Social Security:

Taxing Nonqualified Deferred Compensation

HRD-90-82: Published: Mar 15, 1990. Publicly Released: Apr 16, 1990.

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Pursuant to a congressional request, GAO provided information on the origin, development, and impact of an amended Internal Revenue Code (IRC) provision that resulted in different social security tax treatments of: (1) employee income deferred through nonqualified plans; and (2) self-employed income deferred through contractual arrangements with customers.

GAO found that: (1) Congress enacted the provision to equalize the treatment of employee income deferred through qualified plans and the treatment of plans that did not meet IRC qualifications, also known as nonqualified plans; (2) limited reporting on nonqualified plans made it difficult to measure the provision's effect on social security tax revenues; and (3) the Internal Revenue Service believed that the broad definition of nonqualified plans made it difficult to distinguish the type of pay arrangements the provision covered. GAO also found that, under the amended IRC provision: (1) employees participating in nonqualified plans paid social security taxes on the deferred income in the year they earned the income; and (2) self-employed taxpayers who deferred income through contractual arrangements with their customers paid social security taxes on the deferred amount in the year they received the income. In addition, GAO found that: (1) the provision provided a tax advantage to employees earning above the maximum taxable amount for social security; (2) the provision could result in increased social security taxes for the self-employed, although it could help those who need additional quarters of coverage to be eligible for social security benefits; and (3) self-employed taxpayers did not make extensive use of contractual arrangements to defer income.

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