred compensation plan is making sure that the employee will not be required to pay income tax on those deferred amounts until the amounts are actually paid to the employee.