Excluding Phantom Stock Distributions

[Below Ground]

Client uses a "Phantom Stock Program".  This type of program does not involve an actual exchange of equity, but does result in periodic payments which coordinate with actual dividends paid to actual stock holders.  These payment are processed through payroll, and are shown on W-2 as taxable income (payroll taxation does apply).  These monies are only paid to a select group of HCE.  The question is, can these monies be excluded for purposes of 401(k) Safe Harbor Match calculations?  Finally, would such exclusion violate the requirement to use Total Compensation under a 401(k) Safe Harbor Plan?

[C. B. Zeller]

You can always exclude any portion of compensation for HCEs and still have a safe harbor definition of compensation. That said, this this phantom stock plan sounds like a nonqualified deferred compensation plan. Here is what 1.415(c)-2(c) says:

Quote

 

(c) Items not includible as compensation. The term compensation does not include—

(1) Contributions (other than elective contributions described in section 402(e)(3), section 408(k)(6), section 408(p)(2)(A)(i), or section 457(b)) made by the employer to a plan of deferred compensation (including a simplified employee pension described in section 408(k) or a simple retirement account described in section 408(p), and whether or not qualified) to the extent that the contributions are not includible in the gross income of the employee for the taxable year in which contributed. In addition, any distributions from a plan of deferred compensation (whether or not qualified) are not considered as compensation for section 415 purposes, regardless of whether such amounts are includible in the gross income of the employee when distributed. However, if the plan so provides, any amounts received by an employee pursuant to a nonqualified unfunded deferred compensation plan are permitted to be considered as compensation for section 415 purposes in the year the amounts are actually received, but only to the extent such amounts are includible in the employee's gross income.

 

 

[Below Ground]

Thanks Mr. Zeller.

[Luke Bailey]

On ‎8‎/‎21‎/‎2020 at 3:29 PM, C. B. Zeller said:

In addition, any distributions from a plan of deferred compensation (whether or not qualified) are not considered as compensation for section 415 purposes, regardless of whether such amounts are includible in the gross income of the employee when distributed. However, if the plan so provides, any amounts received by an employee pursuant to a nonqualified unfunded deferred compensation plan are permitted to be considered as compensation for section 415 purposes in the year the amounts are actually received, but only to the extent such amounts are includible in the employee's gross income.

C.B. Zeller, I have always found these two sentences confusing. The first sentence excludes qualified and nonqualified, but of course qualified plan distributions are not 415 comp. But then the next sentence says you can include nonqualified deferred comp when it is received, which is directly opposite to what the part of the first sentence that applies to nonqualified deferred comp says, and then says, but only if included in income, which is close to saying , "only if you comply with the federal income tax law", and "only if the plan so provides." Just horrible drafting, I think.

If the plan uses a W-2-based safe harbor definition,  the plan will so provide. So it's really the equivalent of saying nonqualified deferred comp is includible when distributed, unless specifically excluded by the plan document.  If you are using the classic safe harbor, which the language you quoted is part of, I think, then it is probably excluded, but if you are using W-2 based safe harbor, it is almost certainly included. There is a separate timing rule, which you have not quoted, i.e. the deferred comp that is included must be includable whether or not the employee has terminated employment, i.e., it must be deferred comp that pays out on a fixed date or upon a performance goal, which would likely be the case for phantom stock or units, and not deferred comp the distribution event for which is separation from service.

[C. B. Zeller]

Good point Luke. The W-2 safe harbor definition includes wages as defined in 3401(a), and 3401(a)(23) explicitly includes amounts includible in income due to 409A.

[EBECatty]

2 hours ago, C. B. Zeller said:

Good point Luke. The W-2 safe harbor definition includes wages as defined in 3401(a), and 3401(a)(23) explicitly includes amounts includible in income due to 409A.

Generally this language means an amount includible in income due to a violation of 409A. An amount is includible under 409A only if there is a violation. See 409A(a)(1). That said, any amount paid out under a NQDC plan to which 409A applies will generally be wages anyway, but not under the provision following (23). 

[BG5150]

3 hours ago, C. B. Zeller said:

Good point Luke. The W-2 safe harbor definition includes wages as defined in 3401(a), and 3401(a)(23) explicitly includes amounts includible in income due to 409A.

The EOB Compensation grid says NQ Plan Distributions are included in W2 and Withholding Wages, but NOT 415 (and simplified 415) comp, unless the plan says otherwise.

[Luke Bailey]

15 minutes ago, BG5150 said:

The EOB Compensation grid says NQ Plan Distributions are included in W2 and Withholding Wages, but NOT 415 (and simplified 415) comp, unless the plan says otherwise.

BG5150, right. But my point, with which I think C.B. Zeller is tending to agree, is that if you use a W-2 safe harbor for 415, your plan does "say otherwise."