Non-Qualified Deferral Compensation (NQDC)
Explore non-qualified deferred compensation (NQDC) plans to maximize tax deferral for high earners.
Overview
Non-qualified deferred compensation (NQDC) plans are agreements between an employer and an employee to defer some part of an employee’s earnings to a future date (typically after they retire or leave the company), with the goal of deferring income tax.
Unlike qualified plans such as 401(k)s, which have limits on how much income can be deferred in a calendar year, NQDCs do not have such limits, and are hence a common tax tool for high earners to set aside more income above the 401(k) ceiling. However, they are additionally subject to a number of restrictions and rules set out by the IRS in Section 409A.
Most notably NQDCs must remain “unfunded”, in that the employer does not set aside the deferred compensation in a protected account. Instead, those funds remain on the employer’s books, and are exposed to the general risks of the business. In other words, there is a risk the employee will not attain those funds if the employer ends up in financial trouble.
In addition, 409A specifies other rules, such as the employer’s election to defer their compensation must be made in the prior calendar year. E.g., an individual cannot decide to change their NQDC mid-year just before their Christmas bonus - the election has to have been determined in the prior calendar year.
Taxability and Reporting
The taxability of employee and employer match contributions to NQDCs works like so:
- Contributions are not taxable for FIT and SITs at the time of deferral; they only become taxable when they are distributed.
- Contributions are taxable for FICA and FUTA at the time of deferral. However, for some NQDC plans, the employee’s right to access the deferred compensation is subject to a vesting schedule or certain performance conditions, and in these situations, FICA and FUTA taxes are only subject when these requirements have been met (i.e., when the employee is no longer subject to a “risk of forfeiture”).
For reporting, NQDC contributions and distributions get reported in the following places:
- W-2 Box 11: Report either distributions from NQDC plans OR vesting of prior year deferrals.
- If an employee has both distributions and vesting of prior year deferrals, they also must file Form SSA-131.
- W-2 Box 12 Code Y: Deferrals to NQDC plans. Per the IRS instructions, this is optional.
- W-2 Box 12 Code Z: If the NQDC plan fails to satisfy Section 409A, then all deferred compensation in the plan should be reported here and included in Box 1 as taxable income.
- 1099-MISC Box 12: Also optional, just like W-2 Box 12 Code Y.
NQDCs in Check
NQDC contributions can be recorded in Check with the benefit type nqdc.
Check does not support NQDC plans with any of the following properties:
- NQDC plans with multi-year vesting schedules: Check does not support tax calculations nor reporting requirements for NQDC plans with employer contributions that vest over a multi-year period. These contributions are subject to FICA and FUTA at the time of vesting, and must be reported in W-2 Box 11.
- NQDC distributions: Check does not support tax calculations nor reporting requirements for NQDC distributions. This usually only happens when the EE retires or leaves the company.
- NQDC plans that fails to meet Section 409A: Check does not support the tax calculation nor reporting requirements for NQDC plans that fails to meet Section 409A. If a NQDC plan fails to meet Section 409A, deferred compensation must be taxed for FIT and reported in Box 12 Code Z.
Last updated on September 22, 2025