A deferred compensation tax strategy lets an executive move income into a later year, but only if the plan follows the rules. Break them and the tax bill can be worse than if you'd never deferred. Here's what Section 409A requires and how to plan around it.

How does deferred compensation reduce taxes?

It delays when you receive and report income, so you can spread it across years instead of stacking it on top of a high-income year. The catch is Section 409A: if a plan fails its requirements, an additional tax of 20 percent of the compensation required to be included in income applies, plus interest.

The interest is calculated at the underpayment rate plus one percentage point, back to when the compensation was first deferred. Here is a made-up example, not a client result. An executive defers $100,000 and the plan fails. The $100,000 becomes taxable, the 20% add-on is $20,000, and interest is added on top of the regular tax.

When can you make the deferral election?

Generally before the year you earn the pay. The statute requires elections no later than the close of the preceding taxable year, with a 30-day window for someone newly eligible.

In a made-up example, an executive who wants to defer part of 2027 salary would generally elect by December 31, 2026. Waiting until the bonus is announced is usually too late.

When can deferred compensation be paid out?

Only on set events. Section 409A(a)(2)(A) permits distributions on separation from service, disability, death, a specified time or fixed schedule, a change in control, or an unforeseeable emergency.

Can you change the payout later?

Only under tight limits. A change to the time or form of payment generally requires at least 12 months before it takes effect and a further deferral of at least 5 years, with exceptions for death, disability and unforeseeable emergency.

Because of that, the payout schedule you choose at the start is the one you should expect to keep. Choose it with your expected future income in mind, since tax rates you'll face later are not known today.

What is the special rule for key employees?

For specified employees, distributions on separation from service can't occur until six months after separation. The statute defines a specified employee as a key employee of a corporation whose stock is publicly traded, so check whether it covers you.

What should you check before you sign?

The payout schedule, the trigger events, and how the plan interacts with your other income. We read the plan document as an attorney and model the tax as a CPA.

If the plan also touches your retirement accounts, see retirement tax planning strategies.

If you'd like to see how this applies to your situation, book your tax strategy call or call 702-852-2577. For how we approach the bigger picture, see our advanced tax strategies page.

---

About the author: D. Lenny Whiting, Esq., CPA, MS is the Managing Partner of CPA Attorney, LLC in Las Vegas. He is a Nevada attorney and a Nevada CPA. More about Lenny.

This article is general information, not legal or tax advice for your situation. Tax rules change, and results depend on your facts.

CPA Attorney, LLC, 10155 W. Twain Ave., Ste. 100, Las Vegas, NV 89147. Attorney responsible for this content: D. Lenny Whiting.