Nonqualified deferred compensation
Nonqualified deferred compensation (NQDC) is pay you promise to deliver in a later year under an agreement outside the qualified retirement plan rules.
Payroll treats the promise and the payment as two separate events. Social Security and Medicare tax can apply when the amount vests, often years before any money moves. Income tax withholding generally waits for the distribution. A nonduplication rule keeps the later distribution from counting again for Social Security and Medicare. A nonqualified plan is an unsecured promise, can be offered to selected executives only, and leaves the balance exposed to your creditors.
When does payroll tax and report the deferral?
Two clocks run on a nonqualified deferral, and payroll has to track both. Missing the vesting-year calculation is the common payroll error. The correction reaches back into a closed quarter, not the quarter that writes the check. Payments to a former employee still go on a Form W-2Form W-2. Form W-2 is the annual wage and tax statement you give employees and file with the Social Security Administration, reporting wages paid and taxes withheld.Click to open the term when the underlying relationship was employment. Payments to a non-employee follow the Form 1099 path. Confirm the timing for a specific plan against current IRS guidance and the plan documents.
| EVENT | TAX | FORM W-2 |
|---|---|---|
| Services performed or forfeiture risk lapses, whichever is later | Social Security and Medicare, under the special timing rule | Boxes 3 and 5, even when boxes 1 and 16 show nothing extra |
| Distribution | Federal income tax withholding, generally | Box 1, and box 11 unless box 3 or 5 also reports deferrals that year |
| Amounts that fail the section 409A requirements on elections, distribution timing, or funding | Includible in income immediately, plus an additional tax on the employee | Box 12, code Z |
- 26 CFR §31.3121(v)(2)-1, Treatment of amounts deferred under certain nonqualified deferred compensation plans
- General Instructions for Forms W-2 and W-3 (2026)
General information, not legal or tax advice. Apply current federal and state rules with qualified guidance.